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Inter-affiliate Swap Clearing Relief Extended to December 31, 2014
Practical Law Legal Update 6-560-4445 (Approx. 5 pages)
Inter-affiliate Swap Clearing Relief Extended to December 31, 2014
by Practical Law Finance
| Published on 14 Mar 2014 • USA (National/Federal) |
The CFTC released two no-action letters, which together extend previously granted relief from mandatory swap clearing and exchange-trading requirements for certain inter-affiliate swaps. This relief expires on December 31, 2014.
On March 6, 2014, the CFTC released two no-action letters, which together extend previously granted relief from mandatory Dodd-Frank Title VII swap clearing and exchange-trading requirements for certain inter-affiliate swaps. The CFTC issued:
- No-action Letter No. 14-25 (No-action 14-25), which grants temporary relief to eligible affiliates (see Eligible Affiliates) from the "outward-facing swaps condition" (OFSC) set out in the final inter-affiliate exemption rules under Part 50 of the CFTC Regulations (17 CFR 50.52(a)), and therefore from Title VII's mandatory swap clearing requirement under CEA Section 2(h)(1) (see Outward-facing Swaps Condition and No-action 14-25).
- No-action Letter No. 14-26 (No-action 14-26), which grants analogous relief to eligible affiliates from Title VII's mandatory swap exchange-trading requirement under CEA Section 2(h)(8).
The relief granted under No-action 14-25 and No-action 14-26 expires on December 31, 2014. After that date, under the final CFTC inter-affiliate exemption rules:
- Eligible affiliates must comply with the outward-facing swaps condition to qualify for the inter-affiliate exemption from clearing (see Outward-facing Swaps Condition and No-action 14-25).
- Swaps between eligible affiliates that are required to be cleared must also be exchange traded.
Outward-facing Swaps Condition and No-action 14-25
Under the final inter-affiliate exemption's OFSC requirement (17 CFR 50.52(b)(4)(i)), in order to qualify for the inter-affiliate swap clearing exemption, each eligible affiliate that enters into a swap that is subject to mandatory clearing under CEA Section 2(h)(1) (see 17 CFR 50.4 for a list of these swaps) with an unaffiliated counterparty must either:
- Clear the swap as required under CEA Section 2(h)(1) or qualify for the end-user exemption to clearing under Section 2(h)(7) of the CEA (see Practice Note, The Commercial End-user Exception to the Dodd-Frank Mandatory Swap Clearing Requirement).
- Clear the swap pursuant to a foreign jurisdiction's clearing requirement that the CFTC has deemed comparable to that of the US or qualify for a foreign jurisdiction's exception to the clearing mandate that the CFTC has deemed comparable to that of the US.
- Clear the swap through a registered derivatives clearing organization (DCO) that is subject to regulation in its home country that has been assessed to be in compliance with the BIS-IOSCO international Principles for Financial Markets.
Under the final inter-affiliate exemption rules, the CFTC allowed temporary compliance with either 17 CFR 50.52(b)(4)(ii) or 17 CFR 50.52(b)(4)(iii) in place of the OFSC, as it recognized that it has not yet deemed any foreign jurisdiction's clearing requirement comparable to that of the US. Those alternate provisions were set to expire on March 11, 2014. However, because the CFTC has still not deemed any foreign jurisdiction's clearing requirement comparable to that of the US, No-action 14-25 extends these alternatives to the OFSC until December 31, 2014. As a result, eligible affiliates that would otherwise qualify for the inter-affiliate swaps exemption but for the OFSC, may instead comply with:
- The first alternative to the OFSC to eligibility for the inter-affiliate swaps exemptions from Title VII clearing (17 CFR 50.52(b)(4)(ii)). Under the first alternative, eligible affiliates located in the European Union (EU), Japan and Singapore may satisfy the OFSC by either:
- paying and collecting full daily variation margin on all swaps with unaffiliated counterparties; or
- paying and collecting full daily variation margin on all swaps with all other eligible affiliates, including eligible affiliates outside of those jurisdictions.
In order to take advantage of this alternative to the OFSC, the eligible affiliate that controls the other eligible affiliate (or the third party that controls both eligible affiliates) may not be a financial entity as defined in Section 2(h)(7)(C)(i) of the CEA and neither eligible affiliate may be, or may be an affiliate of, a swap dealer or major swap participant. - The second alternative to the OFSC to eligibility for the inter-affiliate swaps exemptions from Title VII clearing (17 CFR 50.52(b)(4)(iii)). Under the second alternative, eligible affiliates located in the US that enter into swaps with eligible affiliates in non-US jurisdictions outside of the EU, Japan and Singapore may satisfy the OFSC by either:
- paying and collecting full daily variation margin on all swaps with unaffiliated counterparties; or
- paying and collecting full daily variation margin on all swaps with all other Eligible Affiliate counterparties.
However, this alternative is not available to that eligible affiliate if the aggregate notional value of all of the swaps otherwise required to be cleared under Title VII that the eligible affiliate has entered into with counterparties that are located in non-US jurisdictions outside of the EU, Japan or Singapore exceeds 5% of the total swaps held by the eligible affiliate that are required to be cleared.
No-action 14-25 extends the availability of these two alternatives to the OFSC for eligible affiliates until December 31, 2014, provided that:
- All other requirements of 17 CFR 50.52 are satisfied.
- The counterparty to the swap is located outside of a jurisdiction for which the CFTC has determined a comparable clearing requirement exists (again, currently there are no such jurisdictions).
- The party seeking the eligible affiliate exemption must be prepared to provide the CFTC with documentation supporting its compliance with the regulations and the no-action guidance.
After December 31, 2014, eligible affiliates will be required to clear outward-facing swaps as required under the Title VII or the analogous regulations of a jurisdiction deemed comparable by the CFTC.
Entities that do not qualify for an alternative to the OFSC must clear swaps as would otherwise be required under Section 2(h) of the CEA.
Eligible Affiliates
As defined in 17 CFR 50.52(a), an eligible affiliate is:
- A derivatives counterparty that directly or indirectly holds a majority ownership interest in the other counterparty.
- The counterparty that holds the majority interest in the other counterparty reports its financial statements on a consolidated basis under US GAAP or International Financial Reporting Standards.
- Such consolidated financial statements include the financial results of the majority-owned counterparty.
Alternatively, an eligible affiliate can exist when:
- A third party, directly or indirectly, holds a majority ownership interest in both counterparties to a derivatives contract.
- The third party reports its financial statements on a consolidated basis under US GAAP or International Financial Reporting Standards.
- Such consolidated financial statements include the financial results of both of the counterparties.
A counterparty or third party directly or indirectly holds a majority ownership interest if it directly or indirectly holds a majority of the equity securities of an entity, or the right to receive upon dissolution, or the contribution of, a majority of the capital of a partnership.