Capital Markets: Derivatives 2024 Comparisons

Regulators

The derivatives markets in the United States are primarily regulated by the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). In addition, other US regulators and agencies with jurisdiction over specific markets and/or market participants have regulatory authority that extends to derivatives transactions. These include the US Prudential Regulators (including the Board of Governors of the Federal Reserve System and other banking regulators), the US Department of the Treasury, and the National Futures Association, among others.

The regulatory jurisdiction of all these regulators often overlaps and is sometimes in tension. This has resulted in a very complex regulatory regime that often requires parsing the extent of a regulator’s jurisdiction and which regulator’s rules will apply to a particular derivative or market participant.

Statutes

The statute governing most US derivatives regulation is the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which came into effect in 2010 following the failure of Lehman Brothers and the ensuing financial and market crisis. Pursuant to Dodd-Frank, the CFTC, SEC and other US regulators have introduced rules regulating all aspects of the derivatives markets. These include rules addressing business conduct standards, disclosure requirements, swap data reporting and record-keeping, transaction execution and documentation, margin requirements, clearing mandates, stays on the exercise of remedies, swap dealer registration, execution mandates, registration and regulation of swap execution facilities, and much more.

Dealers and Non-Dealers

One feature of the US derivatives regulatory regime that is distinct from other “peer” regimes is that the bulk of the US regulations fall directly only on regulated and registered “dealer” entities, and only indirectly on non-dealers. For example, in the US, the regulatory requirement to collect and transfer margin (collateral) to cover swap exposure (risk) is imposed directly on regulated swap dealers – a non-dealer “end-user” is not obliged to comply with the regulatory requirements. However, non-dealers would not be able to participate in the market with dealers if they refused to comply with a dealer demand to receive or transfer margin in accordance with the regulatory requirements. Thus, non-dealer market participants in the US must facilitate dealer compliance with the rules if they want to trade in the derivatives market.

The Significance of Dodd-Frank

Prior to Dodd-Frank, derivatives markets in the US had historically been lightly regulated and shaped primarily by market forces and incentives. The development of credit derivatives and other derivative instruments was led by major investment banks catering to, and in some cases creating, investor demand, and participation in the over-the-counter (OTC) derivatives market required compliance with only minimally burdensome asset tests.

This state of affairs was disrupted by the bankruptcy of Lehman Brothers in 2008 and the ensuing financial crisis, which resulted in the passage of Dodd-Frank. This statute presaged a sweeping regulatory overhaul of the derivatives and financial markets, providing for increased regulation and supervision of banks and derivatives dealers. The various provisions of Dodd-Frank were informed and supplemented by guidance from supra-national institutions such as the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (BCBS-IOSCO) as well as co-operation among the central banks and bank regulators of the major global economies.

Since the passage of Dodd-Frank in 2010, the CFTC, SEC and other US regulators have been developing regulations designed to implement Dodd-Frank’s various mandates, a process which continues to this day. The CFTC has been the quickest of the US regulators in finalising its rules, but the SEC has recently been catching up. Thus, the most important new rules that will affect derivatives and trading markets over the near and medium-term have come from the SEC, including the following.

Latest Key Developments From the SEC

Mandatory clearing of US treasury cash and repo transactions

The SEC in December 2023 finalised its clearing mandate for transactions in US treasury securities, perhaps the most important and far-reaching rule enacted by US regulators during the past year. This rule provides a roadmap for the transition to mandatory clearing of transactions in US treasury securities, including for repurchase (repo) transactions in US treasury securities. The Fixed Income Clearing Corporation (FICC) has proposed a number of changes to its rule book to comply with the SEC’s mandate, including rules addressing risk management, protection of customer assets, and access to clearing and settlement services for “indirect” (ie, non-clearing member) participants. Both the CME Group and Intercontinental Exchange (ICE) have announced their intention to offer US treasury clearing services to compete with those offered by the FICC. The clearing mandate for US treasury repo transactions will come into effect for non-dealer market participants in June 2026.

T+1 Settlement

Beginning from 28 May 2024, the standard settlement cycle for securities transactions was shortened from T+2 to T+1. This change applies to the same types of securities transactions that had been covered under the prior standard, including purchases and sales of stock, bonds, municipal securities, ETFs, as well as some mutual funds and limited partnerships that trade on exchange. The T+1 settlement requirement also applies to the delivery of an underlying security in connection with the exercise of a derivative instrument, including OTC options.

