11 January 2011
In its proposed rule, the Commodity Futures Trading Commission (CFTC) proposes new requirements governing the elective exception to mandatory clearing of swaps for those swap counterparties meeting the requirements under section 2(h)(7) of the Commodity Exchange Act (CEA), as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act.1
These requirements include mandatory reporting by a qualifying end-user2 that it is electing the exception from otherwise required mandatory clearing. The end-user must also provide additional information regarding how it mitigates credit risk from non-cleared swaps.
Specifically, the proposed rule would revise Rule 39.6 of the CFTC Regulations to require notice from an electing counterparty to a registered swap data repository or, if none is available, to the CFTC each time that the end-user elects the clearing exception. If there is more than one electing counterparty for the related swap, all electing counterparties must provide such notice. The notice would contain 11 specific items of additional information, including:
- The identity of the electing counterparty
- Whether the electing counterparty is a “financial entity” as defined in CEA section 2(h)(7)(C)(i)
- Whether the electing counterparty is a “finance affiliate” meeting the requirements of CEA section 2(h)(7)(C)(ii) or 2(h)(7)(D)
- Whether the related swap is being used to hedge or mitigate commercial risk as defined in the proposed rule
- Whether the electing counterparty expects to meet its financial obligations under the related non-cleared swap by using
- A written credit support agreement
- Pledged or segregated assets (including posting or receiving margin)
- A written third-party guarantee
- Solely using the electing counterparty’s own available financial resources
- Any other means
- Whether the electing counterparty is an entity that is an issuer of securities registered under section 12 of, or is required to file reports under section 15(d) of, the Securities Exchange Act of 1934 and, if so:
- The relevant SEC Central Index Key number for the counterparty; and
- Whether an appropriate committee of the board of directors (or equivalent body) has reviewed and approved the determination not to clear the related swap
The proposed rule further provides that, for purposes of CEA section 2(a)(7)(A)(ii) and the proposed rule, a swap will be deemed to hedge or mitigate commercial risk when:
- The swap is:
- “Economically appropriate” to the reduction of risks in the conduct of the management of a commercial enterprise, where such risks arise from:
- The potential change in value of assets that a person owns, produces, manufactures, processes or merchandises or reasonably anticipates owning, producing, manufacturing, processing or merchandising in the ordinary course of the enterprise’s business;
- The potential change in the value of liabilities that a person has incurred, or reasonably anticipates incurring, in the ordinary course of the enterprise’s business;
- The potential change in the value of services that that a person provides, purchases, or reasonably anticipates providing or purchasing in the ordinary course of the enterprise’s business;
- The potential change in the value of assets, services, inputs, products or commodities that a person owns, produces, manufactures, processes, merchandises, leases or sells, or reasonably anticipates owning, producing, manufacturing, processing, merchandising, leasing or selling in the ordinary course of the enterprise’s business;
- Any potential change in value related to any of the foregoing arising from foreign exchange rate movements associated with such assets, liabilities, services, inputs, products or commodities; or
- Any fluctuation in interest, currency, or foreign exchange rate exposures arising from a person’s current or anticipated assets or liabilities; and either
- The swap qualifies as bona fide hedging for purposes of an exemption from position limits under the CEA; or
- The swap qualifies for hedging treatment under the Financial Accounting Standards Board’s Accounting Standards Codification Topic 815, Derivatives and Hedging (previously, Financial Accounting Standard 133).
- The swap is not used:
- For a purpose that is in the nature of speculation, investing or trading or
- To hedge or mitigate the risk of another swap (or security-based swap), unless the other swap (or security-based swap) itself is used to hedge or mitigate commercial risk as defined by Section 39.6(c) (or the equivalent rule of the Securities and Exchange Commission under the Securities Exchange Act).
Comments on the proposed rule are due on or before February 22, 2011.
For more information about the proposed rule or any other matter raised in this Legal Update, please contact
at +1 312 701 7366.
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||1. This so-called “end-user” exception is discussed in our earlier Legal Update dated August 27, 2010. |
||2. Generally, not a “financial entity” and an entity that is “hedging or mitigating commercial risk.” See CEA section 2(h)(7)(A).|