CFTC Proposes Clearing Exemption for Interaffiliate Swaps; Comments Due by September 20, 2012
On August 21, 2012, the Commodity Futures Trading Commission (“CFTC” or “Commission”) published in the Federal Register a proposed rule that would allow counterparties to interaffiliate swaps to elect to exempt such swaps from the Dodd-Frank clearing requirement under certain conditions (“Proposed Rule”).1 The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) generally makes it unlawful for any person to engage in a swap as to which the Commission has issued a clearing determination (mandating the clearing of such swap) unless the person submits the swap for clearing or an exception to the clearing requirement applies. Under the Dodd-Frank Act, swaps that are eligible for the “end-user exception” need not be submitted for clearing, subject to CFTC requirements.2 Although the statute does not contain any exception to the clearing requirement for interaffiliate swaps, numerous commenters in various Dodd-Frank rulemaking proceedings have urged the Commission to establish such an exemption, arguing that interaffiliate swaps do not pose the same level of systemic risk as swaps between unaffiliated entities.3 In the Proposed Rule, the Commission preliminarily accepted these arguments but attached significant eligibility criteria and other conditions to the proposed exemption, including a requirement that affiliated “financial entities” collect and pay variation margin to each other unless they are 100% commonly owned and their obligations are guaranteed by a single affiliated entity. This proposed requirement for collection and payment of variation margin led Commissioners Sommers and O’Malia to dissent from issuance of the Proposed Rule.
Comments on the Proposed Rule must be submitted to the Commission no later than September 20, 2012.
Requirements for Electing the Proposed Clearing Exemption for Interaffiliate Swaps
Under the Proposed Rule, in order to be eligible for the clearing exemption for interaffiliate swaps, the following requirements must be satisfied:
- One swap counterparty must directly or indirectly hold a majority ownership interest in the other, or a third party must directly or indirectly hold a majority ownership interest in both counterparties, and the financial statements of both counterparties must be reported on a consolidated basis.4
- Both counterparties must elect not to clear the swap.
- The terms of the swap must be documented either according to the documentation standards applicable to swap dealers or major swap participants (if one of the counterparties is a swap dealer or major swap participant) or in a swap trading relationship document that includes all material terms of the swap.
- The swap must be subject to a centralized risk management program that either meets the internal business conduct standards applicable to swap dealers and major swap participants (if one of the counterparties is a swap dealer or major swap participant) or is reasonably designed to monitor and manage the risks associated with the swap.
- For a swap in which each counterparty is a “financial entity,”5 both counterparties must pay and collect variation margin for each business day during the life of the swap according to the calculation methodology set forth in the swap documentation, unless the affiliates are “100% commonly-owned and commonly guaranteed . . . where the common guarantor is also 100% commonly owned . . . .”
- Each counterparty must either be located in the United States, be located in a jurisdiction with clearing requirements that are comparable to U.S. clearing requirements, be required to clear swaps with non-affiliated parties in according with U.S. law, or not be permitted to enter into swaps with non-affiliated parties.
- The reporting counterparty under Part 45 of the Commission’s rules must report to a swap data repository (or to the Commission) confirmation that both counterparties have elected not to clear the swap and that each counterparty satisfies the eligibility requirements set forth above.
- Either the reporting counterparty (on a swap-by swap basis) or each counterparty (on an annual basis) must report to a swap data repository (or to the Commission) how the counterparties generally meet their financial obligations associated with non-cleared swaps and, if either counterparty is a public company, the relevant SEC Central Index Key Number for that counterparty and an acknowledgement that an appropriate committee of that counterparty’s board of directors (or equivalent body) has reviewed and approved the decision not to clear the swap.6
Relationship to End-User Exception and Applicability to Third-Party Swaps
Importantly, for swaps that are eligible for both the end-user exception and the proposed exemption for interaffiliate swaps, counterparties would be required to elect only one of the two in order to avoid the clearing requirement. In practical terms, entities would need to consider the interaffiliate exemption only if a swap was not eligible for the end-user exception (e.g., if both counterparties are financial entities or are entering into the swap for purposes other than hedging or mitigating commercial risk). As proposed, the interaffiliate exemption would not apply to swaps between an affiliate and a third party that are entered for the purpose of hedging interaffiliate swaps for which the interaffiliate exemption has been elected. The CFTC release states that “[t]he Commission intends separately to propose a rule addressing swaps between an affiliate and a third party where the swaps are used to hedge or mitigate commercial risk arising from inter-affiliate swaps for which the end-user exception has been elected.”
Click here to view the Proposed Rule.