CFTC and SEC Adopt New Rules Further Defining “Swap
Dealer” and “Security-based Swap Dealer”
May 2, 2012
The U.S. Commodity Futures Trading Commission (the “CFTC”) and U.S. Securities Exchange
Commission (the “SEC” and, together with the CFTC, the “Commissions”) recently jointly
adopted final rules regarding the criteria for a person to be considered a “Swap Dealer” or“Security-Based Swap Dealer” under Title VII of the Dodd-Frank Wall Street Reform andConsumer Protection Act (the “Dodd-Frank Act”).1 A person who is a Swap Dealer or SecurityBased Swap Dealer generally must register with the CFTC or SEC, respectively, and will be
subject to regulation on matters including capital and margin requirements, business conduct,
reporting and recordkeeping, and position limits monitoring, among other provisions.2
The CFTC has responsibility for determinations regarding status as a Swap Dealer and the SEC
has responsibility for determinations regarding status as a Security-Based Swap Dealer. The
joint rulemaking lays out closely similar analyses, though some differences do apply (asdiscussed further below). The new rules and the adopting release for these rules (the“Adopting Release”) generally establish a functional analysis that focuses on the nature andextent of a person’s activities, in light of all relevant facts and circumstances. The rules also
provide exceptions for certain swaps and security-based swaps that will be excluded from thedetermination of Swap Dealer or Security-Based Swap Dealer status, establish de minimis
notional volume thresholds below which a person will not be considered a Swap Dealer or
Security-Based Swap Dealer, and provide a process by which a person designated as a Swap
Dealer or Security-Based Swap Dealer may apply for the CFTC or SEC to limit such designation
only to certain activities, business lines, or types of swaps or security-based swaps.

1 The CFTC rules will be codified at 17 C.F.R. § 1.3(ggg) and the SEC rules at 17 C.F.R. § 240.3a71-1, 3a71-

2, and 3a71-2A.
2 E.g., capital and margin requirements (Commodity Exchange Act (“CEA”) § 4s(e), Securities Exchange

Act of 1934 (“Exchange Act”) § 15F(e)); requirements for segregation of collateral (CEA §§ 4d(f), 4s(l);Exchange Act § 3E); requirements with respect to business conduct when transacting with special
entities (CEA § 4s(h); Exchange Act § 15F(h)); disclosure requirements (CEA § 4s(h)(3)(B); Exchange Act§ 15F(h)(3)(B)); requirements relating to communications (CEA § 4s(h)(3)(D); Exchange Act §15F(h)(3)(C)); conflict of interest provisions (CEA § 4s(j)(5); Exchange Act § 15F(j)(5)); reporting andrecordkeeping requirements (CEA §§ 4s(f), 4s(g); Exchange Act § 15F(f)); regulatory standards related tothe confirmation, processing, netting, documentation, and valuation of swaps and security-based swaps(CEA § 4s(i); Exchange Act § 15F(i)); position limit monitoring requirements (CEA § 4s(j)(1); Exchange
Act § 15F(j)(l)); risk management procedure requirements (CEA § 4s(j)(2); Exchange Act § 15F(j)(2)); andrequirements related to the disclosure of information to regulators (CEA § 4s(j)(3); Exchange Act §15F(j)(3)).

Memorandum – May 2, 2012

The rules will be codified 60 days following publication in the Federal Register, but will not takeeffect until the Commissions act to finalize the definitions of “swap” and “security-based swap”
and such definitions become effective.3 Additionally, once the rules take effect, a phase-in
period will apply to the de minimis exception thresholds, described further in Section IV below.

I.

DEFINITIONS OF SWAP DEALER AND SECURITY-BASED SWAP DEALER

The rules closely follow the statute in defining a Swap Dealer and Security-Based Swap Dealer
as a person who:
(1)
(2)
(3)
(4)

holds itself out as a dealer in swaps or security-based swaps;
makes a market in swaps or security-based swaps;
regularly enters into swaps or security-based swaps with counterparties as an
ordinary course of business for its own account; orengages in any activity causing the person to be commonly known in the trade asa dealer or market maker in swaps or security-based swaps.4

