Mandatory clearing of swaps for certain swap participants under The Dodd-Frank Wall Street Reform and Consumer Protection Act (US) (Dodd-Frank) has come into effect.
As part of the continuing implementation of the key goals of Dodd-Frank, swap dealers, major swap participants and active funds are required to clear certain swaps through registered or exempt derivatives clearing organisations.
Dodd-Frank was enacted into US law in July 2010 and is seen as the most comprehensive reform of US financial services regulatory law since 1933, covering broad aspects such as the oversight and supervision of financial institutions and the regulation of over-the-counter (OTC) derivatives.
In relation to the regulation of OTC derivatives, Dodd-Frank introduces requirements for the registration of market participants who are swap dealers or major swap participants, clearing, execution and reporting of swap transactions, and margin posting in respect of non-cleared swaps.
Certain aspects of Dodd-Frank are intended to have extra-territorial application. The Commodities Futures Trading Commission (CFTC), being the body charged with the regulation of swaps in the US, has issued a cross-border proposal that would impose the registration requirements and certain entity level and transactional requirements under Dodd-Frank on non-US market participants that engage in swap transactions with US counterparties. However, until the proposal is finalised, the CFTC has issued a time-limited exemptive relief to cross border market participants from the requirement to comply with some of these rules.
The clearing requirement is being phased in during 2013, with swap dealers, major swap participants and active funds required to clear certain classes of index credit default swaps and interest rate swaps entered into on or after 11 March 2013. The clearing requirement also applies to changes in the ownership of a swap. Pursuant to the CFTC's time-limited relief, the clearing requirement currently only applies to swap transactions entered into with US counterparties.
There are also certain exemptions to the mandatory clearing requirement, such as the "end-user" exemption for non-financial entities hedging commercial risk. We expect that most market participants caught by the Dodd-Frank clearing requirement will continue to clear swap transactions via intermediaries that are already members of a registered clearing house.
To fulfil its G20 commitment, the EU has also adopted regulation (the European Market Infrastructure Regulation on OTC Derivatives, CCPs and Trade Repositories) aimed at regulating OTC derivatives. While the EU regulation is intended to apply principally to swap transactions between EU counterparties, clearing and risk mitigation obligations under the EU regulation can extend to transactions with non-EU counterparties in certain circumstances. It is expected that the first clearing obligations under the EU regulation will commence in May 2014.