Only July 24, 2012, the CFTC published regulations that establish a schedule to phase-in compliance with certain clearing requirements under new section 2(h)(1)(A) of the Commodity Exchange Act (CEA) and the corresponding trade execution requirement under new section 2(h)(8)(A) of the CEA. The regulations phase-in the clearing requirement based on the type of market participant entering into swaps that are subject to the clearing requirement. However, the compliance schedule does not prohibit any type of market participant from voluntarily complying with the clearing requirement sooner than the compliance deadline.
The triggering event for the compliance schedule will be the CFTC's issuance of a final clearing requirement determination. On July 24, 2012, the CFTC issued its first proposed clearing determination for certain classes of credit default swaps and interest rate swaps.
The Clearing Requirement
The CEA, as amended, provides that it is unlawful for any person to engage in a swap unless that person submits such swap for clearing to a derivatives clearing organization that is registered or exempt from registration if the swap is required to be cleared. Such clearing requirement does not apply to exempt end-users. The regulations published by the CFTC allow for phased-in compliance with a clearing requirement upon the issuance of a mandatory clearing determination. The CFTC issued its first proposed mandatory clearing determination on July 24, 2012.
The Trade Execution Requirement
The CEA, as amended, provides that with respect to a swap that is subject to the clearing requirement counterparties shall (i) execute the transaction on a designated contract market (DCM); or (ii) execute the transaction on a swap execution facility (SEF). A trade execution requirement is triggered for a swap when (1) the CFTC issues a determination that the swap is required to be cleared and (2) any DCM or SEF makes the swap available to trade. A swap is not required to be executed on a DCM or SEF if no DCM or SEF makes the swap available to trade. Note that, if the swap is subject to the end-user clearing exception, mandatory clearing does not apply and therefore the swap is not subject to the trade execution requirement.
The regulations provide for the phased implementation of a trade execution requirement by setting forth a compliance schedule tied to the schedule proposed for the clearing requirement. The compliance schedule for the trade execution requirement would be triggered upon the later of (1) the applicable deadline established under the compliance schedule for the associated clearing mandate; or (2) 30 days after the swap is made available for trading on either a SEF or a DCM. Consequently, market participants always will have at least 30 days after a DCM or SEF has made a swap available for trading to comply with a trade execution requirement.
Phase 1—Category 1 Entities
Category 1 Entities are defined to include a swap dealer, a security-based swap dealer, a major swap participant, a major security-based swap participant, or an active fund. Active funds include any private fund as defined in section 202(a) of the Investment Advisers Act that is not a third-party subaccount and that executes 200 or more swaps per month based on a monthly average over the 12 months preceding the CFTC's issuance of a mandatory clearing determination.
Phased compliance would apply to swaps between a Category 1 Entity and another Category 1 Entity, or any other entity that desires to clear the transaction within 90 days after the CFTC issues its clearing determination. Such entities will therefore have 90 days from the date the CFTC's clearing determination is published in the Federal Register to comply with mandatory clearing. With respect to the trade execution requirement, the CFTC proposes to phase in compliance with this requirement either at the same time as the clearing requirement or 30 days after the swap is made available for trading, whichever is later.
Phase 2—Category 2 Entities
Category 2 Entities are defined to include a commodity pool, a private fund as defined in section 202(a) of the Investment Advisers Act (other than an active fund), an employee benefit plan as defined in paragraphs (3) and (32) of section 3 of ERISA or a person predominantly engaged in activities that are in the business of banking, or in activities that are financial in nature as defined in section 4(k) of the Bank Holding Company Act, provided that the entity is not a third-party subaccount.
Phased compliance would apply to swap transactions between a Category 2 Entity and Category 1 Entity, another Category 2 Entity, or any other entity that desires to clear the transaction within 180 days after the clearing requirement is published in the Federal Register. Mandatory clearing of swaps between these types of market participants would therefore commence after 180 days. The trade execution requirement would be effective either at the same time as the clearing requirement or 30 days after the swap is made available for trading, whichever is later. Note, however, that the CFTC will finalize the final implementation schedule for the trade execution requirement in a separate rulemaking.
Phase 3—Third-Party Subaccounts and all Other Swap Transactions
Mandatory clearing with respect to third party subaccounts and all other counterparties would commence 270 days after the clearing requirement is published. The CFTC defines a third party subaccount to mean a managed account that requires specific approval by the beneficial owner of the account to execute documentation necessary for executing, confirming, margining or clearing swaps. Compliance with the trade execution requirement for such swaps would commence either at the same time as the clearing requirement or 30 days after the swap is made available for trading, whichever is later.
The rules will become effective September 28, 2012.