The Commodity Futures Trading Commission's proposed rules allowing swap agreements to be exempted from futures regulations have drawn predictably opposing views from dealers and the commodities exchanges.
The International Swaps Dealers Association and other swaps market participants are applauding the regulations. They say the rules would remove much of the regulatory and legal uncertainties surrounding swaps transactions.
But representatives of the exchanges say the rules fail to remove legal uncertainties and are unfair because they would keep the exchanges from directly competing with dealers in the swaps market.
Under the proposed rules, one condition that swap agreements must meet to be exempted from futures regulations is that they not be entered into or traded on or through a "multilateral transaction execution facility" which is a technical term for an exchange.
The CFTC had asked members of the public to file formal written comments on the proposed rules by Dec. 14. The exchanges asked for a 30-day extension of the comment period. The commission recently agreed to extend the period to Dec. 28. But the two-week extension has some industry officials to complain the commission wants to rush to finalize the rules before Wendy L. Gramm, the commission's chairwoman, leaves in January.
Gramm announced last month that she would step down from her post before Jan. 20 when President-elect Bill Clinton takes office.
The CFTC proposed the swaps rules last month after being authorized to do so by congress in its recent reauthorization of the Commodity Exchange Act. If adopted in final form, the rules would be retroactively effective as of Oct. 23, 1974, in order to cover all swap agreements entered into since the act was amended to cover financial futures contracts.
Under the proposed rules, which could affect municipal as well as corporate swaps, a swap agreement could be exempted from futures regulations if it met certain conditions.
First, the swap agreement would have to be entered into only by "appropriate persons."
These would include both business entities with a net worth of more than $1 million or total assets of more than $5 million and individuals with a net worth of more than $5 million and total assets exceeding $10 million.
The commission wanted to make sure that the participants of the swap agreements it exempts from regulations are sophisticated and well-capitalized, industry officials said.
Second, the swap agreement could not be part of fungible or interchangeable class of agreements that have standardized material economic terms. Commission officials said they included this condition in the proposed rules because agreements with standardized economic terms look like futures, which must be regulated under the Commodity Exchange Act and traded on or through an exchange.
Third, the creditworthiness of any participant would have to be a "material consideration" in entering into or determining the terms of the swap agreement. In other words, swap agreements could not be subject to a clearing system in which the ultimate guarantor of creditworthiness is that clearing system, industry officials said.
In exchange trading, transactions between buyers and sellers are cleared through a clearing system that distribute credit risks through all of the members of that clearing system.
Finally, the swap agreement cannot be traded on or through an exchange.
However, so-called bilateral margining or payment netting arrangements would be allowed. Bilateral margining arrangements are collateral arrangements between parties that are designed to secure their exposures under the swap agreement. Payment netting arrangements allow buyers and sellers to make net payments.
Gramm, the commission's chairwoman, told swaps dealers last month that the commission will be open to considering clearing house or trading proposals in the future. However, it is not clear whether her successor will feel the same way.
"The commission has clearly indicated a willingness to consider an application from a futures exchange to trade swap contracts," said Kenneth Raisler, a lawyer with Sullivan & Cromwell in New York and former general counsel to the commission.
"Without an application, there is no basis for it to grant an exemption to an exchange because no such market currently exists," he added.
Swap dealers say the proposed rules remove legal uncertainties because the definition of "futures" is so broad and ambiguous that it could have be interpreted by the courts or regulatory agencies to include swaps.
Futures are subject to regulations under the Commodity Exchange Act that require they be traded on or through exchanges, according to swap dealers. Currently, swap transactions are done over the counter or off the exchanges.
Much of the concern that swaps would be considered futures stemmed from a policy statement that the commission issued on swaps in 1989 and from several recent court cases.
But the proposed rules are "an important step in reducing the risk to the financial system" and give the commission "the power to eliminate the legal risks association with swaps in the U.S.," Mark Brickell, a vice president of J.P. Morgan & Co. and a director of the international Swaps Dealers Association said recently.
Representatives of the exchanges, however, say the commission's proposed rules do not remove legal uncertainties because the test of whether a swap agreement is a futures contract is still the same.
"The legal essence of a futures contract has always been that if it's fungible and standardized, it's tradable," said Mark Young, a lawyer with Krikland & Ellis who represents the Chicago Board of Trade.
"What legal certainty has been achieved if the test without the rules is the same test with the rules?" Young asked. He said these were his views and not necessarily those of the exchange.
Young said the proposed rules are unfair because while they would allow dealers to offer swap agreements over their computer screens to their clients, they would not allow them to offer those same agreements over computer screens to exchange members.
"The CFTC is saying that the dealer can be exempt, but the clearing house cannot," Young said, referring to the fact that all exchange trading is done through clearing houses. These rules "allow the exchanges to compete knee to head with the over-the-counter swaps market and not head to head as the CFTC has said it wanted," he continued.
"The two objectives of the commission's attempt to exercise its exemptive powers were to achieve legal certainty and fair competition," Young said, adding. "These proposed rules do not achieve either objective."
The Chicago Board of Trade has expressed interest in establishing a centralized cash market for swaps and similar contracts, Mark Mitchell, a partner at the law firm of Chapman and Cutler in Chicago, said recently.
This kind of market would operate like a bulletin board so that parties would be able to express interest in participating on one side or the other of a swap agreement, he said.
