Inter-affiliate and Certain Other Swaps Exempted from Mandatory Clearing Requirements by CFTC | Practical Law

Inter-affiliate and Certain Other Swaps Exempted from Mandatory Clearing Requirements by CFTC | Practical Law

The CFTC has issued no-action relief exempting certain swaps from mandatory clearing requriements under Title VII of the Dodd-Frank Act. The new relief includes exemptions for inter-affiliate swaps, partially novated or terminated swaps and swaps that result from multilateral compression exercises.

Inter-affiliate and Certain Other Swaps Exempted from Mandatory Clearing Requirements by CFTC

by PLC Finance
Published on 03 Apr 2013 • USA (National/Federal)
The CFTC has issued no-action relief exempting certain swaps from mandatory clearing requriements under Title VII of the Dodd-Frank Act. The new relief includes exemptions for inter-affiliate swaps, partially novated or terminated swaps and swaps that result from multilateral compression exercises.
The CFTC has issued a new rule and two no-action letters that permanently exempt certain swaps from the mandatory swap clearing requirement of Title VII of the Dodd-Frank Act. The CFTC issued:
  • On April 1, 2013, a final rule that exempts inter-affiliate swaps from mandatory clearing under Title VII of the Dodd-Frank Act and exempting these swaps from variation margin posting. The exemption is available if the parties to the swap are majority-owned affiliates, file consolidated financial statements and both parties choose not to clear the swap.
  • On March 20, 2013, No-action Letter 13-02, granting relief from mandatory clearing for partial novation or partial termination of certain swaps.
  • On March 18, 2013, No-action Letter 13-01, granting relief from mandatory clearing for swaps that result from multilateral compression exercises.
Swap clearing for swap dealers (SDs), major swap participants (MSPs) and active funds for certain credit default swaps (CDS) and interest rate swaps became mandatory on March 11, 2013 (see, Checklist, Dodd-Frank Swaps Calendar and Legal Update, Final Clearing Determination for CDS and Interest Rate Swaps Issued by CFTC).
For more information on mandatory Title VII swap clearing requirements, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Swap Clearing and Exchange Trading under Title VII.

Exemption for Inter-affiliate Swaps

On April 1, 2013, the CFTC issued a final rule that exempts inter-affiliate swaps from mandatory clearing under Title VII of the Dodd-Frank Act. Clearing of certain credit default swaps (CDS) and interest rate swaps for swap dealers (SD), major swap participants (MSP) and active funds became mandatory on March 11, 2013. This exemption allows "eligible affiliate counterparties" to choose not to clear swaps if:
  • The counterparties are majority-owned affiliates.
  • The financial statements of the affiliates are included in the same consolidated financial statements.
  • Both counterparties choose not to clear the swap.
  • The terms of the swap are documented in a swap trading relationship document, or, if one of the parties is an SD or MSP, the swap is in compliance with CFTC Regulation 23.504.
  • The swap is subject to a centralized risk management program reasonably designed to monitor and manage swap risks, or, if one of the parties is an SD or MSP, the swap is in compliance with CFTC Regulation 23.600.
  • Each swap that is not exempt from mandatory clearing requirements is cleared.
Counterparties that elect not to clear a swap under the final rule on inter-affiliate exemption must report the following to a swap data repository (SDR), or the CFTC if no SDR is available:
  • That both affiliated counterparties have elected not to clear the swap and that both parties are eligible for the exemption by satisfying the requirements of this final rule.
  • How both affiliated counterparties generally meet the financial obligations associated with entering into uncleared swaps.
  • Specific additional information, if the affiliated counterparties are issuers of securities or are required to file reports under sections 12 and 15(d), respectively, of the Securities Exchange Act of 1934.
The rule will become effective 60 days after it is published in the Federal Register. The CFTC has stated that prior to this rule becoming effective, clearing requirements do not apply to majority-owned affiliated counterparties that report on consolidated financial statements and have elected not to clear swaps. Thus, swaps that meet the criteria for the exemption are not and will not be subject to clearing requirements.
Entities may also take advantage of a foreign jurisdiction's clearing rules, and exceptions thereto, if the CFTC has determined that the rules are comprehensive and comparable to the CFTC's.
This final rule alters the CFTC's proposed rule exempting inter-affiliate swaps from mandatory clearing because it does not require variation margin to be posted between the affiliates (see, Legal Update, Clearing Exemption for Inter-affiliate Swaps Proposed by CFTC).

Exemption for Partially Novated and Partially Terminated Swaps

On March 20, 2013, the CFTC issued no-action relief from the mandatory Title VII swap clearing requirement for "stub swaps." Stub swaps are the remnants of swaps executed prior to mandatory clearing requirements that were subsequently partially novated or partially terminated. In order for stub swaps to be exempt from the clearing requirement:
  • The original swap must not have been cleared.
  • The original swap must have been executed prior to the date upon which the applicable mandatory clearing requirement became effective.
  • The partial novation or partial termination affects only the notional amount of the swap. All other aspects of the stub swap must remain the same.
  • The records for the original swap are left the same, except to amend the notional amount.
Additionally, for swaps that are partially novated after an applicable mandatory clearing deadline, the novated (transferred) part of the swap (between one of the original swap counterparties and a new third-party counterparty) must be cleared according to Section 2(h)(1)(A) of the Commodity Exchange Act (CEA) and CFTC Regulation Part 50.
All new swaps subject to mandatory clearing that are entered into after an applicable mandatory clearing deadline must be cleared, even if they have the functional effect of a full or partial termination or novation of an existing swap.

Exemption for Swaps Resulting from Multilateral Compression

On March 18, 2013, the CFTC issued no-action relief from the mandatory Title VII clearing requirement for swaps that result from multilateral compression exercises. Swaps exempted under this relief include:
  • Swaps that are amended solely to reduce their notional value as part of a compression exercise.
  • Swaps that are entered into to replace existing swaps to reduce notional exposure or total outstanding notional exposure, if the existing swaps predated the applicable mandatory clearing requirement.
The relief requires that:
  • All swaps that are part of the multilateral compression exercise were not required to be cleared (because they were entered into before an applicable mandatory clearing date) and remain uncleared.
  • Amended and new swaps must be entered into with the same counterparty as the existing or replaced swap.
  • The only substantive difference between the old and the new swap is the notional amount. All other material terms must be consistent.
  • The counterparties only enter into new swaps to reduce operational or counterparty credit risk.
For more information on swap portfolio compression, see Practice Note, Swap Dealers and MSPs: Final Dodd-Frank Internal Business Conduct (IBC) Rules.