Security-based SEF registration

The SEC in December 2023 finalised its Reg SE, which establishes a new regime for the regulation and registration of security-based swap execution facilities (SBSEFs). This is an important step in aligning the SEC’s regulatory regime with that of the CFTC and other major global regulators, as it will ultimately pave the way for the SEC to introduce clearing and execution mandates for security-based swaps, in particular relating to single-name credit derivatives. While the market is still waiting for these mandates, the immediate impact of Reg SE was to prohibit persons covered by Reg SE (generally, US persons, and non-US persons whose obligations are guaranteed by a US person or whose trades were arranged, negotiated or executed in the US) from executing security-based swaps on non-US venues that did not intend to register with the SEC.

By contrast with the SEC, the CFTC’s new rules over the past year relating to derivatives were relatively modest in scope. Some highlights are listed below.

Latest Key Developments From the CFTC

Access to foreign boards of trade

The CFTC in August 2024 amended its existing regulations to allow a foreign board of trade (FBOT) to provide direct access to certain introducing brokers acting for its US customers. This development reflects the increasingly important role introducing brokers have taken on in the market for cleared derivatives and financial instruments, and should help to facilitate US customers’ access to FBOTs and increase overall market liquidity.

Reporting related to swap dealer capital requirements

The CFTC recently adopted amendments to its minimum capital requirements and financial reporting obligations for swap dealers (SDs). These amendments are intended to facilitate compliance by non-bank SDs, and to align the compliance obligation for both US and non-US bank SDs with that required by their respective US or home country regulators.

Large trader reporting

Finally, the CFTC is modernising and updating the submission and technological framework for its large trader reporting regime. The CFTC intends these amendments to allow better and more efficient data integration and quality checks, as well as to better accommodate reporting of positions in newer financial contracts.

The trends in markets and products in the US appear to be following those of the UK, EU and other developed markets, with an increased focus on ESG products (including new products in carbon credit markets) and, of course, cryptocurrencies. These larger trends may nonetheless be affected by political developments in the US, given the fact that a new administration takes office in January 2025.

In the US, futures contracts are available for stocks, stock indices, FX, commodities (including energy, agriculture and metals), as well as more recently developed contracts for carbon and certain cryptocurrencies. The major futures exchanges also offer options on futures for most of these contracts. Futures contracts in the US are regulated by the CFTC and traded on regulated exchanges.

Carbon futures have been traded in the US for more than 20 years. The US carbon futures market is a “voluntary” market, offering contracts related to carbon credits and offsets, as well as exposure to carbon market indices. In an effort to further bolster this market, the CFTC in September 2024 issued guidance intended to promote the development of a listed futures contract market in voluntary carbon credits. 

Cryptocurrency futures are another recent development, with Bitcoin contracts debuting on the CME in 2017, and Ethereum contracts available since 2021. These contracts operate in manner similar to futures on stocks, but are limited to cash settlement and are settled by reference to certain bespoke cryptocurrency reference rates managed by the CME.

New Kids on the Block: Crypto ETFs and ETF options

After ten years of efforts by registrants, the SEC in January 2024 finally approved bitcoin (BTC) exchange traded funds (ETFs) in the United States, followed by the SEC’s approval of Ethereum (ETH) ETFs in July 2024. The SEC then granted approval, in September and October 2024, for options contracts referencing BTC ETFs to be listed on the Nasdaq and NYSE.

Swaps in the US are regulated by the CFTC and SEC, depending on the nature of the underlying reference asset and other features of the instrument. Most swaps are subject to the CFTC’s jurisdiction, while the SEC’s jurisdiction is limited to “security-based swaps” (SBS) comprising a much smaller subset of the swap market. A further subset of “mixed swaps”, having features of both swaps and SBS, are jointly regulated by the CFTC and SEC.

The US regulatory regime thus distinguishes between “swap dealers” (SDs) dealing in swaps, who are required to comply with the CFTC’s rules, and “security-based swap dealers” (SBSDs) dealing in SBS, who are required to comply with the SEC’s rules. Updated lists of registered SDs and SBSDs are available on the CFTC and SEC websites.

The US regulations also contemplate supervision of “major swap participants” (MSPs) and “major security-based swap participants” (MSBSPs) by the CFTC and SEC, respectively. These latter categories are intended to describe non-dealer and non-bank participants in the swap and SBS markets that may potentially present systemic risk – the model for these being AIG Financial Products, an essentially unregulated affiliate of an insurance company that engaged in the large-scale trading of credit derivatives and whose failure in 2008 rivalled that of Lehman Brothers in its impact. To date, there are no firms that have been required to register as either an MSP or MSBSP. Firms registered as MSPs and MSBSPs would be subject to prudential supervision in a manner similar to that of SDs and SBSDs, including compliance with business conduct standards and capital, reporting, and margin requirements.

