CFTC Adopts Final Business Conduct Standards For Swap Dealers And Major Swap Participants

Thursday, March 22, 2012 - 14:54

The Commodity Futures Trading Commission recently adopted final rules[1] regarding the business conduct standards with which swap dealers (“SDs”) and major swap participants (“MSPs”) must comply when entering into swaps with counterparties or advising clients regarding swaps.[2]

SDs and MSPs will need to comply with a broad variety of standards including anti-evasion and antifraud, screening of counterparties, particular disclosure requirements to counterparties and enhanced standards when dealing with “Special Entities.”[3]

The compliance date for the rules will be the later of 180 days after April 17, 2012 (the effective date of the rules) or the date on which SDs and MSPs are provisionally required to apply for registration with the CFTC.[4]

Compliance with a number of the final rules (or, as discussed below, satisfaction of certain safe harbors) by SDs and MSPs may be achieved by implementing written policies and procedures reasonably designed to comply with the applicable obligations and/or by obtaining specific representations from their counterparties. 

In anticipation of the approaching compliance dates and recognition of the need for written policies and procedures, entities that anticipate falling within the definition of SD or MSP must consider the steps necessary to prepare and implement such policies and procedures in order to be ready by the compliance dates.[5]  Examples of written policies and procedures that SDs and MSPs, as applicable, will be required to have in operation include policies and procedures reasonably designed to (i) prevent evasion of any provision of the Commodity Exchange Act (and the rules and regulations thereunder), (ii) prevent fraudulent, deceptive or manipulative business practices,[6] (iii) protect material confidential information and (iv) although not expressly stated, facilitate the preparation and distribution to counterparties of applicable disclosures regarding material risks of swaps, material characteristics of swaps, and conflicts of interest the SD or MSP may have.[7]

Even entities that will not fall within the definition of SD and MSP should be aware of the potential amendments to existing documentation and new documents necessitated by the new rules, since they will be asked to review and execute them.  In many instances the rules provide that an SD or MSP may amend existing “counterparty relationship documents” to include representations and certain disclosures that aid in satisfying certain of their obligations. Therefore, counterparties should understand the origins of what they are being asked to review as well as whether requests go beyond that which is required by the new rules.  An SD or MSP, as applicable, may rely on representations from its counterparties in certain instances “unless it has information that would cause a reasonable person to question the accuracy of the representation.”  Examples of representations from a counterparty on which an SD or MSP may rely include (i) representations to aid in compliance with “know your counterparty” rules pursuant to which an SD or MSP needs to obtain and retain a record of essential facts regarding the counterparty, (ii) representations to verify the status of a counterparty as an eligible contract participant and whether such counterparty is a Special Entity,[8] and (iii) representations from a counterparty that it is capable of independently evaluating the risks of the particular swap, or, in the case of a Special Entity, that it is being properly advised by someone other than the SD, to satisfy the SD’s compliance with rules regarding suitability requirements.[9]

In the Business Conduct Rules, the CFTC stated that it believes its compliance schedule will allow SDs and MSPs “to, among other things, implement appropriate policies and procedures, train relevant personnel, execute any necessary amendments to counterparty relationship documentation, receive any representations from counterparties and enable Special Entities to ensure that they have qualified independent representatives . . . .”[10]  The CFTC further stated that it was not persuaded by requests to phase in compliance with certain provisions based on the type of registered entity or asset class, but nevertheless had attempted to take steps to mitigate the costs and lower the burdens involved in complying. 

While the impact of (and costs involved in complying with) the CFTC’s final rules remains to be seen, one thing that is apparent is that parties need to focus on how most efficiently to implement the rules applicable to them.  This will entail adoption or alteration of written policies and procedures, obtaining needed representations from counterparties, and determining whether existing counterparty relationship documents need to be otherwise changed or supplemented.

[1] Business Conduct Standards for Swap Dealers and Major Swap Participants, 77 Fed. Reg. 9734 (Feb. 17, 2012) (to be codified at 17 C.F.R. pt. 4, 23) (“Business Conduct Rules”).

[2] Similar business conduct rules with which security-based swap dealers will have to comply when engaging in security-based swaps will be proposed by the Securities and Exchange Commission (the “SEC”).  At the time of this memo, final business conduct rules have not yet been proposed by the SEC.  Rules proposed by the SEC can be found at Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, 76 Fed. Reg. 42396 (July 18, 2012) (to be codified at 17 C.F.R. pt. 240).

[3]  “Special Entity” means:  “(1) A Federal agency; (2) A State, State agency, city, county, municipality, other political subdivision of a State, or any instrumentality, department, or a corporation of or established by a State or political subdivision of a State; (3) Any employee benefit plan subject to Title I of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1002); (4) Any governmental plan, as defined in Section 3 of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1002); (5) Any endowment, including an endowment that is an organization described in Section 501(c)(3) of the Internal Revenue Code of 1986 (26 U.S.C. 501(c)(3)); or (6) Any employee benefit plan defined in Section 3 of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1002), not otherwise defined as a Special Entity, that elects to be a Special Entity by notifying a swap dealer or major swap participant of its election prior to entering into a swap with the particular swap dealer or major swap participant.”  Id. at 9822-23.

[4] The date on which SDs and MSPs are required to apply for registration is set forth in the final rules set forth in the Registration of Swap Dealers and Major Swap Participants, 77 Fed. Reg. 2613, 2626
(Jan. 19, 2012) (to be codified at 17 C.F.R. pt. 1, 3, 23, 170) (“Registration Release”). 
Rule 3.10(a)(v)(C)(2) states:  “By no later than the latest effective date of the Swap Definitional Regulations [which includes the definition of swap dealer and major swap participant], each person who is a swap dealer or major swap participant on that date must apply to be registered as a swap dealer or major swap participant, as the case may be.”  Pursuant to Rule 3.2, provisional registration will be effective upon filing the required forms with the National Futures Association (the “NFA”). At the time of this memo, the final rules further defining swap, swap dealer and major swap participant had not yet been released.

[5] The Business Conduct Rules are not the only rules that will require policies and procedures.  For example, in connection with the Registration Release, SDs and MSPs will need to consider implementing policies and procedures for monitoring associated persons who might be subject to statutory disqualification.  In connection with the final rules regarding reporting and recordkeeping for swaps, SDs and MSPs will need to consider implementing policies and procedures for reporting swaps to a swap data repository.  Swap Data Recordkeeping and Reporting Requirements, 77 Fed. Reg. 2136 (Jan. 13, 2012).

[6] Rule 23.410(a)-(b) (further providing factors for an affirmative defense)

[7] SDs and MSPs may also comply with their obligation to provide certain of these disclosures by including them in counterparty relationship documents at the outset of the creation of a trading relationship.

[8] Rule 23.430 (providing, as a safe harbor, that an SD or MSP will have a reasonable basis for relying on written representations for purposes of this section if the representations contain certain specified details). Id. at 9824.

[9] Rule 23.434(b)-(c) (providing a safe harbor if, among other factors, the SD or MSP receives representations from its counterparty (other than a counterparty that is also a Special Entity) that it “has complied in good faith with written policies and procedures that are reasonably designed to ensure that the person responsible for evaluating the recommendation and making trading decisions on behalf of the counterparty are capable of doing so” and that in the case of a Specialty Entity other factors are satisfied). Id. at 9825.

[10]  Id. at 9803.


Rita M. Molesworth is a Partner in the Asset Management Group and Jack I. Habert is Of Counsel in the Corporate and Financial Services Department. 

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