The CFTC has approved its final rule on the so-called “end-user exception” to the Dodd-Frank Act’s mandatory clearing requirement applicable to swaps required to be cleared (roughly, standardized swaps). Under the exception, as provided by the Act, a swap counterparty may elect not to clear a swap if the counterparty:
(i) Is not a “financial entity” (e.g., swap dealer, major swap participant, investment fund, bank, or pension plan);
(ii) Is using the swap to “hedge or mitigate commercial risk,” as further defined; and
(iii) Provides certain information along with the swap to a swap data repository or the Commission.
An unofficial version of the rule has been released while publication in the Federal Register remains pending.
Reduced Reporting and Board Approval Requirements
In a win for end users and reporting counterparties, the CFTC reduced the reporting burden associated with electing the exemption for individual swaps from what was required under the proposed rule. Under the final rule, only two pieces of information are strictly required to be reported with each swap:
(1) notice of the election of the exception; and
(2) the identity of the counterparty electing not to clear the swap.
The following information must also be provided, but can be submitted by an annual filing by the electing counterparty rather than provided with each swap:
(1) whether the electing counterparty is a financial entity electing the exception on behalf of an affiliate or as a small financial institution;
(2) whether the swap for which the exception is being elected is used to hedge or mitigate commercial risk;
(3) information regarding how the electing counterparty generally meets its financial obligations associated with entering into non-cleared swaps; and
(4) if the electing counterparty is an “SEC Filer,” whether its board of directors has approved generally the decision to enter into swaps that are exempt from the clearing and trading requirements.
In another win for end users advocated for by dodd-frank.com blogger Steve Quinlivan (see former post), among others, the CFTC clarified that, for SEC Filers, the board approval requirement can be satisfied by general approval with respect to an entity’s swap business, as opposed to requiring swap-by-swap approval as suggested by the proposed rule. On the frequency of board review and/or approval, the CFTC added: “The Commission would expect an SEC Filer’s board to set appropriate policies governing the SEC Filer’s use of swaps subject to the end-user exception and to review those policies at least annually and, as appropriate, more often upon a triggering event (e.g., a new hedging strategy is to be implemented that was not contemplated in the original board approval).”
Hedging or Mitigating Commercial Risk
The CFTC adopted a definition of “hedging or mitigating commercial risk” that is virtually the same as that used in the definition of “major swap participant” recently adopted by the Commission, which encompasses the definition of “bona fide hedging” under the position limits rule (one of several different hedge definitions under the CFTC’s Dodd-Frank regulations), transactions qualifying for hedging treatment under FASB standards, and, more generally, swaps that are “economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise. . . .”
Financial Entity Exceptions
The rule also allows financial entities to take advantage of the exception with respect to certain narrow classes of activities related to financing manufacturing activities and hedging the risks of affiliates, as provided for by the Dodd-Frank Act. Finally, acting upon the Act’s direction to consider an exemption for small banks, savings associations, farm credit system institutions, and credit unions, the CFTC provided a new exemption for such entities having less than $10 billion in total assets.
Clearing Determinations, and Mandatory Clearing, Set for Fall 2012
Chairman Gensler indicated at this week’s rulemaking that the Commissioners expect to consider the first determinations on swaps required to be cleared later this month, suggesting that mandatory clearing could go into effect as early as October 2012.