Banks regulated by the US Prudential Regulators must comply with the Prudential Regulator capital requirements and mandatory swap margin requirements, which apply regardless of whether the bank is dealing in swaps or SBS. Thus, a bank will not be subject to either the CFTC or SEC margin requirements or capital requirements for SDs and SBSDs, notwithstanding that the bank may be registered as a dealer with either or both the CFTC and SEC. However, a bank that is registered as an SD or SBSD must comply with all the other relevant CFTC and SEC swap rules.

The US swaps market comprises both bilateral OTC swaps and swaps that are cleared and that may be subject to mandatory execution requirements. As explained in more detail in 3.1.2 Clearing, the CFTC has mandated that certain standardised interest rate swaps and credit default swap index trades must be executed on a registered SEF and cleared via a central counterparty (CCP) that is a registered derivatives clearing organisation (DCO). However, SEF execution and clearing services are also available for swaps that are not subject to the CFTC’s execution and clearing mandates, such as certain single-name credit default swaps and FX swaps. 

CFTC is for Swaps; SEC is for Security-Based Swaps

CFTC-regulated swaps include the following:

• interest rate swaps;
• commodity swaps;
• FX swaps and non-deliverable FX forwards;
• foreign exchange swaps and (deliverable) foreign exchange forwards (which are exempt from most CFTC swap regulation, as discussed below);
• weather, energy and emissions swaps;
• credit default swaps (CDS) referencing a broad-based security index;
• CDS referencing more than one loan or any loan index;
• total return swaps (TRS) referencing a broad-based security index (whether debt or equity securities);
• TRS referencing more than one loan;
• equity variance and dividend swaps referencing a broad-based security index;
• correlation swaps referencing a broad-based security index and any commodity or commodity index (including FX, rates and rate indices);
• OTC options on or referencing any asset other than an option on a security or a certificate of deposit, or group or index of securities;
• other swaps referencing broad-based securities indices, government securities and most other reference assets; and
• swaptions on any of the above.

The SEC regulates “security-based swaps”, including the following:

• single-name CDS;
• CDS referencing a narrow-based index of securities;
• TRS referencing a single security or loan;
• TRS referencing a narrow-based index of securities;
• OTC options for the purchase or sale of a single loan; and
• equity variance or dividend swaps referencing a single security or narrow-based index of securities.

As noted above, “mixed swaps” have features of both swaps and SBS and are jointly regulated by the CFTC and SEC. These may include the following:

• a TRS on a single security that incorporates an FX swap or hedge;
• a correlation or basket swap that includes both a narrow-based index of securities and an index or basket of commodities; and
• a CDS referencing a single loan.

In assessing whether a derivative referencing an index or basket of securities is regulated by the CFTC or the SEC, one has to distinguish between indices that are “broad-based” and those that are “narrow-based”. The CFTC will regulate a derivative referencing a “broad-based security index”, which is one that has ten or more component securities, or that otherwise does not meet the criteria for a narrow-based security index. The SEC regulates derivatives that reference a “narrow-based security index”, which is an index that has nine or fewer component securities and meets certain weighting and other requirements.

Note that options on securities or securities indices, whether traded OTC or on exchange, are regulated as securities by the SEC, and are not treated as either swaps or SBS.

Foreign exchange swaps and deliverable foreign exchange orwards are defined as “swaps” but are generally exempt from regulation as swaps under the CFTC rules. However, registered swap dealers must comply with the CFTC’s swap data reporting and business conduct standards in connection with their dealing activity in these products. This will be addressed further in 2.6 Exemptions, Non-derivative Products and Spot Transactions.

CFTC Regulation of Swaps

The CFTC’s regulation of swaps encompasses all aspects of the swap market, including the following core areas.

Business conduct standards

The business conduct standards required of SDs (and MSPs) include requirements related to: disclosure of risk and offer of scenario analysis; notification requirements, suitability determinations (subject to safe harbour provision); maintenance of confidential information, limitation of conflicts of interest; verification of counterparty status; establishment of risk management procedures and business continuity plans; and adoption of policies and procedures to mitigate anti-competitive actions. There are additional standards applicable to dealings with ERISA plans (US corporate pension schemes), municipalities and local governments, and other “Special Entities” that the CFTC has determined require additional protection. The business conduct standards are detailed more fully in 3.1.6 Business Conduct.

