Office of the General Counsel (“OGC”) issued a no-action letter providing time-limited relief from requirements arising from the CFTC-SEC joint interpretation that compo equity total return swaps are mixed swaps, subject to regulation by both the CFTC and the SEC. The no-action letter provides that OGC will not recommend that the CFTC commence action against any person in connection with any failure of such person to comply with the CFTC Rules (other than those relating to anti-fraud and anti-manipulation authority) to the extent such failure arises solely because such person treats a compo equity total return swap solely as a security-based swap (subject only to SEC Rules) and not as a mixed swap (subject as well to the CFTC Rules).
The no-action relief is subject to the following conditions:
(i) market participants are required to act reasonably and in good faith in progressing to full compliance with CFTC rules applicable to mixed swaps with respect to compo equity total return swaps by July 1, 2013;
(ii) affected persons are also required to come into full compliance as the technical and operational issues preventing timely compliance have been resolved, even if such resolution occurs prior to July 1, 2013; and
(iii) during the pendency of the no-action period, and prior to reporting compo equity total return swap transaction data records to a swap data repository, affected persons must retain records with respect to all covered transactions and make such records available to the CFTC.
Lofchie Comment: Under the SEC/CFTC Rules, a so-called “compo” swap is treated as being subject to both the CFTC and the SEC Rules, whereas a “quanto” swap is treated as only being subject to the SEC Rules. As a starting matter, I will say that this classification seems illogical to me. If it were necessary to treat one of these swaps as subject to regulation by both regulators, I would have reversed the treatment myself. But I think this intellectual dispute only illustrates how absurd the whole scheme of dual regulation is: is it really necessary to have two regulators govern an equity swap that has a non-leveraged currency conversion element? The regulators can blame the absurdity on Dodd-Frank (which I find easy enough to criticize), but if the CFTC has authority to issue a six-month no-action letter, there seems no reason that the CFTC could not issue a no-action letter of infinite duration and solve the double regulation problem.
Turning back to the substance of the letter, I observe, as I have commented in the past, that the CFTC just seems unwilling to issue no-action letters that come without conditions. After all, what does it mean to say that the no-action relief is subject to firms’ “good faith in progressing”? Does that mean that the CFTC could retroactively declare a quanto swap illegal because a firm had not made sufficient progress in hitting a July deadline (and who is to say that the July deadline will not be further delayed)? Similarly, what does it mean to say that the deadline extends to July 1, but firms must come into compliance earlier if they can? The regulatory philosophy of the CFTC seems at times to be that every single rule, or exemption from a rule, must be subject to a “facts and circumstances” analysis that makes it impossible for regulated persons to know when the rules apply and when they do not.
See: CFTC Letter 12-64 : Mixed swaps, Section 1a(47)(D) of the Commodity Exchange Act; No-Action.