This week the CFTC issued its definitions around the controversial Major Swap Participant (MSP) category required by the Dodd-Frank bill. The intent of the bill was to capture previously unregulated (i.e. non bank) active swap participants who could cause systemic risk. The challenge was to define a set of rules that can encompass this group without the CFTC having to go in an audit every hedge fund, insurance company or active corporate end-user or to create a public list of MSPs.
The rules now pending a 60-day public comment period will require many active swap participants to beef up their systems to properly handle valuations, manage collateralized swaps, track FAS 133 (ASC 815) compliant swaps or bona fide hedge documentation, netting and calculating potential future exposure. The reason is, in order to avoid being tagged an MSP, the swap user has to perform two tests to see if they breach asset class defined position limits that would otherwise require them to register as an MSP, and therefore essentially mirror some of the strict Swap Dealer regulations.
The first step an MSP must take is to not include any hedges of commercial risk. Thankfully the CFTC has allowed a fairly broad array of methods to choose from, but for those entities already in compliance with FAS 133, you are allowed to leverage the standard and existing documentation and systems in place. Not often that a new benefit of FAS 133 comes your way so take advantage of it!
For the remaining positions, you have to perform two tests on determining if you breach the Substantial Position threshold. The first is after you calculate the valuations, you can deduct out those positions that are collateralized and those offset by netting. The threshold for this test is a healthy $1bn in exposure for FX and commodities and $3bn for interest rate exposure. The second test is to measure the potential future exposure of the uncollateralized positions. There is a simple mathematical formula applied that makes intuitive sense but will still require systems to handle the new matrix and discounting requirements. The threshold for potential future exposure is double the first test. Both tests have to be performed on a daily average notional which is required to avoid any buy/sell games to reduce the notional right before the tests are performed.
Go to www.cftc.gov to read the details of the rules in the Federal Register and write in your comments. Simultaneously, if you think you may be close to those thresholds, then the clock is ticking on getting systems in place to calculate the threshold tests and to prepare to comply with being a registered MSP.