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New Security Based Swap Regulation, USA, 2021

A Security Based Swap (SBS) is a swap that references a security or loan as its underlying. The following are some of the examples of SBS.

1. Single-Name Total Return Swap
2. A Single-Name CDS
3. A CDS Basket Swap on Security Basket
4. A CDS Index Swap on Securities Index
5. Any other swaps based on securities

About the regulation

The Dodd-Frank Act established a regulatory framework to be jointly implemented by Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). The SEC's job is to regulate Security-Based Swaps (SBS) and Security Based Swap Dealers (SBSD), while the job of the CFTC is to regulate all other market participants. The CFTC had laid down rules for non-security based swaps and swap dealers in 2012/13 and since then they are being followed by all market participants. However, the SEC did not finalize its rules for SBS and SBSDs.

The jurisdiction on Security Based Swaps (SBS) and Non-Security Based Swap (NSBS) is not a clear-cut divide. There are certain swaps that fall purely under the jurisiction of CFTC such as swaps on rates, currencies, commodities, indices, quantitative measures and swaps on other financial or economic measures. There are certain swaps that fall purely under the jurisdiction of SEC such as the one's mentioned above, while there are some which fall under the jurisdiction of both CFTC and SEC, such as any derivative which is a swap as well as a SBS - for example, a CDS Baset or Index referencing a basket or index comprising of more than 9 securities, a swap based on an index of loans, etc.

The SEC finalized the new rules for SBS and SBSD in 2019 to be implemented from November 2021.

New rules for Security-Based Swaps (SBS) and Security-Based Swap Dealers (SBSD)

The new coming rules on SBS are similiar to the ones we already have under CFTC. The following are some of the rules.

1. The Security Based Swap Dealers (SBSDs) and Major Security-Based Swap Participants (MSBSP) will be required to register with SEC
2. Market participants dealing with SBS will need to comply with new regulations relating to Capital, Margin, Segregation and Transaction Reporting.
3. Non-compliance with regulations will result in fines being imposed by SEC
4. SEC will regulate trading platforms and exchanges on which certain security-based swaps are transacted
5. SEC will also regualte data repositories involved in security based swaps

Parties in a Security-Based Swaps as defined by regulations

SEC regulations have defined three types of counterparties who could enter into security based swap transactions.

1. Security based swap users
2. Major security based swap participants
3. Security based swap dealers

Note
Security based swap users are not required to register with SEC.

Parties who will be affected by these regulations

The regulations will impact the following parties.

1. Major security based swap participants
2. Security based swap dealers
3. Security based swap execution facilities (SEFs)
4. Security based clearing agencies
5. Swap Data Repositories handling SBS transaction reporting

Documentary Changes

For swaps traded on SEF's there are no major changes, the SEF's will amend the rules to comply with these regulations. For OTC trades, parties are required to make changes to their documentation. Parties can either make the changes bilaterally or by adoption of ISDA Protocols, which act at an multilateral level. On March 15, 2021, ISDA had launched the "ISDA 2021 SBS Top-Up Protocol" in order to faciliate compliance with these regualtions. This protocol is in addition to the earlier protocols - the "ISDA 2012 Dodd Frank Protocol Agreement" and the "ISDA 2013 Dodd Frank Protocol Agreement". All these three protocols are commonly now referred to as the "CFTC Dodd-Frank Protocols".

It is possible that some parties have not adhered to the earlier protocols. Such parties can now adhere to the "ISDA 2021 SBS Full Protocol".

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