The rules provide that the Swap Dealer or Security-Based Swap Dealer determination should
not take into account swaps or security-based swaps that are entered into “not as part of aregular business” or that fall within other enumerated exceptions (as discussed in more detail in
Section III below).5
A person meets the definition of “Swap Dealer” or “Security-Based Swap Dealer” by engaging
in non-exempted swap or security-based swap dealing activities (i.e., activities that fall within
the four prongs of the definition of “Swap Dealer” or “Security-Based Swap Dealer”) relating toa notional amount of swaps or security-based swaps above any applicable de minimis thresholdlevel. If a person’s swap dealing activities exceed an applicable de minimis threshold, it mustregister with the CFTC as a Swap Dealer, and if a person’s security-based swap dealing
activities exceed an applicable de minimis threshold, it must register with the SEC as a SecurityBased Swap Dealer. When the person registers or following registration, it may apply to limit
its designation as a Swap Dealer or Security-Based Swap Dealer to specified categories of swaps
or security-based swaps or specified activities in connection with swaps or security-based
swaps.
The Commissions declined to incorporate categorical exclusions for certain types of persons,such as employee benefit plans or agricultural cooperatives; rather, the analysis depends onwhether a person engages in certain types of swap or security-based swap activities involving
swaps or security-based swaps not covered by an exclusion.6

3 See CFTC Final Order regarding Effective Date for Swap Regulation, 76 Fed. Reg. 42508 (July 19, 2011),

as amended by 76 Fed. Reg. 80233 (Dec. 23, 2011).
4 See CFTC Regulation § 1.3(ggg)(1) and Exchange Act Rule 3a71-1(a).
5 See CFTC Regulation §§ 1.3(ggg)(2), 1.3(ggg)(5), and 1.3(ggg)(6); Exchange Act Rule 3a71-1(b) and 3a71-

1(d).
6 See Adopting Release, pp. 97-98.

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Memorandum – May 2, 2012II.

INTERPRETIVE GUIDANCEThe Adopting Release provides interpretive guidance for determining whether a person’s
activities bring it within the scope of the “Swap Dealer” or “Security-Based Swap Dealer”
definitions. The Commissions generally lay out similar interpretive principles, though they
organize them differently and note that each Commission’s analysis and application may differ
and will not necessarily bind the other. The Commissions also note that because of differencesin the uses and markets for different types of swaps and security-based swaps, the applicationof the interpretive principles may vary depending on the context.7
The SEC generally draws on its longstanding “dealer-trader distinction” to interpret thedefinition of “Security-Based Swap Dealer.” The CFTC, while looking to the dealer-trader
distinction by analogy to interpret the definition of “Swap Dealer,” further elaborates byoffering examples of activities that, in the context of the applicable facts and circumstances,
could constitute holding oneself out or being commonly known in the trade as a dealer inswaps or security-based swaps, market making, or engaging as swap dealing as “part of aregular business” (and therefore constitute swap dealing activities under the definition of“Swap Dealer”).
A.

Dealer-Trader Distinction

Both the SEC and CFTC draw by analogy on the “dealer-trader distinction,” which the SEC uses
as a basis for identifying which persons fall within the definition of “dealer” under the
Securities Exchange Act of 1934 (the “Exchange Act”), as opposed to ordinary, non-dealer
investors who buy and sell for their own accounts with some frequency.8 Under thisinterpretive principle, the Commissions look to policy objectives of the regulatory scheme
established by the Dodd-Frank Act that will govern Swap Dealers and Security-Based Swap
Dealers as a guide for determining the types of activities that bring a person within the scope ofsuch regulation.9
Based on this analysis, the Commissions identify several activities indicative of swap or
security-based swap dealing activity, as well as some additional interpretive principles,summarized in the tables below.10

7 See Adopting Release, p. 47.
8 See id. at 50-56, 83-93.
9 In particular, the Commissions identify three main policy objectives—(1) ensuring fulfillment offinancial responsibility associated with Swap Dealers’ and Security-Based Swap Dealers’ activities (e.g.,
the ability to satisfy obligations and the maintenance of counterparties’ funds and assets), (2) othercounterparty protections, and (3) promotion of market efficiency and transparency—to conclude thatthey should interpret the “Swap Dealer” and “Security-Based Swap Dealer” definitions to identify“those persons for which regulation is warranted either: (i) due to the nature of their interactions withcounterparties; or (ii) to promote market stability and transparency, in light of the role those persons
occupy within the swap and security-based swap markets.” Adopting Release, pp. 53-54, 87-88 (citing
provisions listed in note 2, supra).
10 See Adopting Release, pp. 54-55, 89-93.