Reporting and record-keeping

CFTC rules require that swaps must be reported to a swap data repository (SDR) or, if no SDR is available, to the CFTC. The report must include the “primary economic terms” of the swap (price, underlying reference asset, term, etc). In addition, daily updates (“continuation data”) are required for valuation data and changes to primary economic terms. The party with responsibility for reporting is the SD (or MSP), the SEF (for confirmation data in the case of swaps executed on an SEF) or the DCO (in respect of continuation data for cleared swaps). Inter-affiliate swaps may be exempt from the reporting requirement subject to certain conditions. The reporting requirements of the CFTC (and SEC) are addressed more fully in 3.1.5 Reporting.

Swap market participants, including non-dealers, are also required to maintain full, complete and systematic records of all swaps to which they are a party. The records should include data sufficient to identify and re-create the swap, as well as information demonstrating that the party is entitled to rely on the clearing exemption for end-users (if applicable). These records must also be:

• retained for the life of the swap and for a period of five years after termination of the swap;
• retrievable within five business days; and
• made available for inspection upon the regulator’s request.

Clearing

Dodd-Frank mandated that swaps must be cleared if the CFTC determines that clearing is mandatory for a particular swap and a DCO is available that accepts the swap for clearing. This requirement applies to all market participants, except central banks and commercial end-users hedging risk. The US regulatory clearing mandate is discussed in further detail in 3.1.2 Clearing.

Execution and clearing venues

Pursuant to Dodd-Frank, the CFTC regulates multi-participant trading platforms for the execution of swaps (ie, SEFs), as well as clearing houses (ie, central counterparties or CCPs/derivatives clearing organisations or DCOs) that accept swaps for clearing. The CFTC requires SEFs to comply with a number of requirements, including:

• establishing rules for trading, trade processing and participation;
• providing impartial access to the market;
• adopting and monitoring position limits (including those mandated by the CFTC);
• retaining the ability to exercise emergency authority to intervene (including authority to close out or transfer positions, or suspend trading); and
• providing market disclosure of transactions.

DCOs must comply with business conduct standards, ownership and capital requirements, customer protection and collateral segregation requirements, and requirements allowing customers to transfer positions and funds among clearing members of the DCO.

Execution and trading

The CFTC requires swaps that are subject to a clearing mandate and that have been “made available to trade” (MAT) by an SEF, to be executed on the SEF.  Swaps for which MAT determinations have been made are typically listed in the related SEF rule book or website. MAT determinations are submitted by SEFs to the CFTC, and may also be viewed on the CFTC website. The execution requirements for swaps (and SBS) are addressed further in 3.1.3 Mandatory Trading.

Margin

Swaps are subject to mandatory margin (collateral) requirements encompassing both variation margin (VM) and initial margin (IM). The VM requirements are applicable to swaps entered into between all market participants where one party is an SD and the other is either an SD or any “financial end-user”, whereas the IM requirements will only apply where an SD is facing another SD or a financial end-user with “material swaps exposure”, as described below. The definition of “financial end-user” includes financial institutions not registered as SDs, investment funds and advisers, mutual funds, pension plans, insurance companies, and any entity that is primarily engaged in activities of a financial nature. The VM and IM requirements do not apply where an SD faces a party that is not a financial end-user.

CFTC rules

The CFTC rules for VM and IM broadly align with the principles set forth by BCBS-IOSCO and as implemented across most developed market jurisdictions. VM must be exchanged and collected by both parties on the basis of daily determinations of mark-to-market exposure (risk), such that the exposure calculated at the close of any business day is fully collateralised on the following business day (subject to certain notification deadlines to accommodate operational issues). There is no unsecured “threshold” allowed that would result in uncollateralised exposure. In addition, the “minimum transfer amount” below which an amount needed to satisfy a VM requirement does not have to be transferred is capped at USD500,000 (which cap is both shared with the IM requirement, if any, and allocated among all entities sharing a consolidated balance sheet).

Mandatory IM is required for all uncleared swaps entered into between an SD and any financial end-user that has “material swaps exposure” (MSE). MSE is defined as having an average aggregate notional amount (AANA) of swaps outstanding in excess of USD8 billion, as determined by taking the average of the swap (gross) notional outstanding on the last business day of March, April and May of every year. If this average is above the MSE threshold, the IM requirement for that financial end-user will be effective on 1 September of that year. The AANA must include all swaps outstanding for all entities that are balance sheet consolidated, such that the MSE so determined is attributed in total to every entity so consolidated.

