On August 13, 2012, the US Commodity Futures Trading Commission (CFTC) published its final rulemaking further defining the term “swap” (the Swap Definition Rules).1 In its adopting release, the CFTC designated an effective date for the Swap Definition Rules of Friday, October 12, 2012 (the Regulatory Cliff Friday).2 The designation of this effective date was significant because the compliance dates for many other rules promulgated under the Dodd- Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) are dependent (and automatically occur) on the effective date of the Swap Definition Rules. As the October 12, 2012 deadline neared, however, it became clear that there existed a great deal of uncertainty in the market regarding the practical application of the CFTC’s various new rulemakings. Accordingly, in a last-minute effort to alleviate this confusion, the CFTC issued a series of no-action letters and other guidance regarding rules issued under Dodd-Frank. The no-action letters and guidance address a broad range of topics, which include the following categories:
- Swap entity definitions
- Foreign exchange
- Agricultural and exempt commodities
- Commodity pool regulations
- Introducing brokers, commodity pool operators, commodity trading advisors, floor brokers and floor traders
- Energy-related transactions
- Swap data reporting
- Eligible contract participants
Because this Alert offers only a brief summary of these multi-page letters and guidance documents, please feel free to contact any of the authors identified below for clarification.
Swap Entity Definition Guidance
Guidance Regarding Swap Dealers and Major Swap Participants
In response to questions regarding the regulations covering “swap dealers” and “major swap participants” (the Final Entity Rules), the CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO) issued a series of interpretations on the application of the Final Entity Rules.3 The guidance addresses seven discrete topics: (i) calculating the notional amount of swap positions; (ii) aggregation of the swap positions of affiliates; (iii) identifying swap dealing activity; (iv) the insured depository loan exception; (v) special entities (i.e., federal agencies or other government entities, municipalities, ERISA plans and endowments); (vi) calculating the notional amount of options and swaptions; and (vii) major swap participant safe harbors. DSIO was clear, though, that this list should not be construed as a definition of “US Person.”
Extraterritoriality No-Action Relief
Because the CFTC’s extraterritorial interpretive guidance is not yet final, DSIO has offered limited no-action relief in order to enable swap market participants to apply a uniform, ascertainable standard regarding which swaps — as of October 12, 2012 — must be included when assessing swap dealer and major swap participant status.4 Under the limited no action relief, DSIO will not recommend any enforcement action against any person for failure to include a swap executed prior to December 31, 2012 in its swap dealer and major swap participant analysis so long as the counterparty is not: (i) a natural person who is a resident of the United States; (ii) a corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund or any form of enterprise similar to any of the foregoing, in each case that is organized or incorporated under the laws of the United States; (iii) a pension plan for the employees, officers or principals of a legal entity described above, unless the pension plan is exclusively for foreign employees of such entity; (iv) an estate or trust, the income of which is subject to US income tax regardless of source or (v) an individual account (discretionary or not) where the beneficial owner is a person described above.
Consistent with the CFTC’s proposed extraterritorial interpretive guidance, the no-action relief provided by the CFTC applies where the counterparty to the swap is not a person described in (i) through (v) above regardless of whether that counterparty’s obligations under the swap are guaranteed by a person that is described in (i) through (v) above. Finally, DSIO confirmed that it would not recommend that the CFTC take enforcement against any person described in (i) through (v) above for failing to include swaps executed prior to December 31, 2012, or the effective date of a final exemptive order regarding exterratoriality, in its swap dealer or major swap participant assessment if the counterparty is a foreign branch of a person described in (i) through (v) above and such person represents that it intends to register with the CFTC as a swap dealer by March 31, 2013.
FX Swaps and FX Forwards Temporary No-Action Relief
To alleviate uncertainty surrounding the proposed (and not finalized) Treasury determination for FX swaps and FX forwards, DSIO will not recommend enforcement action against an entity for failure to include, in its calculation of the aggregate gross notional amount of swaps connected with its swap dealing activity, any FX swap or FX forward that is covered by an exemption by the Treasury Secretary that is effective prior to December 31, 2012.5 Additionally, DSIO will not recommend enforcement against any entity for failure to include FX swaps and FX forwards in its major swap participant calculation that is covered by an exemption by the Treasury Secretary that is effective prior to December 31, 2012. It is not clear, however, how the entities that rely on this letter will need to comply if the Secretary of the Treasury does not finalize the determination to exempt FX forwards and FX swaps from the definition of swaps by December 31, 2012.
