On January 12, 2015, President Obama signed into law the Business Risk Mitigation and Price Stabilization Act of 2015 (the Amendment), which amends Section 731 of the Dodd-Frank Wall Street Reform and Consumer Protection (the Dodd-Frank Act). The Amendment, which contains language identical to that included in several bills that were approved in previous sessions of the House of Representatives but failed to make it to the president’s desk, was attached to a bill that extended the Terrorism Insurance Program. The new law should address uncertainty that arose as a result of last year’s release of proposed rules in relation to margin requirements for uncleared swaps. The Amendment will allow manufacturers, retailers, transportation companies, and other non-financial users of swaps (along with certain types of financial cooperatives) to continue to hedge their assets and liabilities without a legal requirement to have collateral arrangements in place.
By way of background, the Dodd-Frank Act requires regulators to adopt rules imposing initial margin and valuation margin requirements on swap transactions involving swap dealers and major swap participants that have not been cleared by a central clearinghouse. Although meant to address counterparty risk in a particular transaction and systemic risk caused by large market participants, margining can significantly increase the financing and operational costs of swap activities by introducing monitoring and compliance burdens and preventing capital from being put to productive use due to segregation and restrictions on rehypothecation of collateral. While the rules implementing the statutory margin mandate are not yet in force, certain market participants, including: (a) non-financial entities entering into swaps to hedge and mitigate commercial risk (commercial end-users), (b) affiliates acting on behalf of such an entity that use swaps to hedge or mitigate the commercial risk of such entity or another affiliate that is not a financial entity (exempt affiliates), and (c) cooperatives that meet certain regulatory parameters (exempt cooperatives), have been exempted from mandatory clearing by way of the Dodd-Frank Act and related regulations.
In September 2014, federal regulators proposed new rules that would implement the Dodd-Frank Act’s margin mandate by requiring initial margin and valuation margin to be collected on non-cleared swaps, with compliance dates being rolled out beginning December 1, 2015. The proposed margin rules, which have not yet been finalized, seek to exempt certain entities from the requirement to post and collect initial and variation margin. Namely, dealers would not be under a regulatory obligation to subject commercial end-users and exempt affiliates to margining. Rather, for any trades with such entities, margin would be collected and posted as determined to be appropriate by the dealer (just as it was in the absence of the Dodd-Frank Act). Under the proposed margin rules, exempt cooperatives would be subject to mandatory margining to the same extent as financial end-users. The proposed rules led to industry pressure on lawmakers and regulators to extend relief from mandatory margining to those entities that are exempt from mandatory clearing. For more information on the proposed margin rules, please review our November 3, 2014 Swaps Update.
The Amendment provides that margin requirements will not apply to commercial end-users (including captive finance companies), exempt affiliates, and exempt cooperatives. In light of the fact that margin rules have not yet been finalized, this new law addresses lingering uncertainty regarding whether the entities that are exempt from mandatory clearing will also be exempt from mandatory margining. Furthermore, by codifying the exemption into federal statutes, the Amendment eliminates the risk that future regulatory rulemaking by the Commodity Futures Trading Commission (CFTC) and other financial-industry regulators would require exempt entities to post and collect margin on their non-cleared swaps. An additional advantage of the Amendment over the proposed rules is that the Amendment extends the exemption from margining to exempt cooperatives, while the proposed rules do not.
The Amendment directs federal regulators to issue an interim final rule and seek public comment before issuing a final rule to implement the provisions of the Amendment. In connection with the interim final rule, the regulators are likely to re-propose the margin rules in order to harmonize the statutory and regulatory frameworks. It is important to note that the Amendment does not mean that any entity that is exempt from mandatory clearing will be automatically exempt from mandatory margining. Notably, swaps entered into by certain affiliates acting on behalf of non-financial affiliates within a corporate group for the purpose of hedging or mitigating commercial risk (so-called “eligible treasury affiliates”) are exempt from mandatory clearing as a result of a no-action letter issued by CFTC staff. The Amendment does not exempt eligible treasury affiliates from the margin requirements, and federal regulators may yet decide to include these entities within the scope of the final margin rules. Accordingly, a market participant’s evaluation of its eligibility for an exception to mandatory margining should be in addition to and independent from the analysis of whether it is exempt from mandatory clearing.