Prudential Regulator margin rules

Note that banks regulated by the Prudential Regulators must comply with the Prudential Regulator margin rules for swaps and SBS. While these are very similar to the CFTC rules, one of the key distinctions relates to how the MSE determination is made for the purposes of the IM requirement. While the MSE threshold is the same (USD8 billion), the Prudential Regulator IM rules require the AANA to be determined on the basis of the swap notional outstanding on every business day of June, July and August of every year. If the AANA is above the MSE threshold, the IM requirement is effection on 1 January of the following year.

General

For both the CFTC and Prudential Regulator rules, the amount of the IM is determined on the basis of either an approved model, or by reference to the schedule included in the rule. Most SDs will use an IM model that was developed by the International Swaps and Derivatives Association, Inc (ISDA) and that has been approved by the CFTC – this is the so-called “Standard Initial Margin Model” (SIMM, sometimes referred to as “ISDA SIMM”). The IM must be exchanged bilaterally with no offset, so that each party is holding the appropriate amount as determined on the basis of either SIMM or the schedule. In addition, the IM must be held at a third-party custodian or depository in order to mitigate the risk of loss in the event the secured party with respect to such IM becomes insolvent.

Collateral posted to satisfy the VM and IM requirements must meet specified criteria in order to be valid and in compliance with the margin rules. This generally includes cash (USD or another major currency) and government securities (US treasuries or other major economy government debt securities), as well as debt of US government-sponsored entities (GSEs), certain publicly traded corporate equities, money market funds linked to US treasuries, and gold. Minimum regulatory haircuts (discounts) apply to all non-cash collateral. Note, however, that collateral for the VM between SDs is limited to cash denominated in USD or other major currency, or denominated in the settlement currency of the swap. 

The margin rules require that swap documentation include the methodology agreed by the parties for determining the swap exposure, the value of the collateral, and the amount of the IM, as well as dispute resolution procedures related to these determinations. 

Swap dealers and major swap participants

Entities that meet certain specified criteria must register with the CFTC as an SD or MSP. An entity may be considered an SD if it:

• holds itself out as a dealer in swaps;
• makes a market in swaps;
• enters into swaps with counterparties for its own account as an ordinary course of business; or
• otherwise engages in any activity which would cause the entity to be known in the market as a dealer or market maker in swaps. 

These activities are enumerated in the disjunctive, so that engaging in any single one of these activities might be sufficient for an entity to be considered an SD, even if none of the other activities apply.

There are a number of exceptions provided in the CFTC SD rules, including for entities that:

• enter into swaps for their own account but not as part of a “regular business”;
• are insured depository institutions offering swaps to customers in connection with originating loans to those customers; and
• are engaging in de minimis dealing activity, meaning dealing in swaps with US persons that have a total notional amount outstanding of less than USD8 billion over any 12-month period.

As a general rule, investment advisors and the investment vehicles for which they act would not be considered to be engaging in swap-dealing activity. However, certain activities or business lines that investment advisers or asset managers engage in may need to be carefully assessed in view of the broad scope of the enumerated activities under these rules.

The MSP designation is intended to capture non-dealer and non-bank entities that engage in swap activity to an extent that raises the potential for systemic market risk. Thus, the MSP rules provide that an MSP is an entity:

• that has a “substantial position” in swaps of any category (excluding those entered into for hedging or mitigating commercial risk);
• whose swaps result in “substantial counterparty exposure” that presents systemic market risk (disregarding whether such swaps are related to hedging activity); or
• that is “highly leveraged” and has a substantial position in swaps of any category (disregarding whether such swaps are related to hedging activity). 

An entity may be an MSP based on its position in any one of four enumerated categories of swaps, including rate swaps, credit swaps, equity swaps (other than SBS, which are relevant only for major security-based swap participant thresholds), and commodity swaps.

There are a number of exceptions and safe harbours provided in the MSP rules. However, the key factor in determining whether an entity is an MSP relates to its uncollateralised exposure, such that the MSP rules are not a concern for the vast majority of market participants that post collateral to cover their swap exposure. Indeed, there is no entity that has yet been required to register with the CFTC as an MSP. That said, careful analysis of the MSP criteria may be required in connection with certain business lines and swap activities that involve very large notional amounts (eg, USD100 billion or more) and for which the collateral or security package consists of assets or obligations other than cash and securities.

