On August 2, 2016, federal banking regulators (Prudential Regulators)1 adopted a final rule (PR Margin Exemptions)2 implementing exemptions from the Prudential Regulators’ impending initial and variation margin requirements for non-cleared3 swaps (PR Margin Requirements).4 The PR Margin Exemptions mirror the exemptions and exceptions from the mandatory clearing of certain non-cleared swaps or non-cleared security-based swaps of specified counterparties granted by the Commodity Futures Trading Commission (CFTC)5 and Securities and Exchange Commission (SEC).6

Background. Pursuant to the PR Margin Requirements, registered swap dealers (SDs), major swap participants (MSPs), security-based swap dealers (SBSDs) and major security-based swap participants (MSBSPs) that are regulated by any of the Prudential Regulators (each a covered swap entity)7 soon will be required to collect and post various initial and variation margin payments depending on the counterparty for all non-cleared swaps and security-based swaps.8 In adopting the non-cleared margin rules, the Prudential Regulators also published interim rules9 to implement 2015 amendments to the Dodd-Frank Act,10 which provided that certain swaps and security-based swaps that qualify for an exemption from the CFTC or SEC’s clearing mandate also would be exempt from any Prudential Regulator non-cleared margin requirements. The PR Margin Exemptions adopt the Prudential Regulators’ interim rule with no additional changes.11

Eligibility Requirements. The PR Margin Exemptions specify that non-cleared swaps and non-cleared security-based swaps entered into between a covered swap entity and one of the following types of entities are exempt from the PR Margin Requirements:

  1. Non-Financial Entities: Entities defined to include commercial end users, small banks, savings associations, Farm Credit System institutions, credit unions and captive finance companies12 that are excepted from the mandatory clearing requirement under sections 2(h)(7)(A) of the Commodity Exchange Act (CEA) or 3(C)(g)(1) of the Securities Exchange Act (SEA);13
  2. Cooperative Entities: Cooperatives that are financial entities that enter into swaps either in connection with originating loans for their members or to hedge or mitigate commercial risk related to loans or certain swaps with their members that are exempted from the mandatory clearing requirement under Part 50 of the CFTC regulations;14 and
  3. Treasury Affiliates: Affiliates of persons who qualify for an exception from the clearing requirements under CEA Section 2(h)(7)(A) that are excepted from the mandatory clearing requirement under sections 2(h)(7)(D) of the CEA or 3(C)(g)(4) of the SEA.15

Consistent with the CFTC and SEC exemptions and exceptions described above, counterparties falling within any of the three classes specified in the PR Margin Exemptions must enter into the non-cleared swap or non-cleared security-based swap to hedge or mitigate commercial risk in order to be exempted from the PR Margin Requirements. Additionally, eligible counterparties must report to either the CFTC or the SEC how they generally meet financial obligations associated with entering into non-cleared swaps or non-cleared security-based swaps. The PR Margin Exemptions contemplate that compliance with this reporting requirement can be satisfied by the CFTC regulatory requirements, and ultimately the SEC regulatory requirements, for clearing.16