How Then Shall We Live: The CFTC’s Business Conduct Standards for Swap Dealers and Major Swap Participants.
On January 17th, the CFTC published new final rules prescribing business conduct standards for swap dealers (“SDs”) and major swap participants (“MSPs”). The rules delineate recordkeeping and compliance procedures and govern the dealings SDs and MSPs have with counterparties generally, and include additional requirements when they deal with “Special Entities.” Special Entities include governmental entities, employee benefit plans subject to the Employee Retirement Income Security Act (“ERISA”), governmental plans, and endowments.
The final rules are principles-based and generally follow the framework of the proposed rules. They prohibit certain abusive practices, require disclosures of material information to counterparties, and require SDs and MSPs to undertake certain due diligence relating to their dealings with counterparties. Certain rules do not apply to transactions initiated on a swap execution facility (“SEF”) or designated contract market (“DCM”) when the SD and MSP do not know the identity of the counterparty prior to execution.
Generally, the new rules will not apply to unexpired swaps executed before the effective date of the adopting release. However, the CFTC will consider a material amendment to the terms of a swap to be a new swap, subject to the business conduct standard rules.
Under the new business conduct standards, all SDs and MSPs owe their counterparties the duties to (i) verify counterparty eligibility; (ii) disclose material information; (iii) disclose the daily mark; (iv) provide clearing disclosures; and (v) communicate fairly.
SDs must also provide, at the counterparty’s request, a scenario analysis for swaps that are not made available for trading on an SEF or DCM. An SD must also understand the risks and rewards of a recommended swap and have a reasonable basis to believe that a recommended swap is suitable for the counterparty. And the final rules include a suitability safe harbor. An SD will be deemed to have satisfied its duty to have a reasonable basis to believe that a recommended swap is suitable for the counterparty if it exchanges specified representations with the counterparty or the counterparty’s agent.
The final rules for MSPs do not include the suitability duty, pay-to-play, “know your counterparty,” and scenario analysis provisions.
SDs and MSPs can also reasonably rely on the representations of counterparties to meet due diligence obligations, make disclosures by any reliable means agreed to by the counterparty, make disclosures of material information to counterparties in a standard format, and include representations and disclosures in counterparty relationship documentation.
On Tuesday, the CFTC also released a letter from the Department of Labor stating that compliance with the business conduct standards will not, by itself, cause an SD or MSP to be an ERISA fiduciary.
However, independent representatives advising state and municipal Special Entities on swaps may be subject to registration with the CFTC as a commodity trading advisor and the SEC as a municipal advisor.
Swap dealers and major swap participants must comply with the business conduct rules on the latter of 180 days after the effective date of the rules or the date on which swap dealers or major swap participants are required to apply for registration pursuant to Commission rule 3.10.