CFTC and SEC Finalize Definitions of Swap, Security-Based Swap and other Key Terms

July 12, 2012

The Commodity Futures Trading Commission (the “CFTC”) and the Securities and Exchange Commission (the “SEC”) recently issued final rules and interpretations that define the terms “swap” and “security-based swap” and whether a particular instrument is a swap regulated by the CFTC or a security-based swap regulated by the SEC. These final definitions are of significant importance to many advisers to private funds because an adviser to a private fund that invests in swaps may be required to register with the CFTC as a commodity pool operator.


The term swap includes foreign exchange swaps and forwards (unless exempted by the Secretary of Treasury); foreign currency options; commodity options; non-deliverable forwards in foreign exchange; cross-currency swaps; forward rate agreements; contracts for differences; options to enter into swaps; forward swaps; interest rate and other monetary rate swaps; total return swaps on a broad-based security index1 or on two or more loans; credit default swaps on a group of obligations constituting a broad-based security index; and swaps on futures (other than security futures). The CFTC has jurisdiction over swaps, which are considered commodity interests and count towards the thresholds in the Rule 4.13(a)(3) de minimis exemption from registration as a commodity pool operator.2

Security Based Swap

The term security-based swap includes total return swaps on a single security, loan, or narrow-based security index; credit default swaps based on a single reference obligation or a group of obligations constituting a narrow-based security index; derivatives on yields (where “yield” is a proxy for the price or value of a debt security, loan, or narrow-based security index), except in the case of certain exempted securities; and derivatives based on security futures (other than futures on certain foreign government debt securities). The SEC has jurisdiction over security-based swaps and these instruments will not count towards the thresholds in Rule 4.13(a)(3).

Security-Based Swap Agreement and Mixed Swap

The CFTC and the SEC also recently adopted a further definition of the term “security-based swap agreement” and prescribed regulations concerning “mixed swaps.” Security-based swap agreements are swaps over which the CFTC has regulatory and enforcement authority but for which the SEC also has antifraud and other authority. Security-based swap agreements include, for example, swaps on a broad-based security index. Mixed swaps are regulated by both the CFTC and the SEC. Mixed swaps include, for example, swaps on a single security where the counterparties embed interest-rate optionality or a non-securities component.

Insurance, Security Forwards and Consumer and Commercial Transactions

Without additional guidance, certain products that were not intended to be regulated by the CFTC or the SEC could be considered swaps or security-based swaps under the broad definitions of those terms. The CFTC and the SEC have clarified that insurance products, security forwards and certain consumer and commercial transactions are neither swaps nor security-based swaps. Security forwards include mortgage-backed securities that are eligible to be sold in the to-be-announced market. Consumer transactions are transactions entered into primarily for personal, family or household purposes, such as consumer loans or mortgages. Commercial transactions are transactions that involve customary business or commercial arrangements, such as employment contracts and retirement benefit arrangements. In addition, loan participations that reflect an ownership interest in the underlying loan or commitment will not be considered swaps or security-based swaps.

These definitions will become effective 60 days after the date of publication in the Federal Register, however, the compliance date for many rules will be 180 days after such date of publication. This memorandum is not a comprehensive discussion of these definitions. Following publication of the final definitions, we will provide more detailed guidance.

If you have any questions regarding these definitions, please contact an attorney in the Investment Management Group at Seward & Kissel.


1 A broad-based security index is a security index that is not a narrow-based security index. Generally, a narrow-based security index is an index that meets any one of the following four criteria:

(a) it has nine or fewer component securities;
(b) a component security compromises more than 30% of the index’s weighting;
(c) the five highest weighted component securities in the aggregate comprise more than 60% of the index’s weighting; or
(d) the lowest weighted component securities comprising, in aggregate, 25% of the index’s weighting have an aggregate dollar value of average daily trading volume of less than $50 million (or in the case of an index with more than 15 component securities, $30 million).

2 Please see our memorandum from May 2, 2012 for a discussion of the Rule 4.13(a)(3) de minimis exemption from registration as a commodity pool operator.