CFTC Releases First Mandatory Clearing Determination

On November 28, the Commodity Futures Trading Commission issued final rules to implement the first mandatory clearing determination under Dodd-Frank.¹ Under this determination, certain classes of interest rate swaps and credit default swaps (“CDS”) will be subject to the mandatory clearing requirement, with limited exceptions. Implementation of the determination will be phased in by counterparty type, beginning on March 11, 2013. The CFTC also issued two no-action letters that provide time-limited relief from the clearing requirement for certain swaps.

I. Clearing Requirement Generally

The Commodity Exchange Act, as amended by the Dodd-Frank Act, makes it unlawful for any person to engage in a swap required to be cleared unless that person submits the swap for clearing through a derivatives clearing organization (“DCO”). This requirement applies to any swaps determined by the CFTC to be subject to mandatory clearing, and is subject to certain limited exceptions. Swaps subject to mandatory clearing must be submitted to a DCO that accepts them for clearing as soon as technologically practicable after execution, but no later than the end of the day of execution.

II. Swap Classes Required To Be Cleared

The CFTC’s final rules require mandatory clearing for two classes of CDS and four classes of interest rate swaps. The covered swaps reflect the highest volume of swaps currently submitted for clearing on a voluntary basis and comprise a significant percentage of the swaps market by notional amount.

The covered interest rate swap classes are:

• Fixed-to-floating swaps
• Basis swaps
• Forward rate agreements
• Overnight index swaps

The clearing determination for these interest rate swap classes covers swaps in major currencies and reference rates for multiple maturities.

The covered CDS classes are:

• USD-denominated untranched CDS indices referencing North American corporate credits
• Euro-denominated untranched CDS indices referencing European corporate credits 

The clearing determination for these swaps covers specified indices/series and tenors.

For more detail regarding the classes of interest rate swaps and CDS subject to the determination, see the attached Appendix.

III. Implementation Schedule

Implementation of the CFTC’s final determination will be phased in depending on counterparty type, as follows:

• Category 1 entities will be required to clear covered swaps entered into on or after March 11, 2013. Category 1 entities include swap dealers, security-based swap dealers, major swap participants, major security-based swap participants, and “active funds.”
• Category 2 entities will be required to clear covered swaps entered into on or after June 10, 2013. Category 2 entities include commodity pools, private funds other than active funds, and financial entities (including entities predominantly engaged in activities that are in the business of banking or activities that are financial in nature).
• All other entities will be required to clear covered swaps entered into on or after September 9, 2013. This category includes “third-party subaccounts” and ERISA pension plans.

“Active fund” means any private fund, as defined in Section 202(a) of the Investment Advisers Act of 1940, that is not a “third-party subaccount” and that executes 200 or more swaps per month based on a monthly average over the twelve months preceding November 1, 2012.

“Third-party subaccount” means an account that is managed by an investment manager that is independent of and unaffiliated with the account’s beneficial owner or sponsor, and that is responsible for the documentation necessary for the account’s beneficial owner to clear swaps.

Swaps Between Counterparties in Different Categories: Swaps entered into by counterparties that fall within different counterparty categories will be subject to the later of the two applicable compliance dates. For example, covered swaps between a Category 1 entity and a Category 2 entity would be subject to mandatory clearing beginning on June 10, 2013.

Effect of Assignment: For purposes of the CFTC’s implementation schedule, assignment of a swap is treated as if the parties have entered into a new swap. Accordingly, a swap may be subject to mandatory clearing upon assignment although the original swap was not.

End-User Exception Reporting: Counterparties electing the end-user exception to mandatory clearing with respect to any particular swap will be required to comply with the associated reporting requirements on the date they would otherwise be required to clear that swap.

IV. No-Action Relief

On November 28, the CFTC issued a no-action letter providing relief from the clearing requirement for the covered swaps between affiliated counterparties. The reason for this relief is that the CFTC has proposed, but not yet finalized, an inter-affiliate clearing exemption.² The inter-affiliate no-action relief is subject to three conditions:

• Either one counterparty is the majority owner of the other counterparty, or a third party is the majority owner of both counterparties;
• The parties (and third-party majority owner, if applicable) report their financial statements for accounting purposes on a consolidated basis; and
• Both counterparties agree not to clear the swap.

This relief expires on the earlier of April 1, 2013, and the effective date of a final inter-affiliate exemption.

On the same date, the CFTC also issued a no-action letter providing time-limited relief from mandatory clearing for certain swaps entered into by cooperatives meeting certain conditions.³

* * * * *

Please feel free to reach out to your regular contacts at the Firm if you have any questions about the matters addressed in this Alert.

Appendix

Interest Rate Swap Classes

Credit Default Swap Classes

Source: CFTC Regulation §50.4

*This alert was co-authored by Geoffrey Aronow, Kenneth Kopelman and Tabitha Macharia.

¹ The release is available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister112812.pdf.

² See CFTC No-Action Letter No. 12-35 (Nov. 28, 2012). See also 77 Fed. Reg. 50425 (proposed Aug. 21, 2012).

³ See CFTC No-Action Letter No. 12-36 (Nov. 28, 2012).