The CFTC has approved its final rules regarding business conduct standards for swap dealers (“SDs”) and major swap participants (“MSPs”), which governs their dealings with counterparties generally and imposes additional requirements to their dealings with Special Entities (which include governmental entities, certain employee benefit plans under ERISA, and endowments). The rules prohibit certain abusive practices, require disclosures of material information to counterparties, and require SDs and MSPs to undertake certain due diligence relating to their dealings with counterparties.
Prohibition of Abusive Practices; Confidentiality
Prohibitions include those against fraudulent, deceptive, and manipulative acts or practices. An affirmative defense is available to non-scienter fraud violations based on good faith compliance with policies and procedures. Counterparty information must be treated with confidentiality.
Duties to All Counterparties
Verification of Counterparty Information – SDs and MSPs must verify that a counterparty is an eligible contract participant and whether a counterparty is a Special Entity; specified counterparty representations may be relied on as a safe harbor.
Disclosure of material information – SDs and MSPs must disclose material information in a manner sufficient to allow their counterparties counterparty to assess material risks and characteristics of transactions and SD/MSP incentives and conflicts of interest.
Daily Mark – SDs and MSPs must provide counterparties the daily mid-market mark for their uncleared swaps.
Clearing Disclosures – SDs and MSPs must notify counterparties of their rights (1) to clear swaps that are not required to be cleared and (2) to select derivatives clearing organizations.
Communications and Fair Dealing – SDs and MSPs must communicate with counterparties in a fair and balanced manner based on principles of fair dealing and good faith.
Scenario Analysis (applies to SDs only) – SD counterparties may elect to receive scenario analyses from SDs for swaps that are not made available for trading on swap execution facilities or designated contract markets.
Duties to Special Entities
Advising Special Entities (SDs only) – A SD that “acts as an advisor to a Special Entity” has a duty to act in the “best interests” of the Special Entity. A SD “acts as an advisor to a Special Entity” when it recommends a swap or swap trading strategy tailored to the needs or characteristics of the Special Entity. Safe harbors are available with respect to ERISA plans that represent that they have ERISA fiduciaries and under other specified circumstances based on representations by SDs and their Special Entity counterparties.
Special Entity Representatives – A SD or MSP must have a reasonable basis to believe that a Special Entity (other than an ERISA plan) has a “representative” that meets the following criteria:
• is sufficiently knowledgeable to evaluate the transaction and risks;
• is not subject to statutory disqualification;
• is independent of the SD or MSP;
• acts in the best interests of the Special Entity;
• makes appropriate and timely disclosures to the Special Entity;
• evaluates, consistent with any guidelines provided by the Special Entity, fair pricing and appropriateness of the swap; and
• in the case of a governmental Special Entity, is subject to restrictions on certain political contributions to public officials of the governmental Special Entity
Political Contributions by SDs
SDs must refrain from entering swaps with a governmental Special Entity for two years after making certain political contributions to officials of the governmental Special Entity.
Means of Compliance with Business Conduct Standards
As appropriate, SDs and MSPs can:
• reasonably rely on representations of counterparties to meet due diligence obligations
• make disclosures by any reliable means agreed to by the counterparty
• make disclosures of material information to counterparties in a standard format
• include representations and disclosures in counterparty relationship documentation, and deem them renewed with each subsequent swap.