Capital requirements

SDs and MSPs that are not regulated by the Prudential Regulators are subject to the CFTC’s capital requirements. The CFTC rules provide three alternative methods for SDs to determine and comply with their minimum capital requirements, including:

• a net liquid assets method;
• a bank-based method; and
• a tangible net worth method.

MSPs are required to maintain a positive tangible net worth. Those SDs (or MSPs) that are regulated by the Prudential Regulators must comply with the Prudential Regulator rules, rather than those of the CFTC. There are no exemptions.

The CFTC capital rules for SDs and MSPs also address processes for the approval of models, reporting and notification requirements, and substituted compliance for SDs that are required to comply with the capital requirements of a non-US regulator.

SEC Regulation of Security-Based Swaps

The SEC’s rules for SBS cover the same core areas as described above in relation to the CFTC’s swap regulations. There are, however, some important distinctions between the CFTC and SEC rules that should be noted, as follows.

SBS initial margin

The SEC’s initial margin rules for SBS are in general designed to align the margining of SBS with the margin requirements applicable to US broker-dealers in connection with securities transactions. As such, the SEC’s rules for initial margin are a bit different from the CFTC (or Prudential Regulator) rules. For example, the SEC rules do not require two-way posting or exchange of initial margin for SBS, nor do they require that initial margin posted by a counterparty in respect of SBS be held at a third-party custodian or depository. Rather, only the registered SBSD is required to collect initial margin, and the SBSD is required to hold this margin in a manner consistent with how US broker-dealers hold customer assets. The amount of initial margin required is generally determined in accordance with standard US broker-dealer haircuts and margin requirements applicable to securities positions; the use of models (like SIMM) is limited to SBS such as single-name CDS that are not “equity SBS”, unless the SBSD is a “standalone” SBSD that is registered with the SEC only as an SBSD and not also as a broker-dealer.

Clearing and execution

The SEC has not yet proposed mandatory clearing rules for any security-based swap. And although the SEC has recently finalised REG SE relating to the registration of SBSEFs and execution of SBS (as noted in 1.2 Historical and Forward-Looking Trends), no SBSEF has yet formally submitted a MAT determination for any SBS.

With the exception of FX forwards, forward contracts are not regulated as “derivatives” in the US, and are not subject to regulations that apply to swaps and SBS.

Commodity Forwards

Commodity forwards are outside the jurisdiction of the CFTC, as long as they fit within the statutory exclusion. This exclusion applies to any forward contract that relates to “non-financial” commodities, and effectively removes most spot and forward contracts in commodities from the CFTC’s jurisdiction. However, FX forwards are subject to CFTC regulation as swaps, although physically-settled foreign exchange swaps and foreign exchange forwards are exempt from most swap regulation, and are treated as a more lightly regulated subset of swaps. The regulation of these products is addressed in more detail in 2.6 Exemptions, Non-derivative Products and Spot Transactions.

Security Forwards

Similarly, forward contracts in securities are expressly excluded from the definition of swap and security-based swap, as long as the contract settles by physical delivery based on a fixed price. This approach accommodates standard practice in the “to-be-announced” (TBA) market for mortgage-backed securities issued or guaranteed by the US GSEs (Fannie Mae, Freddie Mac, and Ginnie Mae).

As in most developed markets, the US has both OTC and exchange-traded (or “listed”) markets in derivatives. As a general rule, the exchange-traded markets are more accessible to retail investors, whereas access to the OTC markets is limited to financial institutions and investors who meet certain minimum asset tests. This follows from the fact that the listed markets are more highly regulated and standardised, whereas the OTC market is more flexible and allows for greater risk-taking. In this vein, the products that trade on exchange are typically regulated and registered financial instruments that meet criteria specified by the exchange and/or the regulator; the products traded OTC are unregistered and can include whatever terms the parties agree, subject to certain regulatory requirements described elsewhere in this article (eg, margin rules, business conduct standards, etc).

Eligible Contract Participants (ECPs)

The primary criteria required of non-dealer participants in the US OTC derivatives market is that they be “eligible contract participants” (ECPs) as defined by the CFTC. An ECP can be a bank, dealer, broker, insurance company or pension plan, a registered investment adviser, a commodity pool with at least USD5 million in assets, any corporate entity with at least USD10 million in assets, or an individual with at least USD1 million in assets.

