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In July 2010, the U.S. Congress addressed the economic risks of swaps when it passed the Dodd-Frank Act. Though the CFTC and its predecessor agencies have regulated derivatives since the 1920s, its jurisdiction was limited to futures. Now, the Commission, along with the SEC, is tasked with bringing its regulatory expertise to the swaps marketplace. There are three critical reforms of the derivatives markets included in the Dodd-Frank Act. First, the Dodd-Frank Act requires swap dealers and major swap participants to come under comprehensive regulation. Second, the Dodd-Frank Act moves the bulk of the swaps marketplace onto transparent trading facilities – either exchanges or swap execution facilities (SEFs). Third, the Dodd-Frank Act requires clearing of standardized swaps by regulated clearinghouses to lower risk in the marketplace.

The Dodd-Frank Act provides for the registration and comprehensive regulation of swap dealers and major swap participants. The regulatory requirements are set forth in new Section 4s of the CEA.

• The Dodd-Frank Act generally prohibits any person from acting as a swap dealer or a major swap participant unless the person is registered with the Commission. A primary purpose of registration is to screen an applicant's fitness to engage as a swap dealer or major swap participant. The applicant for registrant would initiate the registration process by submitting appropriate forms by means of the NFA's online registration system. The NFA would conduct a background check to assess whether the applicant's principals were unfit for registration or subject to a statutory disqualification from registration.
  
  
• The Dodd-Frank Act directs the Commission to adopt regulations governing the business conduct standards for swap dealers and major swap participants. Such regulations would require swap dealers and major swap participants to conform with regulations relating to timely and accurate confirmation, processing, netting, documentation, and valuation of all swaps. Swap dealers and major swap participants also would be required to: monitor their trading in swaps to prevent violations of applicable position limits; establish robust and professional risk management systems; designate a chief compliance officer; and implement conflict of interest systems and procedures.
  
  
• The Commission also is required to adopt regulations that would require swap dealers and major swap participants to: 1) verify the eligibility of their counterparties; 2) disclose to their counterparties material information about swaps, including material risks, characteristics, incentives and conflicts of interests; and 3) provide counterparties with information concerning the daily mark for swaps. Swap dealers and major swap participants also would be subject to a duty to communicate in a fair and balanced manner based on principles of fair dealing and good faith.
  
  
• The Dodd-Frank Act also directs the Commission to adopt regulations imposing capital and margin requirements for all registered swap dealers and major swap participants that are not banks, including non-bank subsidiaries of bank holding companies regulated by the Federal Reserve Board. The Commission is further directed to adopt regulations imposing financial reporting requirements on all swap dealers and major swap participants.
  
  

The Dodd-Frank Act requires that standardized swaps be cleared through CFTC-registered DCOs. Clearing has lowered risk in the futures marketplace since the 1890s, and DCOs play an important role in mitigating risk in the markets that the CFTC regulates.

• The Commission on an ongoing basis is required to review each swap, or any group, category, type or class of swaps (collectively, "swaps") to make a determination as to whether the swaps should be required to be cleared, i.e., mandatory clearing, as well as to make a determination as to the eligibility or continuing qualification of a DCO to clear a swap. DCOs that clear swaps must submit the contracts to the CFTC, which must then make a decision as to whether the swaps are subject to the Dodd-Frank Act's clearing requirement. The CFTC has 90 days after the submission, including a 30-day comment period, to make such determinations. Though the CFTC does not yet know the total number of contracts that will be submitted for clearing, and the Commission may be able to group many by class, the largest swaps clearinghouse clears nearly one million unique contracts at any point in time.
  
  
• The CEA requires that an entity that seeks to provide clearing services with respect to futures contracts, options on futures contracts, or swaps must first obtain registration as a DCO. A DCO's registration is predicated on its demonstration of compliance with the CEA and Commission regulations pertaining to core principles augmented by the Dodd-Frank Act. The Commission likely will see an increase in the number of DCOs seeking registration, including entities that are located outside the United States. In addition, the Dodd-Frank Act creates a new category of systemically important DCOs. These entities will have to comply with heightened risk management and other prudential standards concerning payment, clearing and settlement supervision, and the Commission will be required to examine systemically important DCOs at least yearly. DCOs play a vital role in the proper functioning of the financial markets and are increasingly important given the mandated central clearing of standardized swaps.
  