Agricultural and Exempt Commodities Transitional No-Action Relief
According to the CFTC, over the past several weeks, several major trading platforms that have been providing over-the-counter (OTC) markets for cleared swaps in exempt commodities, such as energy commodities and metals, have announced their intention to transition the cleared swap activities offered on those markets to cleared futures contracts.6 To enable any such transition to proceed in an orderly manner, DSIO stated that it will not recommend that the CFTC take enforcement action against any person for failure to include, in its calculation of the aggregate gross notional amount of swaps connected with its swap dealing activity, a swap that: (i) references an exempt commodity or agricultural commodity, and (ii) is executed prior to December 31, 2012, and (iii) is either cleared on a registered derivatives clearing organization (DCO) or entered into contingent upon its being subsequently exchanged for and cleared as a futures position as part of an exchange for related position transaction conducted in accordance with a DCM’s rules.
Utility Special Entities Temporary No-Action Relief
DSIO is still considering a petition to exempt swaps that relate to state and local utilities for purposes of the swap dealer assessment. In the meantime, therefore, DSIO provided no-action relief with regard to the special entity de minimis threshold for utility special entities.7
Eligible Contract Participant (ECP) Guidance
In response to various requests for further clarification regarding the scope of the ECP definition, the CFTC’s Office of General Counsel (OGC) provided the following additional interpretations: (i) OGC interprets the CEA to require that each guarantor of a swap must also be an ECP unless certain conditions are satisfied; (ii) CEA section 2(e) makes it unlawful for a non-ECP to be a jointly and severally liable swap counterparty because such conduct would constitute entering into a swap and (iii) while assets purchased or a project constructed with loan proceeds count towards the $10 million in the total assets threshold of CEA section 1a(18)(A)(v)(I), so too do the cash proceeds of the loan, upon receipt by the borrower. 8
Additionally, OGC granted no-action relief to address three specific requests for relief relating to: (a) additional persons that would qualify as an eligible guarantor able to confer ECP status on certain non-ECPs; (b) “anticipatory ECPs,” where, for example, a lender has provided a borrower a commitment to fund a loan amount greater than $10 million, and therefore the borrower would qualify as ECPs under the asset test, except that the loan is funded incrementally as a project progresses and (c) an interpretation of the provision in the CEA that was amended to refer to an ECP with regard to its “assets invested on a discretionary basis.”
Commodity Pool Guidance
Commodity Pool Exclusions
Dodd-Frank amended the CEA to add swaps to the list of “commodity interests” in the definition of “commodity pool.”9 As a consequence, many pooled investment vehicles that enter into swaps will be deemed to hold “commodity interests” and could be regulated as commodity pools by the CFTC. Most significantly, persons who perform day-to-day, administrative functions with respect to such pooled vehicles could be required to register as commodity pool operators (CPOs). Notwithstanding the expanded definition of “commodity pool,” DSIO determined that certain pooled vehicles should not be included within the definition of “commodity pool” and their operators should not be included within the definition of “commodity pool operator.” Specifically, DSIO will exclude securitization vehicles and their operators from the definition of “commodity pool” and “commodity pool operator” (CPO) when specific conditions are satisfied.10 DSIO will also exclude real estate investment trusts from the definition of “commodity pool” when certain conditions are satisfied.11 These letters follow an interpretive letter from DSIO on October 5, 2012 finding that a limited liability company whose members were all family members was not a commodity pool and, as a result, the managing member was not a required to register as a CPO.12 DSIO also published an FAQ document on August 14, 2012 that attempted to clarify several grey areas in connection with CPO and CTA regulation.13 Despite this guidance, many questions still remain.
