Clearing Exemption for Inter-Affiliate Swaps: CFTC Proposes Rule to Exempt Swaps between Certain Affiliated Entities from the Clearing Requirement under Dodd-Frank

Sullivan & Cromwell LLP - September 4, 2012
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On August 16, 2012, the CFTC issued a proposed rule to exempt swaps between certain affiliated entities within a corporate group from the clearing requirement imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). Dodd-Frank amended the Commodity Exchange Act (CEA) to require clearing of any swap that the Commodity Futures Exchange Commission (CFTC) determines should be subject to mandatory clearing. However, the statute does not exempt from this requirement transactions between affiliates. A number of commenters and market participants have urged the CFTC to adopt a regulatory clearing exemption for inter-affiliate swaps, arguing that such swaps offer significant benefits and create substantially less risk than swaps between unaffiliated entities. The proposed rule would allow the counterparties to an inter-affiliate swap to elect not to clear the swap, subject to the following limitations:

  • Only majority-owned affiliates would be eligible for the exemption;
  • Both counterparties would have to elect not to clear the swap;
  • Swap trading relationship documentation would be required;
  • The swap would need to be subject to a centralized risk management program within the group of affiliated entities that is reasonably designed to monitor and manage the risks associated with inter-affiliate swaps;
  • Daily marking-to-market and posting of variation margin would be compulsory if both counterparties are financial entities, except in the case of 100% commonly owned and commonly guaranteed affiliates where the common guarantor is also 100% commonly owned;
  • Each affiliated counterparty would be required to satisfy one of the following conditions:
    • it is located in the United States;
    • it is located in a country with a comparable and comprehensive clearing regime;
    • it is required to clear swaps with unaffiliated counterparties in compliance with U.S. law; or
    • it does not enter into swaps with unaffiliated counterparties; and
  • Additional reporting requirements would apply.

The proposal was passed by a seriatim vote of 3 to 2, with Commissioners Jill Sommers and Scott O’Malia dissenting. The dissenting commissioners strongly supported a clearing exemption for inter-affiliate swaps but opposed conditioning it upon the posting of variation margin. The comment period will be open for 30 days after notice of the proposed rulemaking is published in the Federal Register.