Central clearing of over-the-counter derivatives is a central pillar of the financial services reforms that are embodied in the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The presumption of mandatory clearing of swaps portends vast changes to the hedging activities of manufacturing companies, energy producers, natural resources firms, transportation companies and other non-financial companies (“commercial end-users”). Those non-financial companies will be required to start clearing swaps in the third quarter of 2013 unless they qualify for an exception from mandatory clearing (the “Commercial End-User Exception”) and satisfy the requirements to fall outside of the clearing regime.

To Clear or Not to Clear … That is the Question -

Cleared swaps will be similar in many respects to exchange traded financial instruments and will drive hedging towards standardization and homogenization. Swap clearing may benefit commercial end-users by reducing spreads, but it may also have disadvantages. Those could include more limited scope to engage in bespoke hedging for complex businesses, higher margin requirements and operational issues arising from the need to understand and comply with clearinghouse rules.

The Commercial End-User Exception was mandated by the Dodd-Frank Act in order to ensure that non-financial companies can opt out of clearing where it is appropriate for their business needs to continue to transact bilateral swaps. A commercial end-user faced with the choice of whether to enter into a cleared and exchange traded swap or a non-cleared swap will likely make such a decision on the basis of the structure and hedging needs of its particular business as well as commercial considerations of cost, liquidity, and credit risk.

Please see full alert below for more information.