Broker-Dealers and Futures Commission Merchants (FCMs)

By contrast, there are no specific criteria or asset tests required for non-dealers to participate in the market for listed derivatives. Rather, these markets must be accessed via the registered brokers who act as intermediaries. For listed options on securities and securities futures relating to a single security or a narrow-based index of securities, the intermediary would be a broker-dealer registered with the SEC. For futures contracts (including futures on broad-based securities indices) and listed commodity options (or options on futures), the intermediary would be a futures commission merchant (FCM) registered with the CFTC.

The US derivatives market includes all the major asset classes available to trade on global markets. The market for listed futures contracts and options on futures includes contracts for agricultural, energy, metal and other commodities, currencies and financial instruments (including US treasuries and equity indices).  Options, both listed and OTC, are available on equities, equity indices, ETFs, debt securities, commodities and foreign currency. The swap market includes interest rate swaps, credit default swaps, equity swaps, FX, commodity swaps, inflation swaps, weather and similar contingent-event swaps, swaps referencing carbon credits, cryptocurrency swaps, and many more. 

The CFTC prohibits so-called “event” contracts that are contingent on the occurrence of a specific event (such as a political election), if related to illegal activity, or if otherwise contrary to public policy.

In recent years, the US market has seen increased liquidity in ESG (environmental, social, and governance) products. This has largely been focused on carbon credit trading, including OTC swaps referencing California carbon credit allowances and other voluntary carbon credits. This development has been facilitated by the development of standardised documentation for use with these products, including the publication by ISDA of the 2022 ISDA VCC Transactions Definitions. Further supporting these trends, the CFTC in September 2024 issued guidance relating to listed derivatives contracts in verified carbon credits (VCCs), with the goal of promoting the development of a futures contract market in VCCs. 

There has also been growing interest and liquidity in cryptocurrency derivatives, in particular, relating to BTC and ETH futures contracts, as well as in OTC markets, including crypto-swaps referencing BTC and ETH, BTC options, and BTC non-deliverable forwards. Most recently, the SEC has approved the listing of options on BTC ETFs on the Nasdaq and NYSE.

Foreign currency and commodity spot transactions are not regulated as swaps and are generally exempt from formal regulation. However, the CFTC has authority to regulate trading platforms and enforce rules against market manipulation and fraud, as well as to impose spot month position limits for derivatives contracts in the commodities markets, as described in 3.1.4 Position Limits. In addition, physically-settled foreign currency forwards and foreign currency swaps, while both technically within the definition of swap, are exempt from many of the CFTC rules regulating swaps, including margin, exchange trading or clearing requirements, although they remain subject to the rules governing business conduct standards and reporting that are applicable to swaps. 

Retail foreign exchange (forex) trading is regulated by the CFTC and the NFA, and retail forex dealers must be registered members of the NFA. Forex dealers must maintain records of transaction and customer information, and are also subject to leverage limitations designed to protect retail investors.

The CFTC also regulates leveraged commodity contracts, including rules providing for registration of leverage commodities and limits on short leverage contracts. These contracts are also subject to the CFTC’s rules relating to fraud, manipulation and other market abuse. 

Derivatives are not generally subject to local regulation in the US. The rules of the CFTC, SEC and Prudential Regulators will, in almost all cases, pre-empt or supersede local regulations, if any.

The National Futures Association (NFA) is a self-regulatory organisation designated by the CFTC as a registered futures association with oversight over the US derivatives markets. Many market participants, including commodity pool operators, commodity trading advisers, futures commission merchants and swap dealers, are required to be members of the NFA and must follow the NFA’s rules. The NFA’s supervisory and oversight functions encompass many aspects of derivatives markets activity, including rules relating to market integrity and customer protection, reporting and disclosure, and enforcement.

The Financial Industry Regulatory Authority (FINRA) is a self-regulatory organisation operating under the supervision of the SEC and authorised by the US Congress to provide oversight of registered broker-dealers and the US securities market. Registered broker-dealers in the US are required to be members of FINRA and to comply with FINRA rules. FINRA oversees many facets of broker-dealer activity, including enforcing ethical rules, conducting examinations and enforcing compliance with both FINRA and SEC rules, and promoting market transparency.