  
• The additional clearinghouses that will register as DCOs and those DCOs which are designated as systemically important likely will clear many more products that will require Commission review and determinations concerning mandatory clearing. The risk profile of these cleared products will be more complex than traditional futures and options on futures. At the same time, it will require an increase in the Commission's financial and risk oversight of entities that pose a risk to the clearing process. Existing financial and risk surveillance tools and systems will have to be enhanced and modified to identify, monitor and assess the risks posed by DCOs, clearing members, and market participants to enable the Commission to continue to effectively discharge its statutory duty to reduce systemic risk.
  
  

The Commission will implement many new provisions related to the oversight of swaps trading activity. These include procedures for the review and oversight of an entirely new regulated market category, SEFs.

• The Commission currently oversees 16 designated contract markets (DCMs). Based on industry comments, there could be at least 30-40 entities that will apply to become SEFs. This estimate is based on the number of exempt commercial markets (ECMs), exempt boards of trade (EBOTs), interdealer brokers, information service providers and swap dealers who have formally or informally expressed an interest in registering as SEFs. Furthermore, some DCMs that in the past listed only futures will start listing swaps.
  
  
• Each SEF must comply with a total of 15 core principles, as adopted by the Dodd-Frank Act, as a condition of obtaining and maintaining registration as a SEF. The SEF also must be in compliance with all implementing regulations and other applicable provisions of the CEA. This will require thorough evaluation by staff before making registration determinations. Registered SEFs will be subject to CFTC examinations for ongoing compliance.
  
  

The CFTC currently administers a Commission-set position limit regime for a total of nine DCM-listed agricultural futures contracts. Under the Dodd-Frank Act, the Commission is instructed to implement and enforce new aggregate position limits that will cover not only the futures market, but also some portion of the swaps market. These limits would apply to more than 30 agricultural and exempt (mostly metals and energy) commodities.

The Dodd-Frank Act establishes a new registration category for swap data repositories (SDRs). The Dodd-Frank Act requires registrants—including swap dealers, major swap participants, SEF and DCMs—to have robust record-keeping and reporting, including an audit trail, for swaps. Under the Dodd-Frank Act, to register and maintain registration with the Commission, SDRs are required to comply with specific duties and three core principles as well as other requirements that the Commission may prescribe by rule. The CFTC recently adopted rules in this area, effective October 31, 2011, to require SDRs to perform their core function of collecting and maintaining swaps data and making it directly and electronically available to regulators. Initial estimates are that the Commission will receive at least two or three SDR applications upon the general effective date of the rules and some international SDRs intend to register as well. That number could grow significantly to the extent that any DCMs, SEFs or DCOs seek to establish in-house SDRs to facilitate their swap business. In addition, the Commission, as required by the Dodd-Frank Act, anticipates issuing rules that will provide for the real time dissemination of price and other information about swaps trading to promote transparency.

Surveillance has become dependent on the ability to review large volumes of data and the development of sophisticated analytics to identify trends and/or outlying events that warrant further investigation. To the extent possible, the CFTC is seeking to leverage applications and analytics across the organization through the use of industry standardized data sets. It is anticipated that through the collection of standardized data sets, the Commission will have the unique and essential ability to aggregate data received by all market participants, allowing a more encompassing view of futures, options and swaps transactions. This aggregated data will allow the Commission to conduct market-level surveillance and perform financial risk analyses of market participants. This capability is particularly important with the expansion of the Commission's mandate in the disaggregated swaps markets, as market participants may have swaps data residing in multiple SDRs, multiple DCMs, and multiple SEFs. The Commission's ability to view aggregated data across this industry landscape is essential.

The Dodd-Frank Act's creation of a new registered foreign board of trade (FBOT) category will obviate the need for the current FBOT no-action letter program, but the substantive requirements that will be imposed on registered FBOTs will likely be more robust than the requirements imposed under the no-action regime. Currently, 20 FBOTs operate in the United States based upon no-action letters dating back to 1999. The Commission expects at least that number of FBOTs will apply to register upon the implementation of the registered FBOT regulations, plus an additional six to 10 FBOTs who have recently expressed an interest in becoming registered.

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