Final Dodd-Frank Rules for Swap Clearing Members Issued by CFTC | Practical Law

Final Dodd-Frank Rules for Swap Clearing Members Issued by CFTC | Practical Law

The CFTC issued final Dodd-Frank rules covering the activities of non-security-based swap clearinghouse clearing members, including rules on customer swap clearing documentation, timing of swap acceptance for clearing and clearing member risk management for futures contract merchants (FCMs), swap dealers (SDs) and major swap participants (MSPs).

Final Dodd-Frank Rules for Swap Clearing Members Issued by CFTC

Practical Law Legal Update 1-518-6337 (Approx. 5 pages)

Final Dodd-Frank Rules for Swap Clearing Members Issued by CFTC

by PLC Finance
Published on 29 Mar 2012 • USA (National/Federal)
The CFTC issued final Dodd-Frank rules covering the activities of non-security-based swap clearinghouse clearing members, including rules on customer swap clearing documentation, timing of swap acceptance for clearing and clearing member risk management for futures contract merchants (FCMs), swap dealers (SDs) and major swap participants (MSPs).
On March 20, 2012, the CFTC issued final rules under Title VII of the Dodd-Frank Act for clearing members of non-security-based swap clearinghouses. The final rules cover:
  • Certain parameters for the documentation between customers and clearing members (financial institutions that submit swaps to a non-security-based swap clearinghouse for clearing on behalf of customers) that are futures commission merchants (FCMs), swap dealers (SDs) and major swap participants (MSPs).
  • The timing of acceptance or rejection of swaps for clearing by derivatives clearing organizations (DCOs) and clearing members of non-security-based swap clearinghouses.
  • Risk management protocol for SDs, MSPs and FCMs that are clearing members on non-security-based swap clearinghouses.
The goal of the final rules is to facilitate customer access to clearing, bolster risk management at the clearing member level and minimize the time between submission and acceptance or rejection of non-security-based swaps for clearing by DCOs and clearing members.
For detailed information on the role of clearing members in a cleared swap transaction, see Practice Note, Mechanics of Derivatives Clearing. Note that many FCMs will also be swap dealers or MSPs under Title VII of the Dodd-Frank Act.

Rules on Customer Swap Clearing Documentation

The final rules prohibit non-security-based swap clearing members, which are FCMs, SDs and MSPs, from including in their customer non-security-based swap clearing documentation:
  • Provisions that would require the disclosure to the FCM or any SD or MSP of the identity of a customer's original executing counterparty to the swap that is being submitted for clearing. No further clarification is provided on this point.
  • Limitations on the number of counterparties with which a customer may enter into a swap. No further clarification is provided on this point.
  • Restrictions on the size of the swap position a customer may take with any individual counterparty, apart from an overall credit limit for all positions held by the customer in the aggregate.
  • Provisions that impair a customer's ability to enter into a swap transaction on terms that have a reasonable relationship to the best market terms available.
  • Provisions that prevent compliance with time frames specified by regulators for acceptance of swaps for clearing.
The regulations also prohibit FCMs, SDs, MSPs, and DCOs from entering into agreements, including those known in the industry as "trilateral agreements," with terms restricting an FCM's customer's ability to access all willing counterparties in the market and obtain a swap on reasonably competitive terms.

Timing of Acceptance of Swaps for Clearing

The final rules also required clearing members and DCOs of which they are members to accept or reject each swap submitted for clearing as quickly as would be technologically practicable if fully automated systems were used. However, note that this final rule has been modified by the CFTC to two minutes rather than as soon as technologically practicable (see Legal Update, CFTC Sets Two-minute Time Frame for Clearing Members to Accept or Reject Swaps).
Trade processing with manual steps will be accommodated provided that the process can operate within the same time frame as automated systems.
The final rules establish the following time frames for swap execution facilities (SEFs), designated contract markets (DCMs) and clearing members that are SDs, MSPs and FCMs to submit non-security-based swaps to a DCO for clearing:
  • When submitting swaps that are required to be cleared under Dodd-Frank rules, the swap must be submitted for clearing to a DCO as soon as technologically practicable after execution, but no later than the close of business on the day of execution.
  • When submitting swaps that are not required to be cleared under Dodd-Frank rules, the swap must be submitted for clearing to a DCO not later than the next business day after execution of:
    • the swap; or
    • the agreement to clear, if later than execution of the swap.

Clearing Member Risk Management for SDs, MSPs and FCMs

Under the final rules, each clearing member that is an SD, MSP or FCM must:
  • Establish credit-based and market-risk-based limits on clearing customers' swap position sizes, order sizes, margin requirements and other related factors.
  • Use automated means to screen orders for compliance with these risk-based customer limits.
  • Monitor for adherence to risk-based limits both intraday and overnight.
  • In the case of an FCM clearing member, conduct stress tests of all swap positions in any proprietary account of the clearing member and in any customer accounts that could pose material risk to the FCM at least once per week. In the case of an SD or MSP clearing member that is not also an FCM, conduct stress tests under extreme but plausible conditions of all positions at least once per week.
  • Evaluate at least once per week its ability to meet initial margin requirements (note that it is unclear exactly what this requirement entails. ISDA and the Futures Industry Association (FIA) commented to the CFTC during the proposal stage that this requirement is unclear, however, the CFTC retained the original language).
  • Evaluate at least once per week its ability to meet variation margin requirements in cash (note that it is unclear exactly what this requirement entails. ISDA and the Futures Industry Association (FIA) commented to the CFTC during the proposal stage that this requirement is unclear, however, the CFTC retained the original language).
  • In the case of an FCM clearing member, evaluate at least once per quarter its ability to liquidate in an orderly manner the positions in its proprietary and customer accounts and estimate the cost of the liquidation. In the case of an SD or MSP clearing member that is not also an FCM, evaluate at least once per quarter its ability to liquidate positions it clears in an orderly manner and estimate the cost of the liquidation.
  • Test all lines of credit at least once per year.
The regulations only establish the general elements to be included in the design and testing of an SD's, MSP's or FCM's risk management program and do not prescribe specific protocol, systems or details.

Compliance Dates

For FCMs, DCMs and DCOs, the final rules take effect on October 1, 2012. For SDs and MSPs, the final rules take effect on the later of:
  • October 1, 2012.
  • The date that Dodd-Frank registration rules for SDs and MSPs take effect.
For SEFs, the final rules take effect on the later of:
  • October 1, 2012.
  • The date that Dodd-Frank rules implementing the core principles for SEFs take effect.
For more information on the final rules, see the CFTC's fact sheet and Q&A.
To learn more about the regulation of swaps and derivatives under the Dodd-Frank Act, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives.