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Clearing Exemption for Inter-affiliate Swaps Proposed by CFTC
Practical Law Legal Update 8-520-9726 (Approx. 4 pages)
Clearing Exemption for Inter-affiliate Swaps Proposed by CFTC
by PLC Finance
| Published on 22 Aug 2012 • USA (National/Federal) |
The CFTC issued a proposed rule that would exempt swaps between certain affiliated entities (inter-affiliate swaps) from Dodd-Frank's swap clearing requirement.
On August 15, 2012, the CFTC issued proposed rules that would exempt swaps between majority-owned affiliates within a corporate group from the Dodd-Frank Act's swap clearing requirement, subject to certain conditions. The proposed rules stem from the CFTC's determination that inter-affiliate swaps pose less counterparty risk than swaps between unaffiliated entities.
Under the proposed rules, inter-affiliate swaps would be exempt from Title VII's mandatory swap clearing requirement subject to the following conditions:
- Clearing. Each counterparty to the inter-affiliate swap must elect to not clear the swap.
- Majority ownership. The exemption would only cover swaps between majority-owned affiliates whose financial statements are reported on a consolidated basis. Affiliates would be considered majority owned if either:
- one affiliate holds a direct or indirect majority ownership interest in the other affiliate; or
- a third party holds a direct or indirect majority ownership interest in both affiliates.
- Centralized risk management. The inter-affiliate swap must be subject to a centralized risk management program reasonably designed to monitor and manage the risks associated with inter-affiliate swaps.
- Swap trading relationship documentation. The inter-affiliate swap must be documented in a "swap trading relationship document" (for more on swap trading relationship documentation, see Legal Update, CFTC Proposes Rules on Documentation of Trading Relationships for Swap Dealers and Major Swap Participants). The swap trading relationship document must be in writing and include all terms governing the trading relationship including, without limitation, terms addressing:
- the parties' payment obligations under the transaction;
- netting of payments;
- events of default or other termination events;
- calculation and netting of obligations on termination of the transaction;
- transfer of a party's rights and obligations under the transaction;
- governing law;
- valuation methodology; and
- dispute resolution procedures.
- Variation margin. Affiliates that are financial entities, as defined in Section 2(h)(7)(C) of the Commodity Exchange Act, must post variation margin collateral for each swap for which the exemption is elected. Variation margining consists of marking open positions (and posted collateral) to their current market value on a daily basis and transferring funds between the parties to reflect changes in these values since the last time the positions were marked to market. If both counterparties are financial entities, each counterparty must pay and collect variation margin for each inter-affiliate swap for which the proposed exemption is elected. The counterparties must set out and describe in the swap trading relationship document the methodology used to calculate variation margin.The variation margin requirement would not apply to 100% commonly owned and commonly guaranteed affiliates if the common guarantor is also under 100% common ownership. In other words, the variation margin requirement would not apply in instances where the swap is between two wholly owned subsidiaries of a common parent or where one affiliate is wholly owned by the other.
- Jurisdictional requirements. Each affiliate must satisfy any one of the four following criteria:
- it is located in the US;
- it is located in a jurisdiction that has a comparable and comprehensive swap clearing requirement;
- it is otherwise required to clear all swaps it enters into with non-affiliate counterparties in compliance with US law; or
- it does not enter into any swaps with non-affiliate counterparties.
- Swap data reporting requirements. In addition to any other applicable Dodd-Frank swap data reporting requirements, the proposed rules would implement data reporting requirements specifically for uncleared inter-affiliate swaps. Under the proposed rules, the reporting counterparty must affirm that both counterparties elected not to clear the inter-affiliate swap and that they have satisfied the other conditions of the exemption. In addition, the reporting counterparty would need to report in connection with each inter-affiliate swap or, alternatively, on an annual basis:
- how each counterparty generally meets its financial obligations with respect to uncleared swaps; and
- if the counterparty is registered under Section 12 of the Exchange Act or required to file reports under Section 15(d) of the Exchange Act, both the relevant SEC Central Index Key and an acknowledgement that an appropriate committee of the board of directors of the counterparty has approved the decision to enter into swaps subject to the clearing exemption.These reports would be made to a registered swap data repository (SDR) or, if no SDR is available, to the CFTC.
Counterparties that also qualify for the CFTC's end-user exception to clearing would be able to elect to not clear swaps under either the end-user exception or this proposed exemption (for more information on the end-user exception, see Legal Update, Final Rules on End-user Exception to Swap Clearing Requirement under Dodd-Frank Issued by CFTC).
The CFTC is accepting comments on the proposed rule until September 20, 2012.
To learn more about Dodd-Frank swap clearing requirements, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Swap Clearing under Dodd-Frank.