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Memorandum – May 2, 2012

Dealer-Trader Distinction
Factors Indicative of Swap Dealing Activity

Factors Indicative of Security-Based Swap
Dealing Activity(1) Providing liquidity by accommodating
demand for or facilitating interest in swaps,
holding oneself out as willing to enter into
swaps (independent of whether another party
has already expressed interest), or being
known in the industry as being available toaccommodate demand for swaps(1) Providing liquidity to market professionals orother persons in connection with securitybased swaps (e.g., by accommodating demandor facilitating interest expressed by othermarket participants, or maintaining a sales
force in connection with security-based swaps)(2) Advising a counterparty as to how to use
swaps to meet the counterparty’s hedging
goals, or structuring swaps on behalf of acounterparty(2) Providing advice in connection with securitybased swaps or structuring security-based
swaps(3) Presence of regular clientele and actively
soliciting clients(3) Having a regular clientele and actively
advertising or soliciting clients in connection
with swaps(4) Acting as a market maker on an organized
security-based swap exchange or trading
system(4) Acting in a market maker capacity on anorganized exchange or trading system forswaps(5) Seeking to profit by providing liquidity inconnection with security-based swaps (e.g., byseeking a spread, fees, or other compensation
not attributable to changes in the value of the
security-based swap)(5) Helping to set the prices offered in the market(such as by acting as a market maker) rather
than taking those prices (although the fact thata person regularly takes the market price for its
swaps does not foreclose the possibility thatthe person may be a Swap Dealer)(6) Use of inter-dealer brokers

Dealer-Trader Distinction
Additional Interpretive Considerations11(1) A willingness to enter into swaps on either side of the market is not a prerequisite to Swap Dealer or
Security-Based Swap Dealer status12(2) The Swap Dealer or Security-Based Swap Dealer analysis does not turn on whether a person’s swap
or security-based swap dealing activity constitutes that person’s sole or predominant business(3) A customer relationship is not a prerequisite to Swap Dealer or Security-Based Swap Dealer status(i.e., exchange-traded swaps or security-based swaps are relevant in the determination)(4) In general, entering into a swap for the purpose of hedging, absent other activity, is unlikely to be
indicative of dealing

Hedging and Security-Based Swap Dealer Determination. For purposes of determining whether a
11 See id. at 55.
12 The Commissions note that party to a swap or security-based swap can often use other derivatives or

instruments to hedge the risks associated with a swap or security-based swap position, meaning that
two-way trading is not necessary to maintain a flat risk book. See Adopting Release, p. 52 (n. 176).
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Memorandum – May 2, 2012

person is a Security-Based Swap Dealer, the SEC also applies the dealer-trader distinction toaddress the use of security-based swaps for hedging purposes. Specifically, the SEC states that“to the extent that a person engages in security-based swap activity to hedge commercial risk,
or otherwise to hedge risks unrelated to activities that constitute dealing under the dealer-trader
distinction (particularly activities that have the business purpose of seeking to profit byproviding liquidity in connection with security-based swaps), the Commissions would not
expect those hedging transactions to lead a person to be a security-based swap dealer.”13 For
purposes of determining whether a person is a Swap Dealer, the CFTC separately addresses
hedging through the interim final rule discussed in Section III below.
B.
Indicia of holding oneself out or being commonly known in the trade as a dealerin swaps or security-based swaps
A determination as to Swap Dealer or Security-Based Swap Dealer status based on whether aperson “holds itself out as a dealer” in swaps or security-based swaps depends on theapplicable facts and circumstances. The interpretive guidance, however, offers a few examplesof activities that could cause a person to satisfy this prong of the applicable definition,
depending on the context. The Commissions note that none of these factors alone is “per seconclusive,” but instead will be considered in light of all activities of the person in question.14
Indicia of Holding Oneself Out or Being Commonly Known in the Trade as a Dealer in Swaps or
Security-Based Swaps15(1) Contacting potential counterparties to solicit interest;(2) Developing new types of swaps or security-based swaps and informing potential counterparties of
their availability and of the person’s willingness to enter into the swap or security-based swap;(3) Membership in a swap association in a category reserved for dealers;(4) Providing marketing materials describing the type of swaps or security-based swaps the party is
willing to enter into; and generally expressing a willingness to offer or provide a range of products orservices that include swaps or security-based swaps

C.

Market Making

While the final rules lack specificity as to what constitutes making a market in swaps or
security-based swaps sufficient to render a person a Swap Dealer or Security-Based Swap
Dealer under the second prong of the relevant definition, the CFTC offers interpretive guidancefor purposes of a Swap Dealer determination. Specifically, the CFTC defines making a market
in swaps as “routinely standing ready to enter into swaps at the request or demand of acounterparty,” with “routinely” meaning that “the person must do so more frequently thanoccasionally, but there is no requirement that the person do so continuously.”16 Drawing on the
dealer-trader distinction, the CFTC offers a few examples of activities that might be indicative of
13 Adopting Release, p. 94.
14 See id. at 58, 96.
15 See id. at 56 (n. 187), 96.
16 Id. at 58-59.

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Memorandum – May 2, 2012

making a market in swaps, summarized in the table below, when conducted on a “routine”
basis:17
Activities Potentially Indicative of Making a Market in Swaps(1) Quoting bid or offer prices, rates, or other financial terms for swaps on an exchange;(2) Responding to requests made directly, or indirectly through an interdealer broker, by potential
counterparties for bid or offer prices, rates, or other similar terms for bilaterally negotiated swaps;(3) Placing limit orders for swaps; or(4) Receiving compensation for acting in a market maker capacity on an organized exchange or trading
system for swaps.

Both the CFTC and SEC note that a person who seeks to avoid the Volcker Rule in connection
with swap or security-based swap activities by asserting the availability of the proposed market
making exception to the Volcker Rule would likely be required to register as a Swap Dealer or
Security-Based Swap Dealer (unless otherwise exempted).18
D.

Activities Part of / Not Part of a “Regular Business”

The definitions of “Swap Dealer” and “Security-Based Swap Dealer” include a person that
“regularly enters into [swaps or security-based swaps] with counterparties as an ordinary
course of business for its own account,” but expressly exclude “a person that enters into [swaps
or security-based swaps] for such person’s own account, either individually or in a fiduciary
capacity, but not as a part of regular business.”19
For purposes of the “Swap Dealer” definition, the Commissions interpret these phrases to focus
on activities of a person that are usual and normal in the person’s course of business andidentifiable as a swap dealing business. The Commissions further offer examples of activities
that, based on the facts and circumstances, could indicate that a person enters into swaps “aspart of a regular business”:20

17 See id. at 58-62.
18 See id. at 59 (n. 193), 92 (n. 272).
19 CFTC Regulation §§ 1.3(ggg)(1)(iii) and 1.3(ggg)(2); Exchange Act Rule 3a71-1(a)(3) and 3a71-1(b).

TheCommissions interpret the phrases “ordinary course of business” and “a regular business” to have thesame meaning for purposes of the definitions of “Swap Dealer” and “Security-Based Swap Dealer.” See
Adopting Release, p. 63.

20 See Adopting Release, pp. 62-66.

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Memorandum – May 2, 2012

“Ordinary Course of Business” / “As Part of a Regular Business”(1) Entering into swaps with the purpose of satisfying the business or risk management needs of thecounterparty (as opposed to entering into swaps to accommodate one’s own demand or desire toparticipate in a particular market);(2) Maintaining a separate profit and loss statement reflecting the results of swap activity or treating
swap activity as a separate profit center; or(3) Having staff and resources allocated to dealer-type activities with counterparties, including activities
relating to credit analysis, customer onboarding, document negotiation, confirmation generation,
requests for novations and amendments, exposure monitoring and collateral calls, covenantmonitoring, and reconciliation.

III.

PRODUCT EXCLUSIONS

The rules exclude certain swaps and security-based swaps from a determination as to whether aperson is a Swap Dealer or Security-Based Swap Dealer. In particular, swaps and securitybased swaps between majority-owned affiliates will not be included in either determination.
Swaps between an insured depository institution and a customer in connection with originating
a loan with that customer, certain swaps entered into by floor traders, and swaps entered intofor hedging physical positions will be excluded from a Swap Dealer determination.21
A.

Swaps or Security-Based Swaps with Certain Affiliates

The determination of whether a person is a Swap Dealer or Security-Based Swap Dealer
excludes swap or security-based swap activities between majority-owned affiliates.22 Thecounterparties qualify as “majority-owned affiliates” if one party directly or indirectly holds amajority ownership interest in the other, or if a third party directly or indirectly holds a majority
interest in both, based on holding a majority of the equity securities of an entity or the right toreceive upon dissolution or the contribution of a majority of the capital of a partnership.23 The
Adopting Release notes that in the case of majority-owned affiliates, the economic interests ofsuch affiliates are adequately aligned, and the swaps and security-based swaps between suchmajority-owned affiliates serve to allocate or transfer risks within an affiliated group, rather
than to move those risks out of the group to an unaffiliated third party.

21 See CFTC Regulation § 1.3(ggg)(5) and 1.3(ggg)(6); Exchange Act Rule 3a71-1(d).

Section III below

further discusses these exceptions.
22 See CFTC Regulation § 1.3(ggg)(6)(i); Exchange Act Rule 3a71-1(d)(2).
23 The Commissions declined to apply a definition of “affiliate” as used in the securities laws, noting thatsuch an approach is too broad for the purpose of this exclusion from dealing activity. For example,
unlike Rule 405 under the Securities Act of 1933, which uses the terms “affiliate” and “control” toidentify those persons that have the power to effect registration of an issuer’s securities, the exclusion ofinter-affiliate swaps and security-based swaps from the dealer analysis should be more tightly focused
to address situations in which counterparties have similar economic interests. See 17 C.F.R. § 230.405.
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Memorandum – May 2, 2012

B.

