CFTC Announces the Beginning of Mandatory Clearing for Certain Swap Classes (with Lofchie Comment)

As of March 11, 2013, swap dealers, major swap participants and private funds active in the swaps market are required to begin clearing five swap classes including index credit default swaps (CDS) and interest rate swaps that they entered into on or after March 11, 2013.

The clearing requirement applies to newly executed swaps, as well as changes in the ownership of a swap. Non-financial entities hedging commercial risk are eligible to elect an exception from clearing. CFTC Chairman Gensler referred to this implementation as "one of the most significant Dodd-Frank reforms . . . [which] lowers the risk of the highly interconnected financial system."

Lofchie Comment: The CFTC press release asserts that central clearing eliminates the need for market participants to individually determine counterparty credit risk, as clearinghouses now stand between buyers and sellers. To me, this seems overly optimistic. Market participants should be aware of the credit risk that remains, or perhaps more accurately, the new credit risk that has replaced the pre-existing credit risk. The FCMs that are responsible for clearing swaps have credit exposure to their customers. On the other hand, customers to swaps that are cleared by FCMs should be concerned about the credit risk of exposure to their FCMs (e.g., MF Global or Peregrine), unless they feel comfortable that CFTC regulation has wholly eliminated such risks going forward. As a practical matter, most market participants will continue to be concerned with credit risk relating to swaps. Ultimately, credit risk is not so easy to wholly eliminate. Parties that wish to discuss the terms of their various clearing agreements may contact me or Jeff Robins.

Click hereto view notice in full (links externally to CFTC website).Clickhere to see a description of the five swap classes subject to mandatory clearing.