As most market participants are aware, the Dodd-Frank rule requiring all swap guarantors to be eligible contract participants (“ECP”s) under the Commodity Exchange Act (“CEA”) became effective on March 31, 2013. Six months after effectiveness, lenders continue to address ECP issues under existing documents, and should be sure they are properly protected under new agreements.
A Summary of the Rule and ECPs
Under the new Dodd-Frank rule, all parties to swaps that are not executed on a registered exchange must be ECPs under the CEA. ECPs are (generally) entities with more than $10 million in total assets.
It is common for lenders under credit facilities to provide swaps to borrowers. Oftentimes, the swap obligations will be part of the defined term “Obligations” under the credit documents, which are in turn all secured by pledged collateral and guaranteed by affiliates of the borrower. However, under the new rules, if “Obligations” includes the swap obligations, each guarantor will be required to be an ECP when the swap is entered into, otherwise the guaranty of those swap obligations will not be enforceable. To address this, loan documentation should be clear that guarantees of swap obligations by guarantors that are not ECPs at the time the swap is entered are excluded.
While the application of these rules to guarantees is clear, the application of the rules to pledges of collateral is uncertain. However, the consensus in the market (including upon the advice of the Loan Syndications and trading Association (“LSTA”)) seems to be that lenders should also exclude from swap obligations any pledges of collateral from entities that are not ECPs are the time to swap is entered.
What’s a Lender to Do?
Both the International Swaps and Derivatives Association (“ISDA”) and the LSTA have published sample provisions to deal with these ECP issues, to ensure that guarantees and pledges remain enforceable. Lenders documenting new credit facilities should ensure that their counsel has included these or similar provisions in the drafts. Lenders would also be wise to see that these provisions are added in connection with any amendments of existing loan documents (or even consider amending documents for the sole purpose of adding these provisions).