Swaps between an Insured Depository Institution and a Customer in Connection
with Originating a Loan with that Customer

The statutory definition of the term “Swap Dealer” excludes an insured depository institution“to the extent it offers to enter into a swap with a customer in connection with originating a loan
with that customer.”24 This exclusion does not appear in the definition of the term “SecurityBased Swap Dealer.” The exclusion may be claimed by an insured depository institution andapplies to any swap that meets the conditions summarized in the table below:
Exclusion for Swaps between an Insured Depository Institution and a Customer in Connection with
Originating a Loan
(1) the insured depository institution enters into a swap with the borrower that does not extend beyond
the termination of the loan;(2) the swap is connected to the financial terms of the loan or is required by loan underwriting criteria to
be in place as a condition of the loan in order to hedge the borrower’s commodity price risks;(3) the loan is within the common law meaning of “loan” and it is not a sham or a synthetic loan;(4) the insured depository institution is the sole lender or, if it is a participant in a lending syndicate, it is
responsible for at least 10% of the loan (otherwise, the notional amount of the swap may not exceed
the amount of the insured depository institution’s participation);(5) the swap is entered into within 90 days before or 180 days after the date of the loan agreement, or any
draw of principal under the loan;(6) the aggregate notional amount of all swaps entered into by the borrower with all persons inconnection with the financial terms of the loan at any time is not more than the aggregate amount of
the borrowings under the loan at that time; and(7) the insured depository institution reports the swap to a swap data repository, in order to ensure theconsistent reporting of swaps and allow the CFTC and other regulators to monitor the use of the
exclusion.

An insured depository institution that enters into swaps that do not meet these conditions, andthus do not qualify for the statutory exclusion, is not necessarily required to register as a Swap
Dealer. Rather, the insured depository institution—like any other entity—would apply thestatutory definition and the provisions of the rule solely with respect to its swaps that are notsubject to the loan origination exclusion or other exceptions, in order to determine whether it
engages in swap dealing activity that exceeds the de minimis threshold.
C.

Swaps between a Cooperative and Its Members

The Swap Dealer analysis also excludes swaps between certain cooperatives and their members,
so long as the swaps in question are reported to the relevant swap data repository by thecooperative and are subject to policies and procedures of the cooperative which ensure that itmonitors and manages the risk of such swaps.25 As is the case for affiliated groups of corporate
24 See CEA § 1a(49)(A), 7 U.S.C. § 1a(49)(A).
25 See CFTC Regulation § 1.3(ggg)(6)(ii).

The exemption applies to a cooperative that is either (1) acooperative association of producers as defined in Section 1a(14) of the CEA, 7 U.S.C. § 1a(14) or (2) aPage 8

Memorandum – May 2, 2012

entities, the CFTC noted that when one of these cooperatives enters into a swap with one of its
members, the swap serves to allocate or transfer risks within an affiliated group, rather than tomove those risks from the group to an unaffiliated third party. Note that the cooperatives are
not categorically excluded from the dealer definitions; rather, swaps between a cooperative andits members are excluded from the dealer analysis, so that if a cooperative were to engage inother swap activities that are covered by, and not otherwise excluded from, the statutory
definition of the term “Swap Dealer,” then it would be required to register as a Swap Dealer.
D.

Interim Final Rule Excluding Swaps Entered Into for Hedging Physical Positions

In contrast to the statutory definition of the term “Major Swap Participant,” which explicitly
excludes positions in swaps held for hedging or mitigating commercial risk, the statutory
definition of the term “Swap Dealer” leaves the treatment of hedging swaps to the CFTC’s
discretion. The CFTC has provided, in an interim final rule, that entering into a swap in certain
situations for the purpose of hedging a physical position does not constitute a swap dealing
activity. The interim final rule draws upon the principles of bona fide hedging that the CFTC haslong applied to identify when a financial instrument is used for hedging purposes, and excludes
from the Swap Dealer analysis swaps entered into for the purpose of hedging risks relating to aphysical position. Specifically, the interim final rule provides that the Swap Dealer analysis will
exclude swaps that a person enters into for the purpose of offsetting or mitigating the person’s
price risks if they meet the requirements summarized in the table below:
Exclusion for Swaps Entered Into for Hedging Physical Positions26
The interim final rule provides that the Swap Dealer analysis will exclude swaps that a person enters into
for the purpose of offsetting or mitigating the person’s price risks if:(1) the price risks arise from the potential change in the value of assets that the person owns,
produces, manufactures, processes, or merchandises, liabilities that the person owns oranticipates incurring, or services that the person provides or purchases;(2) the swap represents a substitute for transactions or positions in a physical marketing channel;(3) the swap is economically appropriate to the reduction of the person’s risks in the conduct andmanagement of a commercial enterprise;(4) the swap is entered into in accordance with sound commercial practices; and(5) the person does not enter into the swap in connection with activity structured to evadedesignation as a Swap Dealer.

