Alert March 26, 2013

CFTC Issues No-Action Relief from Clearing Requirement for Multilateral Portfolio Compression Exercises and for Stub Swaps

The CFTC’s Division of Clearing and Risk (the “Division”) issued two no-action letters providing relief from the clearing requirements for swaps under the Commodity Exchange Act and CFTC regulations.  The first letter pertains to swaps resulting from a multilateral portfolio compression exercise, while the second applies to “stub swaps” resulting from a partial termination or partial novation of an existing swap.

Multilateral portfolio compression exercises.  The first no-action letter pertains to the clearing of amended swaps and replacement swaps that are generated as part of a multilateral portfolio compression exercise.  As described in the no-action letter, a “multilateral portfolio compression exercise” is a process by which a service provider analyzes the swap portfolios of multiple swap market participants and then determines the “optimal solution” to net down the size and/or number of outstanding swaps among the participating swap market participants.  The result is a decrease in either the number of outstanding swaps or the aggregate notional value of the swaps.  The intention is to reduce operational risk and, in some cases, counterparty credit risk.  As part of the process, pre-existing swaps may be amended to lower the outstanding notional value, or pre-existing swaps may be terminated and replaced with new swaps reflecting the reduced notional exposure between the counterparties.

The no-action letter states that the Division will not recommend that the CFTC take an enforcement action against any person for failure to clear an amended or replacement swap generated as part of a multilateral portfolio compression exercise, provided that certain conditions are met.  The conditions include, among others, the following requirements: (1) no original swap subject to the multilateral portfolio compression exercise had been cleared by a derivatives clearing organization or required to have been cleared; (2) the multilateral portfolio compression exercise must involve more than two market participants; and (3) the resulting swaps must have the same material terms as the original swaps with the exception of reducing the notional amount.

Stub swaps.  The Division’s second no-action letter addresses so-called “stub swaps,” the portion of an original swap that remains after the partial termination or partial novation of an uncleared “original swap” that would have been required to be cleared had it been executed after the applicable mandatory clearing compliance date.  The letter uses the term “partial termination” to refer to the extinguishing of all rights and obligations for a stated portion of the notional amount of an original swap (other than a single termination payment) and uses the term “partial novation” to refer to the transfer of ownership of a stated portion of the notional amount of an original swap from one of the original counterparties to a third party.  In the letter, the Division states that it will not recommend that the CFTC take an enforcement action against any person for failure to clear a stub swap under certain conditions.  Such conditions include the following requirements: (a) the original swap was not cleared by a derivatives clearing organization and was executed prior to the applicable clearing compliance date; (b) the records of the original swap counterparties be amended solely to reflect the reduced notional amount of the original swap; and (c) all other terms of the stub swap remain the same as the terms of the original swap.  In the case of a partially novated swap, the novated portion must be cleared in accordance with CFTC regulations.  The letter also notes that ISDA, the entity that requested the relief, explicitly stated that it was not requesting relief from clearing where the original counterparties enter into a new swap that fully or partially offsets the risk of an existing uncleared swap.