The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) amended the definition of Eligible Contract Participant and created the new terms Swap Dealer, Security-Based Swap Dealer, Major Swap Participant and Major Security-Based Swap Participant. The Commodity Futures Trading Commission (the “CFTC”) and the Securities and Exchange Commission (the “SEC”) recently adopted further definitions of these terms.

Eligible Contract Participant

Under the Dodd-Frank Act, it is unlawful for a person that is not an Eligible Contract Participant to (i) enter into a swap other than on, or subject to the rules of, a designated contract market or (ii) enter into a security-based swap that is not effected on a national securities exchange registered with the SEC. In addition, certain forex transactions, if entered into by a person other than an Eligible Contract Participant, will be deemed retail forex transactions. Retail forex transactions are subject to additional regulation and are counted towards the de minimis test in the Commodity Exchange Act Rule 4.13(a)(3) exemption from registration as a commodity pool operator, although this should not be the case for most hedge funds, as discussed in further detail in the next paragraph.

A commodity pool is generally an Eligible Contract Participant if it has $5,000,000 in total assets and is formed by a person subject to CFTC regulation (or a foreign person subject to foreign regulation), provided that for purposes of retail forex transactions, each participant in the pool must also an Eligible Contract Participant.¹ The CFTC’s further definition of Eligible Contract Participant provides, however, that the pool participants are not required to be Eligible Contract Participants, if the pool:

(i) is not formed for the purpose of evading regulation by the CFTC;
(ii) has total assets exceeding $10,000,000; and
(iii) is formed and operated by a registered commodity pool operator or by a commodity pool operator who is exempt from registration as such pursuant to Rule 4.13(a)(3).²

Dealers and Major Participants

Any person who engages in swap dealing or security-based swap dealing activities (which are different from hedging or proprietary trading activities) that are neither exempt nor under specified de minimis thresholds is required to register as a Swap Dealer or a Security-Based Swap Dealer, respectively.³ Swap Dealers and Security-Based Swap Dealers will also be subject to requirements concerning, among other things, margin, capital and business conduct.

A person who is not a Swap Dealer or Security-Based Swap Dealer, but who is deemed by the SEC or the CFTC to be systemically important, will be required to register as a Major Swap Participant or a Major Security-Based Swap Participant.⁴ Major Swap Participants and Major Security-Based Swap Participants are subject to similar regulations as Swap Dealers and Security-Based Swap Dealers. The SEC and the CFTC anticipate that very few people will fit within the Major Swap Participant or Major Security-Based Swap Participant definitions.

If you have any questions regarding these definitions, please contact an attorney in the Investment Management Group at Seward & Kissel. In addition, the amendments can be accessed at www.ctfc.gov.

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¹ Persons other than a commodity pool have different tests for determining Eligible Contract Participant status. For example, an individual is an Eligible Contract Participant if he or she invests, on a discretionary basis, an aggregate amount in excess of $10,000,000.

² The CFTC stated in the adopting release that a pool whose participants are limited solely to non-US persons and that is operated by a commodity pool operator located outside of the United States will not need to look-through to its participants when determining Eligible Contract Participant status.

³ Subject to certain exceptions, a person is a Swap Dealer or Security-Based Swap Dealer if it
(i) Holds itself out as a dealer in swaps or security-based swaps;
(ii) Makes a market in swaps or security based swaps;
(iii) Regularly enters into swaps or security based swaps with counterparties as an ordinary course of business for its own account; or
(iv) Engages in any activity causing it to be commonly known in the trade as a swap dealer, security-based swap dealer or market maker in swaps or security-based swaps.

⁴ Subject to certain exceptions, a person is a Major Swap Participant or Major Security-Based Swap Participant if such person is not a swap dealer and
(i) maintains a substantial position in swaps for any of the major swap categories or security-based swaps for any of the major security-based swap categories, in each case excluding certain positions, including those held for hedging or mitigating commercial risk;
(ii) has outstanding swaps or security-based swaps that create substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets; or
(iii) is a financial entity that: (1) is highly leveraged relative to the amount of capital such entity holds and that is not subject to capital requirements established by an appropriate Federal banking agency; and (2) maintains a substantial position in outstanding swaps in any major swap category or security-based swaps in any major security-based swap category.