Yesterday, the CFTC’s Division of Clearing and Risk issued a no-action letter providing a clearing exception to “treasury affiliates” of commercial swap end-users, subject to specified conditions. This relief is particularly critical given the imminent June 10, 2013 deadline on which financial entity treasury affiliates would otherwise need to begin clearing designated interest rate swaps and credit default swaps with swap dealer and financial counterparties. The letter provides immediate relief, and allows treasury affiliates until September 9, 2013 to come into compliance with the letter’s reporting and board approval conditions described below.
The Dodd-Frank Act, and the CFTC’s related rules, require the central clearing of swap transactions designated by the CFTC as subject to the clearing mandate. Commercial end-users entering into swaps to hedge or mitigate commercial risk may elect not to clear their swaps, subject to a number of conditions. This commercial end-user exception is not generally available to “financial entities,” including entities engaged in activities that are financial in nature, but is available to certain financial affiliates that are acting as agent on behalf of commercial end-user affiliates and to a narrow class of captive finance affiliates.
By their terms, these provisions do not allow use of the commercial end-user exception by “treasury affiliates” that aggregate commercial risks of affiliated commercial entities and hedge them as principal on an aggregated basis. Given the prevalence of this practice, the CFTC’s Division of Clearing and Risk has provided no-action relief from the clearing mandate for treasury affiliates meeting certain requirements.
Specifically, to qualify for the relief with respect to a swap subject to the mandatory clearing requirement, the treasury affiliate must:
- enter into the exempted swap for the sole purpose of hedging or mitigating the commercial risk of one or more related affiliates (defined to include only non-financial entities and other treasury affiliates), where the risk was transferred to the treasury affiliate by operation of one or more swaps with such related affiliates;
- not enter into swaps with its related affiliates or unaffiliated counterparties other than for the purpose of hedging or mitigating the commercial risk of one or more related affiliates;
- not (and its related affiliates with which it enters into interaffiliate swaps must not) enter into swaps with or on behalf of any affiliate that is a financial entity, or otherwise assume, net, combine or consolidate the risk of swaps entered into by any financial entity affiliate;
- be subject to a centralized risk management program that is reasonably designed to monitor and manage the risks associated with all of its swaps; and
- have its payment obligations on the exempted swap guaranteed by its non-financial parent, an entity that wholly-owns or is wholly-owned by its non-financial parent or the related affiliates for which the swap hedges or mitigates commercial risk.
In addition, the treasury affiliate must meet a number of qualifications related to its ownership, activities and the regulatory status of it and its affiliates. These include that the treasury affiliate’s ultimate parent must not be a financial entity and must have a majority of its subsidiaries qualify as commercial end users, and that the treasury affiliate is a financial entity solely as a result of acting as principal to swaps with, or on behalf of, one or more of its related affiliates or providing other services that are financial in nature to its related affiliates. Certain entities are ineligible for the no-action relief, including swap dealers, major swap participants and their affiliates, and private funds, commodity pools, certain employee benefit plans, bank holding companies and insured depository institutions.
To rely on this relief, a treasury affiliate that is a public company or a subsidiary of a public company must obtain approval of an appropriate committee of its board of directors or similar governing body to enter into swaps that are exempt from the clearing mandate. In addition, the reporting counterparty to the swap (which will be the swap dealer for any swap to which one is a counterparty) must report to a swap data repository (or, in some cases, the CFTC) information similar to that required under the commercial end-user exception.
The conditions of the relief and related definitions are set out in full in the Division of Clearing and Risk’s no-action letter.