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The CFTC has adopted final rules regarding business conduct standards for swap dealers.  The rules are expected to have far reaching impacts on the way corporate counterparties enter into typical derivative transactions.

Know Your Counterparty.  Swap dealers must implement policies and procedures reasonably designed to obtain and retain a record of the essential facts concerning each counterparty whose identity is known to the swap dealer prior to the execution of the transaction that are necessary for conducting business with such counterparty. For purposes of this section, the essential facts concerning a counterparty are:

  • Facts required to comply with applicable laws, regulations and rules;
  • Facts required to implement the swap dealer’s credit and operational risk management policies in connection with transactions entered into with such counterparty; and
  • Information regarding the authority of any person acting for such counterparty.

Disclosure of Material Information.  Prior to entering into a swap, a swap must disclose to any counterparty to the swap material information concerning the swap in a manner reasonably designed to allow the counterparty to assess:

  • The material risks of the particular swap, which may include market, credit, liquidity, foreign currency, legal, operational, and any other applicable risks;
  • The material characteristics of the particular swap, which must include the material economic terms of the swap, the terms relating to the operation of the swap, and the rights and obligations of the parties during the term of the swap; and
  • The material incentives and conflicts of interest that the swap dealer may have in connection with a particular swap.

Fair Dealing in Communications.  In any communication between a swap dealer and any counterparty, the swap dealer must communicate in a fair and balanced manner based on principles of fair dealing and good faith.

Antifraud Rules.  The Commodity Exchange Act, or CEA,  grants the CFTC discretionary authority to promulgate rules applicable to swap dealers related to fraud, manipulation and abusive practices. The statutory provision prohibits fraudulent, deceptive and manipulative practices by swap dealers.  Rule § 23.410(a) follows the statutory text.  The rules as adopted includes an affirmative defense for violations of the business conduct rules if the swap dealer can establish it did not act intentionally or recklessly in connection with the violation and complied in good faith with policies and procedures designed to meet the business conduct rules.

Private Right of Action.  Commenters on the proposed rule noted that the proposed rules may indirectly subject swap dealers to private rights of action because of the statutory language in Section 4s(h) of the CEA.  Section 22 of the CEA provides a private right of action for any violation of the CEA, and Section 4s(h)(l) states that ‘‘[e]ach registered swap dealer and major swap participant shall conform with such business conduct standards * * * as may be prescribed by the Commission by rule or regulation.”  The CFTC noted in the adopting release that the CFTC cannot exempt swap dealers from private rights of action under Section 22 of the CEA.

Reliance on Representations.  A swap dealer can rely on the written representations of a counterparty to satisfy its due diligence requirements under the business conduct standards, unless it has information that would cause a reasonable person to question the accuracy of the representation. If agreed to by the counterparties, the representations may be included in counterparty relationship documentation and may satisfy the relevant requirements for subsequent swaps offered to or entered into with a counterparty.  However, the  counterparty must undertakes to timely update any material changes to the representations.

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