The CFTC notes that the exclusion depends not on the effect or consequences of the swap, but
on whether the purpose for which a person enters into a swap is to hedge a physical position. If
the purpose is to hedge a physical position, then the swap is excluded from the Swap Dealer
analysis because using swaps for that purpose does not constitute dealing activity.27

person chartered under federal law as a cooperative and predominantly engaged in activities that are
financial in nature as defined in section 4(k) of the Bank Holding Company Act.
26 See CFTC Regulation § 1.3(ggg)(6)(iii).
27 See Adopting Release, pp. 73-74.

Page 9Memorandum – May 2, 2012

The CFTC also notes that the hedging exclusion is in the nature of a safe harbor, and does notmean that other types of hedging activity outside the safe harbor will necessarily constituteswap dealing activity.28
E.

Swaps Entered Into by Floor Traders

The Swap Dealer analysis also excludes swaps that a person enters into in its capacity as a floor
trader as defined by CEA Section 1a(23) or on a swap execution facility, provided that theperson meets the requirements summarized in the table below:
Swaps Entered into by Floor Traders(1) is registered with the CFTC as a floor trader pursuant to CFTC Regulation § 3.11;(2) enters into swaps solely with proprietary funds for that trader’s own account on or subject to therules of a DCM or SEF, and submits each such swap for clearing to a DCO;
(3) is not an affiliated person of a registered swap dealer;(4) does not directly, or through an affiliated person, negotiate the terms of swap agreements, other thanprice and quantity or participate in a request for quote process subject to the rules of a DCM or SEF;
(5) does not directly or through an affiliated person offer or provide swap clearing services to third
parties;(6) does not directly or through an affiliated person enter into swaps that would qualify as hedging
physical positions pursuant to CFTC Regulation § 1.3(ggg)(6)(iii) or hedging or mitigating
commercial risk pursuant to CFTC Regulation § 1.3(kkk), with the exception of swaps that are
executed opposite a counterparty for which the transaction would qualify as a bona fide hedging
transaction;(7) does not participate in any market making program offered by a DCM or SEF; and(8) complies with the record keeping and risk management requirements of CFTC Regulation §§ 23.201,
23.202, 23.203, and 23.600 with respect to each such swap as if it were a swap dealer.

This rule permits floor traders who might otherwise be required to register as a swap dealer tobe registered solely as floor traders with the CFTC.

IV.

DE MINIMIS EXCEPTION

The Dodd-Frank Act provides an exemption from designation as a Swap Dealer or SecurityBased Swap Dealer for a person who “engages in a de minimis quantity of swap dealing inconnection with transactions with or on behalf of its customers.”29 The final rules focus on thenotional amount of a person’s swap or security-based swap positions over the prior 12 months

28 See id. at 71-72.
29 See Dodd-Frank Act §§ 721(a)(2) and 761(a)(6).

Page 10Memorandum – May 2, 2012arising from its dealing activity, and do not include the proposed rules’ limitations on thenumber of swaps or security-based swaps or the number of counterparties.30
A.
1.

Notional Amount of a Person’s Swap or Security-Based Swap Positions over the
Prior 12 Months Arising from Its Dealing Activity
Swap Dealer

The final rule requires that, in order for a person to be exempt from the Swap Dealer definitionon the basis of de minimis activity, the aggregate gross notional amount of the swaps that theperson enters into over the prior 12 months in connection with swap dealing activities must notexceed $3 billion. For swaps in which the counterparty is a “special entity” (as defined under
CEA Section 4s(h)(2)(C), including certain governmental and other entities), the aggregate grossnotional amount of such swaps over the prior 12 months must not exceed $25 million. These deminimis notional thresholds encompass swap dealing positions entered into by an affiliate
controlling, controlled by, or under common control with the person at issue.31
Phase-In. The rule provides for a phase-in of the de minimis threshold to facilitate orderly
implementation of Swap Dealer requirements. During the phase-in period, the de minimis
threshold is $8 billion. The $25 million threshold for swaps with special entities applies
unchanged. Two and one-half years after data starts to be reported to swap data repositories,
the CFTC will prepare a study of the swap markets, including data and information that
becomes available about the de minimis threshold. Nine months after this study, the CFTC, in
its discretion, may end the phase-in period, or propose new rules to change the de minimis
threshold. If the CFTC does not take action to end the phase-in period, it will terminate
automatically five years after data starts to be reported to swap data repositories.
De Minimis Notional Thresholds: Swap Dealer
Notional Thresholds
PeriodGeneralPhase-In(terminates 2½ -5 years after datareporting to swap data repositories
commences)$8 billion

