Alert August 21, 2012

CFTC Proposes Clearing Exemption for Swaps Between Certain Affiliates

The CFTC proposed a rule to exempt swaps between certain affiliates from the clearing requirement.  The proposal follows the Dodd-Frank Act and its related regulations, which collectively mandate the clearing of certain swaps.  The CFTC has previously issued a final rule (discussed in the July 17, 2012 Financial Services Alert) that provides an exception to clearing for end-users.

The proposal, which is based on the premise that affiliated counterparties internalize each other’s counterparty risk and have a greater incentive to perform than they would if their counterparties were unrelated, applies the exemption only to swaps between majority-owned affiliates whose financial statements are reported on a consolidated basis. The exemption would only be available to swaps between U.S. affiliates and swaps between a U.S. affiliate and a non-U.S. affiliate that (1) is located in a jurisdiction with a “comparable and comprehensive clearing regime,” (2) is otherwise required to clear the swaps it enters into with non-affiliated parties under United States law, or (3) does not enter into swaps with non-affiliated parties.  A corporate family relying on the exemption would also be required to subject inter-affiliate swaps to centralized risk management, to meet certain documentation and reporting rules, and, in the case of swaps between two financial entities, to post variation margin (unless both affiliates are 100% commonly-owned and commonly-guaranteed).

As noted in the release, the proposal is likely to benefit corporate entities in which the parent or a centralized “treasury” or similar subsidiary faces counterparties outside the corporate family, while engaging in inter-affiliate swaps to fund or otherwise facilitate the activities of its affiliates. 

The CFTC release proposing the rule notes that counterparties may, in certain circumstances, be eligible to invoke both the end-user exception and the inter-affiliate exemption and may choose to use either.  Because the end-user exception requires the electing counterparty to not be a “financial entity” (where certain “small financial institutions” are not considered “financial entities”), and because the end-user exception requires that the swap not being cleared be used to hedge or mitigate commercial risk, the CFTC suggests that the proposed inter-affiliate exemption will generally be used for swaps between affiliated financial entities or for swaps that do not hedge or mitigate commercial risk.

Comments on the proposal are due by September 30, 2012.