In addition to FINRA and the NFA, there are a number of derivatives exchanges and clearing houses (CCPs) that operate in the United States as self-regulatory organisations. These exchanges and CCPs allow for the execution and clearing of listed futures and options contracts, as well as certain standardised OTC derivatives contracts and repurchase agreements. Membership and participation in these trading and clearing platforms require compliance with the rules and requirements of the platform, including position limits that may be imposed by the platform. Each such exchange and CCP is subject to regulation by the CFTC or SEC, as applicable.

US clearing brokers that act as FCMs and broker-dealers will use their own proprietary documentation for futures and listed option clearing arrangements.  The trading of listed equity options is often included in prime brokerage documentation, but is also available on a standalone basis from brokers who will act solely with respect to the option contracts. The trading of futures contracts requires entering into an agreement with one or more FCMs, who will act as intermediaries and clearing members of the CCP. 

For trading cleared swaps, parties will rely on a Cleared Derivatives Addendum (CDA) used in conjunction with the FCM agreement, that is based on a format published jointly by ISDA and the Futures Industry Association. Parties may also enter into a Cleared Derivatives Execution Agreement that addresses swaps executed bilaterally (ie, not on an SEF) but that are intended to be cleared.

In negotiating cleared swap documentation, sophisticated buy-side clients will be most concerned about aligning terms with those governing their uncleared, bilateral swap portfolios, in particular relating to discretionary unwind and changes to position limits and margin terms. Clearing brokers, on the other hand, will seek to maintain appropriate flexibility to manage counterparty risk in view of their regulatory obligations and their status as clearing members of the CCP.

In order to promote safe and sound banking and market practice, as well as to address systemic and counterpart risk, US regulations require regulated banks, SDs and SBSDs to rely on legal opinions addressing the enforceability of netting and remedies against collateral in connection with swaps and SBS. These opinions have been solicited and are published by ISDA for all of the major global trading jurisdictions, including the US, and are available on the ISDA website. US rules allow parties to rely on these ISDA-published forms, which are updated regularly to address legal and market developments.

Both the CFTC and the SEC have for some time enhanced their focus on cryptocurrency markets and digital asset trading platforms. Thus, the most interesting and significant enforcement activity over the past 12 months has involved unregistered crypto-exchanges and crypto-asset offerings. Some key examples are provided below, including links.

CFTC

• (13 May 2024) CFTC Issues Order Against Crypto Prime Brokerage Firm for Unlawfully Providing US Customers Access to Digital Asset Derivatives Trading Platforms | CFTC
• (26 March 2024) CFTC Charges KuCoin with Operating Illegal Digital Asset Derivatives Exchange | CFTC
• (21 November 2023) Binance and Its CEO, Changpeng Zhao, Agree to Pay USD2.85 billion for Willfully Evading US Law, Illegally Operating a Digital Asset Derivatives Exchange, and Other Violations | CFTC

The CFTC’s approach is readily discerned in the words of CTFC Chairman Rostin Behnam, who is quoted as follows in connection with the Binance action: “American investors, small and large, have demonstrated eagerness to incorporate digital asset products into their portfolios. It is our duty to ensure that when they do so, the full protections afforded by our regulatory oversight are in place, and that illegal and illicit conduct is swiftly addressed. When, as here, an entity goes even further, deliberately avoiding to employ meaningful access controls, intentionally avoiding knowing customers’ identities, and actively concealing the presence of US customers on its platforms, there is no question that the CFTC will strike hard and aggressively”.

SEC

• (30 July 2024) SEC.gov | SEC Charges Nader Al-Naji with Fraud and Unregistered Offering of Crypto Asset Securities
• (7 February 2024) SEC.gov | SEC Charges TradeStation Crypto for Unregistered Offer and Sale of Crypto Asset Lending Product
• (22 December 2023) SEC.gov | BarnBridge DAO Agrees to Stop Unregistered Offer and Sale of Structured Finance Crypto Product

In speaking about the BarnBridge DAO action, Gurbir S Grewal, Director of the SEC’s Division of Enforcement, provides the quote that speaks to the SEC’s approach: “The use of blockchain technology for the unregistered offer and sale of structured finance products to retail investors runs afoul of the securities laws. This case serves as an important reminder that those laws apply to all who wish to access our capital markets, regardless of whether they are, or purport to be, incorporated, decentralised or autonomous.”

Both the CFTC and SEC regularly provide updates and guidance as to their enforcement and examination priorities. The SEC’s priorities for 2025 were published on 21 October 2024, and note a focus on security-based swap dealers, security-based swap execution facilities, and crypto-assets. The CFTC provides an annual summary of its enforcement actions, the latest of which for 2024 is available here.