Bona Fide Hedging Rule under CFTC 4.5
On February 24, 2012, the CFTC amended its regulation 4.5 concerning CPOs and Commodity Trading Advisors (CTAs) to include a commodity interest trading threshold above which the operator of a registered investment company (e.g., a mutual fund) would be included within the definition of “commodity pool operator.”14 The amended regulations excluded from the calculation of these thresholds, however, any positions that would qualify as “bona fide hedging” within the “meaning and intent” of CFTC regulations 1.3(z)(1) and 151.5, defining “bona fide hedging” for the separate purpose of exclusion from position limits for futures and swaps. On September 28, 2012, the position limits rule that promulgated CFTC regulation 151.5, and amended CFTC regulation 1.3(z)(1), was vacated by a US District Court. However, because the specific issue in the position limits litigation was not the appropriate standard for bona fide hedging in the context of the definition of a CPO, DSIO confirmed that it will continue to apply the bona fide hedging tests set forth in CFTC regulation 1.3(z)(1) and CFTC regulation 151.5 for purposes of determining whether the commodity interest trading thresholds in CFTC regulation 4.5 are triggered. It is worth noting that CFTC regulation 4.5 is itself subject to litigation and it remains unclear whether the CFTC’s amendments to regulation 4.5 will withstand judicial scrutiny.
Registration Deadlines for CPOs, CTAs and Other Regulated Entities
DSIO confirmed that it will not recommend an enforcement action be brought against any of the following regulated entities for failing to register by October 12, 2012, if their registration obligations arise solely because of their activities involving swaps: CPOs, CTAs, introducing brokers, floor brokers, floor traders, associated persons of any of the foregoing or associated persons of a futures commission merchant (FCM). This no-action relief is only temporarily available, and the regulated entities must make certain filings with the NFA prior to December 31, 2012.
Proposed Energy-Related Transactions
In August 2012, the CFTC published (and requested comment on) two proposed orders that would exempt certain energy-related transactions from many of the requirements of the CEA. The first proposed order15 would exempt non-financial energy derivative transactions between government-owned electric utilities and/or cooperatively-owned electric utilities when such transactions are intend to be physically settled and are entered into for the primary purpose of meeting current or anticipated contractual obligations to facilitate the generation, transmission or delivery of electricity. The second proposed order16 would exempt four types of transactions when they are offered or sold in a market administered by certain Regional Transmission Organizations (RTOs) and Independent System Operators (ISOs) pursuant to a tariff or protocol that has been approved by the Federal Energy Regulatory Commission (FERC) or, as applicable, the Public Utility Commission of Texas (PUCT). The CFTC is still considering comments on the two proposed orders. Therefore, to maintain the status quo, the various divisions of the CFTC responsible for the two proposed orders have agreed not recommend any enforcement action pertaining to the entities and transactions that would satisfy the conditions set forth in the two proposed orders.17
Swap Data Reporting
Compliance Dates for Swap Data Reporting
In response to questions regarding the swap reporting obligations pertaining to swap dealers, major swap participants, and non-swap dealers and non-major swap participants (i.e., the Nons), the CFTC issued a Q&A document18 clarifying the compliance dates for swap data reporting. The following table summarizes the reporting obligations for each type of entity under parts 45 and 46 of the CFTC’s regulations:
To view table click here.
Reporting of Cleared Swaps
In addition to clarifying the compliance dates for swap data reporting, the CFTC responded to a series of frequently asked questions regarding the reporting of cleared swaps.20 Most of the CFTC’s responses relate to technical reporting requirements for derivatives clearing organizations (DCOs). The guidance addresses, among other things, which party will send selected data to the swap data repository, whether registered entities and counterparties may contract with third parties to facilitate reporting, and whether non-US dollar swaps data should additionally provide a USD equivalent.
As the CFTC continues to implement its new regulatory regime over swaps, it is likely that additional no action letters and interpretive guidance will be forthcoming. Moreover, it is expected that the CFTC will publish rules or guidance on the following subjects by the end of the year: (i) extraterritoriality; (ii) clearing determinations; (iii) customer funds protection and (iv) transparency and rules on swap execution facilities, Core Principle 9, “made available to trade” determinations, and block trades.