CFTC Approves Clearing Exemption for Inter-Affiliate Swaps

by Katten Muchin Rosenman LLP

On April 1, the Commodity Futures Trading Commission approved a final rule that permits certain affiliates to elect not to clear a swap. To qualify for the clearing exemption, the counterparties’ financial statements must be reported on a consolidated basis and one counterparty must hold a majority ownership interest in the other counterparty or a third party must hold a majority interest in both counterparties. In addition, the following conditions must be met: (i) both counterparties must elect not to clear the swap; (ii) the terms of the swap must be documented in swap trading relationship documentation that satisfies certain CFTC requirements; (iii) the swap must be subject to a centralized risk management program that is designed to monitor and manage the risks associated with the swap; and (iv) each “outward-facing” swap entered into by the affiliated counterparties with unaffiliated counterparties must be cleared or exempt from clearing in accordance with CFTC or comparable foreign requirements.

The requirement to clear outward-facing swaps (Clearing Requirement), which was adopted by the CFTC to address potential evasion of the mandatory clearing requirement by market participants entering into swaps with affiliates in jurisdictions that do not have mandatory clearing requirements, may be met by: (i) complying with the CFTC’s clearing requirement; (ii) complying with a foreign jurisdiction’s clearing mandate that the CFTC has determined is comparable to its clearing requirement; (iii) complying with an exception or exemption from the clearing requirement under the Commodity Exchange Act or CFTC regulations; (iv) complying with an exception or exemption from mandatory clearing under a foreign law that the CFTC has determined is comparable to the analogous CFTC exceptions or exemptions; or (v) clearing such swaps through a registered derivatives clearing organization or a clearing organization that is subject to supervision by appropriate government authorities in the home country of the clearing organization and that has been assessed to be in compliance with the Principles for Financial Market Infrastructures.

If one of the affiliates involved in a transaction in a class of swaps that is subject to mandatory clearing under CFTC rules is located in the European Union, Japan or Singapore (Qualifying Affiliate), the Clearing Requirement will not apply to the outward-facing trades effected by such affiliate until March 11, 2014. However, if a “financial entity” controls one or both of the affiliates or the affiliates are affiliated with a swap dealer or major swap participant, the affiliates may satisfy the Clearing Requirement by ensuring that the trade between the two affiliates or the trade between the Qualifying Affiliate and an unrelated counterparty is marked to market on a daily basis. This “mark-to-market” exception terminates on March 11, 2014.

If one of the affiliates involved in a transaction in a class of swaps that is subject to mandatory clearing under CFTC rules is not located in the United States, the European Union, Japan or Singapore, and the aggregate notional value of such swaps between the affiliates does not exceed five percent of the aggregate notional value of all such swaps between all counterparties (as measured on a quarterly basis), then the outward-facing trades effected by such affiliate are exempt from the Clearing Requirement until March 11, 2014 if mark-to-market requirements similar to those described above are satisfied.

If the inter-affiliate clearing exemption is elected, the reporting counterparty must provide to a swap data repository: (i) confirmation that both counterparties meet the criteria for the inter-affiliate clearing exemption and are electing not to clear the swap; (ii) information regarding how the counterparties meet their financial obligations associated with the uncleared swaps; and (iii) certain additional information if the counterparties are issuers of registered securities or are subject to reporting requirements under Section 15(d) of the Securities Exchange Act of 1934.

The final rule will become effective 60 days after publication in the Federal Register.

For more information, click here.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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