The Commodity Futures Trading Commission (“CFTC”), in two separate issuances, has significantly decreased the regulatory burden on entities entering swaps with their affiliates.
On April 1, 2013, the CFTC issued its final rule exempting certain interaffiliate swaps from the mandatory clearing requirement ("Final Rule"), which is effective June 10, 2013. A copy of the Final Rule can be found here.
On April 5, 2013, the CFTC’s Division of Market Oversight and Division of Clearing and Risk issued a No-Action Letter that relieves swap counterparties that are not swap dealers or major swap participants from the requirement to report swaps between affiliates to a swap data repository (“No-Action Letter”). A copy of the No-Action Letter can be found here.
Importantly, if both counterparties to an interaffiliate swap elect to exempt the swap from clearing based on the interaffiliate clearing exemption, the swap is ineligible for the interaffiliate reporting exemption. However, if either counterparty elects the end-user exception to the clearing requirement and the other conditions of the No-Action Letter are satisfied, the interaffiliate swap need not be reported to a swap data repository. Accordingly, if a swap satisfies the requirements for both the end-user exception from clearing and the interaffiliate exemption from clearing, counterparties wishing to avail themselves of the interaffiliate reporting exemption should elect the end-user exception from clearing.1
Final Rule Establishing the Interaffiliate Clearing Exemption
Criteria for Interaffiliate Clearing Exemption
In the Final Rule, the CFTC determined that swaps between affiliates are exempt from clearing if they meet the following criteria:
- One affiliate owns a majority interest in the other affiliate, or both affiliates are under common majority control;
- The affiliates' financial statements are reported on a consolidated basis;
- The terms of the interaffiliate swaps are documented, such that there is an accurate and thorough record of the swap (book entries are not sufficient);
- The swaps will be subject to a centralized risk management program;
- The swaps are reported to a swap data repository (“SDR”) (or to the CFTC if an SDR is not available) under Part 45 of the CFTC's regulations; and
- Each affiliate claiming the exemption must (1) clear all swaps with unaffiliated counterparties that are subject to the CFTC's clearing requirements (currently limited to specified credit default and interest rate swaps), (2) claim the end-user exception from clearing such swaps, if applicable, (3) clear all swaps with unaffiliated counterparties pursuant to the CFTC-comparable clearing mandates of a non-U.S. jurisdiction, (4) claim an exception or exemption from clearing of swaps with unaffiliated entities under the CFTC-comparable rules of a non-U.S. jurisdiction, or (5) clear the swap through a CFTC-registered derivatives clearing organization or the foreign equivalent thereof.
Swaps between US Affiliates and EU, Japanese, and Singapore Affiliates
With particular respect to the requirement that affiliates located outside of the U.S. comply with CFTC-comparable clearing requirements for swaps with unaffiliated entities, the Final Rule contains a safe harbor provision that extends to March 11, 2014. If the non-U.S. affiliate is located in the EU, Japan or Singapore, the safe harbor is satisfied if the counterparty holding the majority interest in the other (or a third party holding the majority interest in both) is not a “financial entity” as defined in section 2(h)(7)(C)(i) of the Act and neither counterparty is affiliated with a swap dealer or major swap participant. Alternatively, counterparties can pay and collect margin in one of the following ways: (1) each counterparty (or their common majority owner) pays and collects full variation margin daily on all swaps entered between the counterparty located in the EU, Japan or Singapore and any unaffiliated counterparty, or (2) each counterparty (or their common majority owner) pays and collects full variation margin daily on swaps entered by either counterparty and all other affiliates that are eligible for the interaffiliate clearing exception.
