CFTC Exemption for Clearing Inter-Affiliate Swaps (with Lofchie Comment)
The CFTC issued a final rule to exempt swaps between certain affiliated entities within a corporate group from the clearing requirement under section 2(h)(1)(A) of the Commodity Exchange Act ("CEA") and CFTC regulations, subject to a number of conditions. On November 29, 2012, the CFTC had adopted its first clearing requirement determination, requiring that swaps meeting the specifications outlined in four classes of interest rate swaps and two classes of credit default swaps ("CDS") be cleared. On March 11, 2013, swap dealers, major swap participants, and private funds active in the swaps market were required to begin clearing certain index CDS and interest rate swaps which they entered into on or after March 11, 2013.
Swaps with Affiliates
Pursuant to its authority under section 4(c)(1) of the CEA, the CFTC approved a rule that permits affiliated counterparties to elect not to clear a swap that woud be otherwise subject to the clearing requirement if those counterparties are majority-owned affiliates whose financial statements are included in the same consolidated financial statements. The exemption is subject to the following additional conditions: (i) both affiliated counterparties must elect not to clear the swap; (ii) he terms of the swap must be documented in a swap trading relationship document (or comply with the requirements of CFTC regulation 23.504, if one of the affiliated counterparties is a swap dealer or a major swap participant); (iii) the swap must be subject to a centralized risk management program that is reasonably designed to monitor and manage the risks associated with the swap (or if one of the affiliated counterparties is a swap dealer or a major swap participant, the requirements of CFTC regulation 23.600 must be met); (iv) and each swap entered into by the affiliated counterparties, of a type that would be subject to the clearing requirement, with unaffiliated counterparties must be cleared or exempt from clearing (as described in the next paragraph).
Related Swaps with Unrelated Parties
The above-mentioned requirement to "clear" swaps entered into with unaffiliated counterparties may be met by: (1) complying with the CFTC's clearing requirement or an exception therefrom; (2) complying with a foreign jurisdiction's clearing mandate or with an exception therefrom that the CFTC has determined is acceptable; or (3) clearing such swaps through a registered derivatives clearing organization or a clearing organization that is subject to supervision by appropriate government authorities in the home country of the clearing organization and has been assessed to be in compliance with the Principles for Financial Market Infrastructures. These conditions limit the jurisdictional scope of the clearing exemption.
Reporting Requirements
The final rule requires the reporting counterparty to report to a swap data repository or the CFTC the following information for each swap for which the inter-affiliate exemption applies: (1) confirmation that both affiliated counterparties to the swap are electing not to clear the swap and that each of the electing eligible affiliate counterparties satisfies the requirements of the rule; (2) information regarding how both affiliated counterparties generally meet their financial obligations associated with entering into non-cleared swaps; and (3) certain information, if the affiliated counterparties are issuers of securities registered under section 12, or are required to file reports under section 15(d), of the Securities Exchange Act of 1934.
Timing
The Rule sets out timing requirements, effectively delaying the requirements of the rule. The Rule sets out timing requirements for mandatory clearing of certain CDS indices on European corporate names.
Lofchie Comment: This is an important exemption because it provides not only a means for affiliates to trade without clearing, but also a means by which business may be done across national borders without subjecting non-U.S. entities to the full burden of U.S. regulation. It may be expected that non-U.S. entities that want to trade with a U.S. swap dealer will likely instead trade with the U.S. firm's foreign affiliate, and that the affiliate in turn can transfer any risk back to the swap dealer in the United States. This will at least allow U.S.-based firms to be competitive in non-U.S. markets, although, it likely will continue to encourage the steady movement of financial jobs outside the United States.The Rule is also significant because it represents a fairly significant retreat by the CFTC from its position that its swaps rules would govern the world markets. This position was not workable in light of opposition from non-U.S. regulators. Now, it will be interesting to see how both the process of determining comparability works and what jurisdictions are deemed comparable. Many corporate groups that do not act as swap dealers centralize their external swaps activities in one (or a few) members of the corporate group. Such corporate grops that are not subject to CFTC registration should be aware that various conditions in the exemptive order apply to them if they wish to avoid clearing intra-group swaps with their affiliates; e.g., the documentation requirement and the requirement of a risk management program. As to the requirement of a risk managemenet program, the rule states that the CFTC anticipates that it would include "rigorous valuaton provisions" and "procedures for elevating and resolving disputes." Corporate groups should also be aware that the exemption is subject to various jurisdictional limitations.
See: Final Rule (links to the CFTC's website).See also: CFTC Press Release; Statement from CFTC Chairman Gensler.For a compilation of recent news stories on clearing, link to "Current Topics - Clearing."