Regulatory Developments: CFTC Proposes Exemption from Dodd-Frank Clearing Requirement for Certain Inter-Affiliate Swaps
On August 16, 2012, the Commodity Futures Trading Commission (CFTC) issued a proposed rule to exempt swaps between certain affiliates within a corporate group from the clearing requirement under new Section 2(h) of the Commodity Exchange Act. To qualify for the proposed exemption, the following key requirements must be met:
Consolidated Financials Requirement: the exemption is applicable only to swaps between majority-owned affiliates whose financial statements are included in the same consolidated financial statements. Under the proposed rule, the CFTC queries whether a higher ownership threshold should be required, i.e. 100% or 80% (based on Section 1504 of the Internal Revenue Code).
Risk Management, Margin and Reporting Requirements: to take advantage of the exemption, the parties will be required to have centralized risk management; document the exempted swap; make variation margin payments; and satisfy reporting requirements. The margin requirement may be particularly controversial. Two CFTC Commissioners published a joint statement of dissent in respect of the proposed rule, in particular due to the variation margin requirements which they see as administratively and operationally burdensome as well as unnecessarily tying up capital that could otherwise be used for investment. The proposed rule requires that, if both affiliates are financial entities, such affiliates must collect variation margin from each other. An exemption from the margin requirement is provided for a swap between wholly-owned affiliates with a common guarantor if the guarantor is a wholly-owned affiliate. The proposed rule requires that the documentation for the exempted swap specify the methodology for calculating the variation margin such that the CFTC and any prudential regulator would be able to calculate it independently.
Affiliate Requirements: each affiliate that is party to an exempted inter-affiliate swap must meet one of the following four conditions: (1) the affiliate is located in the United States; (2) the affiliate is located in a jurisdiction with a comparable and comprehensive clearing requirement; (3) the non-US affiliate is required to clear all swaps it enters into with non-affiliate counterparties in compliance with US law; or (4) the affiliate does not enter into swaps with non-affiliate counterparties.
Bilateral Election for Exemption: the affiliated counterparties must both elect the inter-affiliate clearing exemption in order for the exemption to apply to the inter-affiliate swap.
There is a 30-day comment period from the date of publication of the proposed rule in the Federal Register, which has yet to occur.
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