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Hagan-Lincoln Colloquy Advises SEC and CFTC in Defining Major Swap and Security-Based Swap Participants

By Jim Hamilton

A colloquy between Senator Hagan and Senator Lincoln revealed that, when the CFTC and SEC are making the determination as to whether a person dealing in swaps is a major swap participant or major security-based swap participant, it is the intent of Congress that both the CFTC and the SEC focus on risk factors that contributed to the recent financial crisis, such as excessive leverage, under-collateralization of swap positions, and a lack of information about the aggregate size of positions. According to Senator Lincoln, when determining whether a person has a substantial position, the CFTC and the SEC should also consider the person?s relative position in cleared versus uncleared swaps and may take into account the value and quality of the collateral held against counterparty exposures. Congress wants the regulators to distinguish between cleared and uncleared swap positions when defining what a substantial position would be. (Cong. Record, July 15, 2010).

Similarly, where a person has uncleared swaps, the regulators should consider the value and quality of such collateral when defining substantial position. Bilateral collateralization and proper segregation substantially reduces the potential for adverse effects on the stability of the market. Entities that are not excessively leveraged and have taken the necessary steps to segregate and fully collateralize swap positions on a bilateral basis with their counterparties should be viewed differently. In addition, it may be appropriate for the CFTC and the SEC to consider the nature and current regulation of the entity when designating an entity a major swap participant or a major security-based swap participant. For instance, entities such as registered investment companies and employee benefit plans are already subject to extensive regulation relating to their usage of swaps under other titles of the U.S.Code. They typically post collateral, are not overly leveraged, and may not pose the same types of risks as unregulated major swap participants. Moreover, as a general rule, the CFTC and the SEC should look at each
entity on an individual basis when determining its status as a major swap participant. (Cong. Record, July 15, 2010).

Full post as published by Jim Hamilton's World of Securities Regulation on August 10, 2010 (boomark / email).