Alert March 13, 2012

CFTC Issues Final Rules on Risk Management and Conflicts of Interest and Proposes Rule on Minimum Block Trades

On February 23, 2012, the CFTC approved a final rule (the “final rule”) pertaining primarily to the responsibilities and conduct of swap dealers and major swap participants.  Additionally, the CFTC proposed a rule (the “proposed rule”) relating to block trading and protecting the identities of swap counterparties in connection with public reporting of swap transactions.

The final rule includes a number of reporting, record-keeping, risk management, and conflict of interest rules for swap dealers and major swap participants.  For example, the rule requires swap dealers and major swap participants to keep full and complete transaction and position information for all swap activities, including all documents on which trade information is originally recorded, and to maintain such records in a manner that is identifiable and searchable by transaction and by counterparty.  Swap dealers and major swap participants are also required by the rule to keep basic business records, such as audit documentation, as well as certain financial records, records of complaints against personnel, and marketing materials.

The final rule also requires swap dealers and major swap participants to establish a risk management program consisting of written policies and procedures designed to monitor and manage the risks associated with their swap activities.  They are also required to establish policies for monitoring their traders throughout the trading day to ensure compliance with trading limits and with procedures for executing and confirming transactions. 

In addition, the final rule restricts the ability of non-research personnel to influence the content of research reports prepared by research analysts employed by a swap dealer, major swap participant, futures commission merchant, or introducing broker, and also prohibits such entities from offering favorable research or threatening to change research for existing or prospective counterparties in exchange for business or compensation.  Futures commission merchants and introducing brokers are also required by the rule to disclose in research reports whether the research analyst maintains a financial interest in any derivative of a type that the analyst follows, and the general nature of such financial interest. 

Finally, the rule requires that swap dealers and major swap participants designate a Chief Compliance Officer, and establishes certain rules regarding the qualifications, reporting lines, and duties of the Chief Compliance Officer, including the preparation of an annual report.

The final rule will go into effect 60 days after its forthcoming publication in the Federal Register. 

The proposed rule pertains to minimum block trade sizes for large notional off-facility swaps and block trades.  The proposal creates a number of specific swap categories within each of the five asset classes previously established by CFTC rule-making:  interest rate, credit, equity, foreign exchange, and other commodity swaps.  The proposed rule lays out a two-period, phased in approach:  during the initial period, which would last at least one year, the CFTC would prescribe minimum block sizes for each swap category within each asset class.  During that initial period, registered swap data repositories would collect data for each asset class; the CFTC would then analyze and use this data to establish appropriate minimum block sizes after the initial period, with the understanding that these minimum block sizes would be updated no less than annually.  The proposal, which is intended to delay the reporting of certain large trades to allow the parties time to hedge the trades before the market moves against them, also includes further measures to protect the identities of parties to block transactions. 

The CFTC had previously proposed a rule on this topic, but chose to withdraw it and replace it after reviewing the comments submitted to the previous proposal.  Comments on the revised proposed rule are due 60 days after its forthcoming publication in the Federal Register.