CFTC Releases Staff Report on Swap Dealer De Minimis Exception

The CFTC issued a Final Staff Report on whether to lower the Swap Dealer De Minimis Exception threshold. Unless the CFTC takes further action, the threshold is scheduled to decrease from $8 billion to $3 billion in December 2017. The scheduled threshold change is provided under Regulation 1.3(ggg), jointly issued by the SEC and the CFTC in May 2012, stating that “a person is not considered to be a swap dealer unless its swap dealing activity exceeds an aggregate gross notional amount threshold of $3 billion over the prior twelve-month period, subject to a phase-in period during which the threshold would be set at $8 billion.” The Final Report, prepared by the Division of Swap Dealer and Intermediary Oversight, reviewed available data and comments by interested parties in order to determine how changes to the current $8 billion de minimis threshold might affect the swap markets.

In the Report, CFTC staff noted that if the de minimis threshold was lowered to $3 billion, approximately 84 additional entities trading in interest rate swaps (“IRS”) and credit default swaps (“CDS”) might have to register as swap dealers. Conversely, if the threshold was raised to $15 billion, approximately 34 fewer entities trading in IRS and CDS might need to register as swap dealers.

CFTC staff concluded that only a substantial increase or decrease in the de minimis threshold would have a significant effect on the amount of IRS and CDS activity that is covered by swap dealer regulation, as measured by notional amount, transactions, or unique counterparties. For that reason, staff made no recommendations concerning whether to (i) set the threshold at the current $8 billion dollar level, (ii) allow the threshold to fall to $3 billion, as scheduled, or (iii) delay the threshold reduction in order to afford enough time for the CFTC to obtain better data.

CFTC Commissioner J. Christopher Giancarlo issued a separate statement in which he criticized the Final Staff Report for failing to make any recommendations, and expressed disappointment with the CFTC for not eliminating, or at least extending, the automatic phase-in of the $3 billion threshold. Commissioner Giancarlo argued that the CFTC “has already witnessed the negative results of setting a de minimis threshold too low, as was the case with utility special entities,” and maintained that dropping to such a level in the broader swap marketplace would “cause many non-financial companies to curtail or terminate risk-hedging activities with their customers, limiting risk-management options for end-users.”

Lofchie Comment: The Report raises a basic question. If the de minimis threshold dropped to $3 billion, will firms that deal in swaps totaling from $3 to $8 billion: (i) register with the CFTC as swap dealers, or (ii) reduce or eliminate their swap-dealing activities? The most likely answer is that most firms would not register, since the costs of regulation would be too high to allow them to stay in the market as smaller regulated dealers. CFTC staff should have made a stronger effort to answer the question. Staff might have attempted to estimate (i) the cost of registering as a swap dealer, and (ii) the profits of dealing in swaps. It is fair to conclude that unless the first amount is materially greater than the second, small firms likely would leave the market.

Instead of focusing on the effect that a reduction in the swap dealer threshold might have on the number of firms willing to deal in swaps, CFTC staff chose to concentrate on a far less significant question: how many additional swaps would smaller dealers enter into if they were required to register? According to the Final Staff Report, the number of additional swaps appears to be immaterial, which suggests that the threshold should not be reduced, particularly if the reduction could chase small dealers out of the market.