The Dodd-Frank Act Mandates Comprehensive Regulation of Derivatives
Authors: Deborah A. Carrillo, Benjamin R. Uy, Jr., Michael Ouimette

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act imposes a new derivatives regulation regime that will have a significant effect on a wide range of market participants.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which was signed into law by President Obama on July 21, 2010, imposes a comprehensive and far-reaching regulatory regime on derivatives and market participants. The most significant provisions of the derivative regulation include: (1) mandatory clearing of certain derivative instruments through regulated clearing organizations and mandatory trading of certain derivative instruments on regulated exchanges or swap execution facilities; (2) regulation of derivatives market participants; and (3) divestment or “push out” of many banks’ swap activities. As with other portions of the act, the full impact of these provisions will not be known until the regulators promulgate rules. Below are summary answers to questions regarding the Dodd-Frank Act’s new derivatives regulatory regime.

Jurisdiction and Definitions: Swaps and Security-based Swaps

Who are the regulating entities?
The Dodd-Frank Act splits regulation of the derivatives markets between the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). Generally, the Dodd-Frank Act grants the CFTC jurisdiction over swaps and swap market participants and the SEC jurisdiction over security-based swaps and security-based swap market participants. However, federal bank regulators have enforcement authority with respect to swap dealers and major swap participants that they regulate.

What is a swap?
The Dodd-Frank Act broadly defines a swap to include a wide range of derivative instruments, including interest rate, equity, currency and fixed income derivative instruments. The Dodd-Frank Act defines foreign exchange swaps and forwards as swaps subject to regulation, unless the Secretary of the Treasury determines to exclude such transactions from the swap definition. The definition of a swap excludes most security-based swaps.

What is a security-based swap?
A “security-based swap” is defined as a swap based on (1) a narrow-based security index, (2) a single security or loan or (3) the occurrence, nonoccurrence or extent of occurrence of an event relating to a single issuer of a security or the issuers of securities in a narrow-based security index, if the event directly affects the financial statements, financial condition or financial obligations of the issuer.

What regulating activities does the Dodd-Frank Act prohibit states from engaging in?
States may no longer regulate swaps or security-based swaps as insurance. Also, state gaming and bucket shop laws may no longer effect security-based swaps between eligible contract participants.

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