Swap Dealer
What Is a Swap Dealer?
A swap dealer is an individual or entity that fills in as a swaps broker, makes markets in swaps, or goes into swaps contracts with counterparties.
Swap dealer, as a legal term, was officially defined in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, a piece of legislation brought into the world in the aftermath of the 2007-2008 financial crisis.
Understanding Swap Dealers
A swap is a type of derivative contract by which two parties exchange the cash flows or liabilities from a pair of various financial instruments. Most swaps include cash flows in view of a notional principal amount like a loan or bond, albeit the instrument can be nearly anything. Generally, the principal doesn't change hands. Each cash flow includes one leg of the swap. One cash flow is generally fixed, while the other is variable and in view of a benchmark interest rate, floating currency exchange rate, or index price.
The most common sort of swap is a interest rate swap. Swaps don't trade on exchanges, and retail investors don't generally take part in swaps. Rather, swaps are over-the-counter (OTC) contracts fundamentally between businesses or financial institutions that are altered to the requirements of the two players. Since these are OTC products, they are more opaque than exchange-traded products.
Prior to the financial crisis, swaps had been to a great extent unregulated, occurring primarily among firms and financial institutions, in generally unregulated transactions. In 2011 the Securities and Exchange Commission (SEC) settled proposition requiring security-based swap dealers and participants to register with the commission, as part of the Dodd-Frank legislation.
The swap market is presently overseen by the SEC and the Commodity Futures Trading Commission (CFTC).
As indicated by Section 721 of the Dodd-Frank Act, a swap dealer is an entity that:
- Holds itself out as dealer in swaps;
- Makes a market in swaps;
- Routinely goes into swaps with counterparties as an ordinary course of business for its own record; or
- Takes part in activity making itself be commonly referred to in the trade as a dealer or market maker in swaps, provided, in any case, in no event will an insured depository institution be considered to be a swap dealer to the degree it offers to go into a swap with a customer regarding starting a loan with that customer.
De Minimus Exception
The Republican-drove administration made strides in 2017 to revoke the Dodd-Frank Act. The legislation is far reaching, addressing numerous parts of banking and finance. The definition of a swap dealer isn't controversial, however there is one provision in the Dodd-Frank Act that Republicans looked to address — the de minimus exception rule. This rule excludes swap dealer designation of an entity that participates in de minimus quantity of swap dealing regarding transactions with or for its customers.
The threshold for aggregate gross notional amount (AGNA) that a swap dealer must have completed has been set to $8 billion, as of November 2018. It should fall to $3 billion, a much lower level that would have brought a lot more substances into the domain of regulatory oversight. In any case, the CFTC decided on a bipartisan basis to set $8 billion as the permanent threshold in a November 2018 meeting. The federal agency refered to the increased regulatory coverage for $8 billion as well as the potential for lower liquidity at a lower threshold figure for nonfinancial commodity swaps. Likewise, the agency stated that it wanted to signal long-term stability of the de minimus threshold to permit market participants to plan as long as possible.
Features
- The de minimus threshold for swap trading has been set at $8 billion. This means that an entity won't be considered a swap dealer except if the aggregate notional amount of its deals surpasses that figure.
- Swap dealers are legally identified in the 2010 Dodd-Frank Wall Street Reform.
- A swap dealer works with transactions in swaps contracts, acting as principal or agent.