Swaps between U.S. Affiliates and other non-U.S. Affiliates
For non-U.S. affiliates located outside the EU, Japan and Singapore, if the aggregate notional value of swaps with U.S. affiliates subject to clearing does not exceed 5% of the aggregate notional value of all swaps subject to clearing of the U.S. affiliate, in U.S. dollar equivalents calculated each quarter, then the safe harbor for complying with CFTC-comparable clearing requirements for swaps with unaffiliated entities applies until March 11, 2014, so long as the parties elect to pay and collect margin in one of the following ways: (1) each counterparty (or their common majority owner) pays and collects full variation margin daily on all swaps entered between the non-U.S. counterparty located outside the EU, Japan and Singapore and any unaffiliated counterparty, or (2) each counterparty (or their common majority owner) pays and collects full variation margin daily on swaps entered by either counterparty and all other affiliates that are eligible for the interaffiliate clearing exception.
No Initial or Variation Margin Required for Interaffiliate Swaps Between U.S. Affiliates
Unlike the notice of proposed rulemaking issued by the CFTC on August 21, 2012 with respect to the clearing of interaffiliate swaps, the Final Rule does not require that initial or variation margin be paid or collected with respect to swaps between U.S. affiliates. However, it does recommend the exchange of margin as a “sound business practice.”
Reporting Swaps For Which The Interaffiliate Clearing Exception Is Elected
The Final Rule does not disturb the CFTC's requirement to report interaffiliate swaps under Part 45 or 46 of the CFTC's rules. Therefore, if the counterparties to a swap elect the interaffiliate clearing exemption for the swap, the swap must be reported to the SDR or CFTC, as the case may be, unless such counterparties elect the relief in the No-Action Letter described more fully below. Reporting of these swaps should include whether a party is electing the interaffiliate clearing exemption for such swaps and how it generally meets its financial obligations with regard to uncleared swaps. The Final Rule includes a new annual filing requirement, much like the report for end users, which will require entities claiming the interaffiliate clearing exemption to make an annual filing with the CFTC. SEC filers claiming the exception will also need to obtain a board committee resolution permitting the entity to entered into uncleared swaps for the year ahead.
No-Action Letter Relieving Parties of Interaffiliate Reporting Obligations
In the No-Action Letter, the CFTC Staff recognized that the interaffiliate clearing exemption will generally be utilized by financial entities, which are ineligible to elect the end-user clearing exception. The No-Action Letter provides relief from the reporting requirements applicable to swaps where the following conditions are met:
- The affiliates' financial statements are reported on a consolidated basis;
- Neither affiliate is a swap dealer or major swap participant, or is affiliated with a swap dealer, major swap participant or financial company designated as systematically important by the Financial Stability Oversight Council;2
- The swap is not executed on or pursuant to the rules of any trading facility or platform where the orders may be exposed to potential execution against unaffiliated counterparties;
- The swap is not submitted for clearing;
- The parties have not elected the interaffiliate clearing exemption;
- The parties report all swaps with unaffiliated counterparties to an SDR, or the unaffiliated counterparty to such swaps makes reports;3 and
- The parties retain records of the swap as required by the CFTC’s regulations.
The scope of the reporting relief depends upon whether the swap involves wholly-owned or majority-owned affiliates. If one affiliate, directly or indirectly, owns a 100% interest in the other affiliate, or if both affiliates are 100% owned by the same third party, the parties must maintain internally generated swap identifiers for each swap subject to this no-action relief.
If one affiliate, directly or indirectly, owns a majority interest in the other affiliate, or if both affiliates are majority-owned by the same third party, the no-action relief does not apply if the swap is required to be reported on a real-time basis.4 In addition, in the case of majority-owned affiliates, the reporting counterparty (as designated under 17 C.F.R. § 45.8) must report swap data to an SDR on a quarterly basis no later than 30 days following the end of each fiscal quarter beginning June 30, 2013.
The No-Action Letter also provides relief with respect to the reporting of historical swap data, regardless of whether the swap involves wholly-owned or majority-owned affiliates so long as the first four conditions listed above are satisfied. Parties must retain data regarding historical swaps in accordance with the CFTC’s regulations..