CFTC Exempts Small Banks and S&Ls from Certain Swap Clearing Requirements

Practical Law Legal Update w-001-3045 (Approx. 5 pages)

CFTC Exempts Small Banks and S&Ls from Certain Swap Clearing Requirements

by Practical Law Finance

Relief Granted to BHCs and SLHCs

Under No-action Letter 16-01, the CFTC has granted relief to BHCs and SLHCs that have consolidated assets of $10 billion or less from mandatory Dodd-Frank swap clearing under CEA Section 2(h)(1)(A) and Part 50 of the CFTC's regulations, provided that the BHC or SLHC elects not to clear the swap in accordance with the requirements of CFTC Regulation 50.50 (17 C.F.R. 50.50).

Under CFTC rules, swaps that require clearing must be cleared by a derivatives clearing organization (DCO) that is either registered with the CFTC or exempt from registration. Currently, four classes of interest rate swaps and two classes of credit default swaps (CDS) require clearing (see Practice Note, The Dodd-Frank Act: Swap Clearing and Exchange Trading under Title VII: CFTC Swap Clearing Determinations).

Under CEA Section 2(h)(7) and CFTC Regulation 50.50(d), an exception from the clearing requirement is available to the following four types of credit institutions, provided they have less than $10 billion in assets and comply with certain conditions:

Banks, as defined in section 3(a) of the Federal Deposit Insurance Act (FDIA), the deposits of which are insured by the FDIC.
Savings associations, as defined in section 3(b) of the FDIA, the deposits of which are insured by the FDIC.
Farm credit system institutions chartered under the Farm Credit Act of 1971.
Insured federal credit unions and state-chartered credit unions under the Federal Credit Union Act.

BHCs and SLHCs enter into interest rate swaps to hedge interest rate risk that they incur as a result of issuing debt securities or making loans to finance their subsidiary banks or savings associations. BHCs and SLHCs must enter into these interest rate swaps (rather than their subsidiary banks or savings associations) in order to gain hedge accounting treatment.

However, BHCs and SLHCs do not fall under any of the above exceptions and are not permitted to elect not to clear a swap. The CFTC has therefore extended no-action relief to BHCs and SLHCs from the clearing requirement, provided that the BHC or SLHC:

Has no more than $10 billion in consolidated assets (the aggregate value of the assets of all of the BHC's or SLHC's subsidiaries on the last day of each subsidiary's most recent fiscal year must not exceed $10 billion); and
Complies with the same conditions that a bank or savings association must comply with under CFTC Regulation 50.50 in order to elect not to clear a swap subject to the CFTC's clearing requirement. These conditions include reporting to either a registered swap data repository (SDR) or the CFTC:
- that it is not a "financial entity";
- that it is using the swap to hedge or mitigate commercial risk; and
- certain other pedigree information (such as the identity of the electing counterparty, how it generally meets its financial obligations associated with its non-cleared swaps, and whether it is under any reporting obligations under the Securities Exchange Act).

For further details, see Practice Note, The Dodd-Frank Act: The Commercial End-user Exception to the Mandatory Swap Clearing Requirement.

In its request for clearing relief on behalf of BHCs and SLHCs, the American Bankers Association (ABA) pointed out that swaps enter into by BHCs and SLHCs generally have a notional amount of $10 million or less, and BHCs and SLHCs enter into swaps less frequently than other swap counterparties. Therefore, the cost of clearing interest rate swaps (including recurring maintenance and transactional costs) are significantly higher for these institutions, considering the limited number and notional value of the swaps they enter into.

The ABA asserts that over 250 banks and savings associations are part of a BHC or SLHC structure that has no more than $10 billion in consolidated assets, and that over 100 of those 250 are part of a BHC or SLHC structure in which swaps are exclusively entered into at the holding company level.

Relief Granted to Community Development Financial Institutions

CDFIs are typically small in scale and promote economic revitalization and community development, providing financial services to underserved, target markets. CDFIs must apply for and receive certification from the US Department of the Treasury.

Because CDFIs provide financial services, they fall within the "financial entity" definition under CEA section 2(h)(7)(C)(i)(VIII). CDFIs are therefore required to clear swaps.

A coalition of CDFIs requested relief from the CFTC from swap clearing requirements due to their unique structure. The CDFIs' request for relief asserts that CDFIs use swaps to hedge interest rate risk that they incur as a result of issuing debt securities or making loans.

CDFIs typically enter into a minimal amount of interest rate swaps in the fixed-to-floating swap class and forward rate agreement class, denominated in US dollars, which are subject to clearing under CFTC Regulation 50.4. The CDFIs assert that the notional value of each CDFI swap transaction is typically between $5 million and $50 million, so the swap activities of CDFIs present a low level of systemic risk.

The CDFI group therefore requested relief from the clearing requirement in order to enter into swaps to manage their financial risk without paying high clearing costs in order to facilitate their goal of promoting economic revitalization and community development.

The CFTC granted relief to CDFIs under No-action Letter 16-02 from the CFTC clearing requirement by allowing CDFIs to elect the exception to the clearing requirement under CFTC Regulation 50.50 for interest rate swaps in the fixed-to-floating swap class and forward rate agreement class denominated in US dollars that are subject to the clearing mandate under CFTC Regulation 50.4(a), as long as the CDFIs meet the following conditions:

The CDFI must be certified and maintain certification from the Treasury Department as a CDFI.
Each CDFI may elect not to clear interest rate swaps and forward rate agreements up to a total aggregate notional value of $200 million per year.
Each CDFI may elect not to clear no more than ten swap transactions per year.
Each CDFI that elects the exception must file a notice of election and additional information, as outlined in CFTC Regulation 50.50(b). Additionally, CDFIs may only elect the exception for swaps that are entered into for the sole purpose of hedging or mitigating commercial risk, as described in CFTC Regulation 50.50(c).

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