The SEC's Newly Proposed Rules on Derivative "Swaps"
This Wednesday, the Securities and Exchange Committee (SEC) voted to propose rules that would impose certain business conduct standards on banks and other firms that deal in complex financial instruments known as “swaps.” For the uninitiated, swaps are derivatives in which parties exchange the benefits of one financial instrument for another in order to trade the cash flow streams of the particular assets. Swaps are typically used either to insure against market risks such as interest rate fluctuations or to make speculative investments based upon expected changes in the prices of the financial benchmarks underlying the instruments.
This effort to regulate conduct in the derivative swap market by the SEC emerges out of the Dodd-Frank Act's comprehensive framework for monitoring over-the-counter swaps and the activities of “security-based swap dealers” and “major security-based swap participants” that engage in security-based swap transactions with counterparties (including “special entities” such as federal agencies, states and political subdivisions, employee benefit plans, governmental plans, and endowments). The rules the SEC advanced this week would require swap dealers to disclose to their buyers the risks associated with transactions, the potential conflicts of interests involved, and the day-to-day values of their swaps, which would aid purchasers in assessing the overall worth of specific deals. The rules would also mandate that swap dealers doing business with special entities ensure that their counterparts use independent financial advisers to assist with transactions. Additionally, dealers would be prohibited from participating in a wide range of “pay to play” practices.
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