The CFTC and SEC continue to provide guidance on the broad range of issues raised during rulemaking deliberations, and in particular have begun to clarify how hedging transactions will be documented under Dodd Frank’s mandatory clearing requirement. For example:

  • CFTC Regulation 50.50 specifically exempts hedges that qualify for GAAP hedge accounting treatment (Qualifying Hedges) from mandatory clearing. Reg 50.50′s broader criteria exempt “swaps that hedge or mitigate commercial risk”, and specifically identify Qualifying Hedges as meeting the “hedge or mitigate” criteria; these types of transactions have thus been a particular focus of market participants tasked with segregating cleared and non-cleared positions for internal and regulatory reporting purposes. The Qualifying Hedge exemption is emphasized in both the August 2012 and March 2013 Dodd Frank protocols issued by ISDA, and as with the other Reg 50.50 exemptions from mandatory clearing, applies to transactions involving non-financial counterparties, and maintains that these transactions are still subject to Dodd Frank’s recordkeeping and transaction reporting requirements.[1] The terms of GAAP also lay out extensive technical and documentation requirements for Qualifying Hedges, which reporting counterparties essentially acknowledge meeting in their applicable Dodd Frank transaction reporting submissions.
  • The SEC has clarified that bilateral Qualifying Hedges that are subsequently novated to be cleared through a central counterparty would not be terminated by the novation under relevant accounting definitions.[3] This alleviated previous concerns on this point that focused on whether a bilateral Qualifying Hedge that is subsequently novated to an exchange would be treated under GAAP as representing a change in counterparty that would trigger a termination of the original bilateral agreement, which in turn would have required a new hedge to be documented to incorporate the CCP. The SEC’s clarification addresses bilateral transactions entered into both before and after the imposition of mandatory clearing requirements; stipulates that other terms of the contract (apart from the novation to incorporate the CCP) must not change; and advises that bilateral contracts entered into after the imposition of mandatory clearing requirements should include provisions that specifically address the possibility that the transaction could be novated to a CCP. The International Accounting Standards Board issued similar guidance last month for entities complying with International Financial Reporting Standards (IFRS); the SEC and IASB guidance were generally viewed by market participants as streamlining transitions to central clearing (by not requiring what, in certain instances, may amount to transaction by transaction reviews to create new Qualifying Hedge documentation that would incorporate a CCP), as well as furthering harmonization of international regulatory standards.

Reg 50.50 defines two other types of hedging transactions as meeting the “hedge or mitigate commercial risk” criteria and thus exempt from mandatory clearing:

  • Transactions involving swaps that are “economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise”; and
  • Transactions involving swaps that meet the criteria of “bona fide hedges” as defined under CFTC Regulation.

Defining the scope of the “bona fide hedge” exemption in particular has been a focus of regulators and market participants over the past year and indicates that this may also be an area that warrants close monitoring going forward; this space will continue to update on relevant developments in this area as they occur.