After Phase-In (unless revised)$3 billion

Special Entities$25 million

30 Following the effective date of the rules, the relevant calculation period will be the shorter of (a) theprior 12 months and (b) the period following the effective date of the rules. See CFTC Regulation §1.3(ggg)(4)(i); Exchange Act Rule 3a71-2(a)(1).
31 The final rule requires the analysis of de minimis levels to be based on effective notional amounts to theextent that the stated notional amount is leveraged or enhanced by the structure of the swap. See CFTC
Regulation § 1.3(ggg)(4)(i).
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Memorandum – May 2, 2012

2.

Security-Based Swap Dealer

The final rule caps an unregistered person’s security-based swap dealing activity involving
credit default swaps (e.g., single-name credit default swaps) at $3 billion in notional amountover the prior 12 months, and involving other security-based swaps (e.g., single-name or
narrow-based equity swaps or total return swaps) at $150 million in notional amount over theprior 12 months.32 In addition, consistent with the proposed rule, the final rule caps an
unregistered person’s security-based swap dealing activity involving counterparties that are“special entities” at $25 million in notional amount over the prior 12 months. The final rulefurther provides that the SEC may establish alternative methods of determining the scope of thede minimis exception by rule or regulation.
Phase-In. For security-based swaps other than credit default swaps, a phase-in period for the deminimis exception is available in connection with persons whose dealing activity involving
those instruments is $400 million or less in notional amount over the prior 12 months. For
dealing activity involving credit default swaps that constitute security-based swaps, a phase-in
period for the de minimis exception is available to persons with notional dealing activity of $8
billion or less over the prior 12 months. Much like under the corresponding CFTC provision,
the phase-in period will be linked to the timing of an SEC report regarding the de minimis
exemption levels. The SEC must complete the report no later than 3 years after the “datacollection initiation date.”33 The final rule provides that nine months following publication ofthis report, the SEC may either (1) terminate the phase-in period and establish and publish thephase-in termination date or (2) propose an alternative de minimis threshold and provide noticeof that determination and establish the phase-in termination date. If the SEC does not establish
the phase-in termination date in either of the two ways, the phase-in termination date willautomatically occur five years following the data collection initiation date.
The phase-in period will not be available in connection with the $25 million threshold for
dealing activity involving special entities. In addition, in connection with security-based swap
dealing activities involving natural persons, the phase-in period is available only to natural
persons who qualify as ECPs by virtue of CEA section 1a(18)(A)(xi)(II), which addresses natural
persons who have $5 million or more invested on a discretionary basis and who enter into asecurity-based swap to manage the risk associated with their assets and liabilities.

32 The final rule, like the CFTC rule, requires the analysis of de minimis levels to be based on effective

notional amounts to the extent that the stated notional amount is leveraged or enhanced by the
structure of the security-based swap (such as, for example, if the exchange of payments associated withan equity swap was based on a multiple of the return associated with the underlying equity). See
Exchange Act Rule 3a71-2(a)(3).
33 The “data collection initiation date” shall be the later of (a) the last compliance date for the registration

and regulatory requirements for Security-Based Swap Dealers and Major Security-Based Swap
Participants under Section 15F of the Exchange Act and (b) the first date on which compliance withtrade-by-trade reporting rules for credit-related and equity-related security-based swaps to a registeredsecurity-based swap repository is required. See Exchange Act Rule 3a71-2(a)(iii).
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Memorandum – May 2, 2012

De Minimis Notional Thresholds: Security-Based Swap Dealer
Notional Thresholds
Credit Default Swaps(“CDS”) that Are
Security-Based Swaps

Security-BasedSwaps other than
CDS

Phase-In(terminates between 3¾ - 5years after the data collection
initiation date)$8 billion$400 million

After Phase-In (unlessrevised)$3 billion

PeriodB.

