Late last week, the SEC announced its approval of conditional temporary exemptions [http://www.sec.gov/rules/exorders/2009/34-59578.pdf]to allow the Chicago Mercantile Exchange Inc. (CME) to operate as a central counterparty (CCP) to clear credit default swaps (CDS), based on a request for exemptive relief submitted by CME and Citadel Investment Group, L.L.C. (Citadel). The conditional exemptions granted are similar to the temporary exemptive relief granted to ICE US Trust LLC two weeks ago and to LCH.Clearnet Ltd. last December. CME and Citadel have entered into a joint venture to be named “CMDX” to provide a trading and clearing solution for CDS, after announcing their intentions to do so last October.

In granting the temporary exemptions, which are effective until December 14, 2009, the SEC said it sought to balance the goal of quickly establishing a CCP for CDS transactions against the need for adequate time to review the operations of CCPs and carefully consider the implications of the exemptions. Pending complete review, the SEC is relying upon existing regulatory safeguards, CME and Citadel’s representations regarding internal compliance standards and procedures and additional conditions imposed by the SEC (requirements related to recordkeeping, access to information, regulatory reporting and making specific pricing information publicly available). In addition to these exemptions, the exemptions under various securities law requirements for CDS granted under interim final temporary rules adopted by the SEC in January also will apply.

The SEC order grants several exemptions:

  • CME will be exempt from registering as a clearing agency under Section 17A of the Exchange Act with respect to its clearance of CDS between eligible contract participants meeting the SEC’s criteria under the order (Cleared CDS).
  • CDS which are not included in the Exchange Act’s definition of “swap agreements” (non-excluded CDS) from the securities laws will be exempt to the same extent that “security-based swap agreements” are exempt. Like security-based swap agreements, however, non-excluded CDS are subject to SEC rules prohibiting fraud, manipulation and insider trading. This exemption is available to CME and parties to non-excluded CDS transactions, other than self-regulatory organizations, registered broker-dealers, and any entities that hold funds of third parties in connection with CDS transactions. Registered broker-dealers have the benefit of separate temporary exemptions granted by the SEC, as discussed below.
  • Clearing members of CME will be exempt from registering as broker-dealers under Section 15(a)(1) of the Exchange Act if such clearing member is registered as a futures commission merchant (FCM) pursuant to Section 4f(a)(1) of the Commodity Exchange Act and holds funds of third parties in connection with CDS transactions. Additionally, with respect to Cleared CDS, these clearing members will be exempt from those provisions of the Exchange Act that do not apply to security-based swap agreements, though they will still be subject to SEC rules prohibiting fraud, manipulation and insider trading.
  • An exemption is provided for registered broker-dealers only, including registered broker-dealers that are also FCMs, narrowly tailored so that it applies solely to their activities in connection with Cleared CDS. Broker-dealers engaging in Cleared CDS will be exempt from the Exchange Act requirements and rules to the same extent they are exempt with respect to security-based swap agreements. However, the antifraud, anti-manipulation and insider trading prohibitions under the Exchange Act are explicitly applicable to broker-dealers engaged in Cleared CDS.

The SEC is currently soliciting public comment on “all aspects of these exemptions” in order to assist in its determination of what further regulatory actions may be necessary with respect to operation of CCPs.