Special Entities$25 million$150 million“Customer” Relationship and Focus on “Dealing” Activity

Consistent with the proposing release, the final rules require neither that a dealer accommodate
the demand of an existing customer nor the presence of a preexisting customer relationship forthe de minimis exception to apply.34
C.

Hedging in Connection with Swap and Security-Based Swap Dealing Activities

The Adopting Release notes that the de minimis exception applies only in connection with aperson’s swap or security-based swap dealing activities, and not to the person’s hedging or
proprietary trading activities. Thus, to the extent that a particular swap or security-based swap
position is not connected to dealing activity, it will not count against the de minimis
thresholds.35 The SEC and CFTC take differing approaches, however, regarding security-based
swap and swap positions that hedge or otherwise offset a position entered into that would
36
comprise part of the person’s dealing activity:
Hedging in Connection with Security-Based Swap Dealing Activities. The SEC notes that one
indicator of dealing activity under the dealer-trader distinction is that a person profit byproviding liquidity in connection with security-based swaps. Accordingly, for purposesof the de minimis exception to the Security-Based Swap Dealer definition, a securitybased swap position that hedges or otherwise offsets a position that was entered into aspart of dealing activity would itself comprise part of the person’s dealing activity, andhence count against the de minimis thresholds.



Hedging in Connection with Swap Dealing Activities. For purposes of the de minimis
exception to the Swap Dealer definition, the CFTC takes the view that the relevant
question in determining whether swaps count as dealing activity against the de minimis
thresholds is whether the swaps fall within the swap dealer definition under the final

34 See Adopting Release, pp. 138-139.
35 See id. at 139-140.
36 See id. at 139-140 (n. 433).

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Memorandum – May 2, 2012rules. If hedging or proprietary trading activities did not fall within the definition,
including as a result of the application of the interim final rule excluding swaps enteredinto for hedging physical positions, then they would not count against the de minimis
thresholds.

V.

LIMITED PURPOSE DESIGNATION

If person must register with the CFTC as a Swap Dealer or with the SEC as a Security-Based
Swap Dealer, the final rules apply a default presumption that such person will be a Swap
Dealer or Security-Based Swap Dealer for all types, classes, or categories of the person’s swaps
or security-based swaps, and for all activities involving swaps or security-based swaps. Uponor after submitting a registration application, however, a person may apply to limit theapplicable dealer designation only to specified categories of swaps or security-based swaps oractivities involving swaps or security-based swaps.37
The CFTC or SEC, as applicable, will consider such limited purpose applications on an
individual basis, through analysis of the unique circumstances of each applicant. Neither the
final rules nor the Adopting Release provide much additional guidance as to the factors theCommissions will apply to such determinations, beyond requiring an applicant to demonstrate
how it would satisfy applicable Swap Dealer or Security-Based Swap Dealer regulations,
including transaction-specific and entity-level requirements, in the context of limited
designations.38

VI.

CONCLUSION

As discussed above, the new rules generally do not establish bright-line designations. Instead,they outline a functional analysis, based on a person’s activities and role in swap and securitybased swap markets in light of relevant facts and circumstances, to determine whether a person
engages in activities within the scope of the “Swap Dealer” or “Security-Based Swap Dealer”
definitions and not subject to specified exceptions. If a person engages in such swap or
security-based swap dealing activity with respect to a notional amount of swaps or securitybased swaps in excess of an applicable de minimis threshold, such person will be subject toregistration and regulatory requirements as a Swap Dealer and/or Security-Based Swap Dealer,
as applicable. Upon or after submitting a registration application, a person may apply to limit
its designation as a Swap Dealer or Security-Based Swap Dealer to specified categories of swaps
or security-based swaps or specified activities in connection with swaps or security-based
swaps, which the CFTC or SEC, as applicable, will consider on a case-by-case basis.
***
For more information about any of the foregoing, please contact a member of the Firm’s
Derivatives Group.

37 See CFTC Regulation § 1(ggg)(3); Exchange Act Rule 3a71-1(c).
38 See Adopting Release, pp. 192-194.

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Memorandum – May 2, 2012

This memorandum is for general information purposes and should not be regarded as legal advice. Pleasecontact your relationship partner if we can be of assistance regarding these important developments. The
names and office locations of all of our partners, as well as our recent memoranda, can be obtained fromour website, www.simpsonthacher.com.
The contents of this publication are for informational purposes only. Neither this publication nor the lawyers who authored it are
rendering legal or other professional advice or opinions on specific facts or matters, nor does the distribution of this publication to
any person constitute the establishment of an attorney-client relationship. Simpson Thacher & Bartlett LLP assumes no liability inconnection with the use of this publication.

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Memorandum – May 2, 2012

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