During 2012 the Commodity Futures Trading Commission (“CFTC”) adopted several final swaps rules under Title VII of the Dodd Frank Act. Asset managers, sponsors of structured vehicles, commercial businesses, and other end-users of swaps (together, “End-Users”) will have to keep the different compliance dates in mind as they seek to conform their swaps trading with those rules.
This Alert describes key swap provisions relevant to these market participants, which either apply to them directly or will affect their trading relationships because they apply to their swap dealer counterparties (“SDs”).1 In addition, this alert provides a timeline for the next several months that identifies when various CFTC swaps requirements go into effect.
I. Swap Data Reporting
The Commodity Exchange Act, as amended by Dodd-Frank, imposes significant reporting requirements both for new swaps and for swaps entered into either (i) before Dodd-Frank was enacted or (ii) following the law’s enactment but prior to the effective date for the reporting requirements applicable to new swaps (collectively (i) and (ii), “Historical Swaps”). These reporting requirements, and related recordkeeping requirements, are found in three Parts of the CFTC’s regulations:
For End-Users, the reporting requirements were scheduled to become effective on April 10, 2013. As discussed in our April 11 alert, however, the CFTC staff has issued time-limited no action relief for End-Users, depending on the type of entity (financial or non-financial) and type of swap. The reporting relief as to new swaps has expired for End-Users such as funds and other financial entities (“Financial End-Users). However, Financial End-Users will have until September 30, 2013 to comply with the reporting requirements for Historical Swaps. As set forth in the accompanying timeline, End-Users of swaps that are not financial entities (“Commercial End-Users”) still have the benefit of the CFTC’s decision to delay implementation of these reporting requirements.
While the no-action relief is helpful, the swaps reporting rules provided that, for a swap between an SD and an End-User, the SD must report the required information. The no-action relief will therefore be relevant only to the extent that an End-User must report the required information — for instance, if an End-User trades with a bank that is not an SD or if the End-User is the only “U.S. person” counterparty to the trade.2
II. Mandatory Swap Clearing; Exceptions to Mandatory Clearing
The Commodity Exchange 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 registered or exempt derivatives clearing organization (“DCO”). The CFTC determines which swaps are required to be cleared. The agency may do so on its own accord upon a petition by a DCO for a clearing determination.
The CFTC issued its first mandatory clearing determination in November 2012. As explained in our December 4, 2012 alert, that determination applies to classes of interest rate swaps and index credit default swaps. The CFTC has determined that firms must comply with the clearing requirement on the following schedule:
It should be noted, however, that clearing for iTraxx credit default swaps has been delayed until October 23, 2013, as reflected in the timeline below.
The CFTC’s regulations generally require a clearing determination to be implemented as follows:
The CFTC is expected to publish clearing determinations with respect to other types of swaps over the next several months. In doing so, it may determine not to apply the foregoing compliance schedule to a particular clearing determination.
Commercial End-Users are eligible to elect an exception from the clearing requirement.6 This exception requires reporting of certain information to a registered swap data repository (an “SDR”), or to the CFTC if no SDR is available, concerning its election. The CFTC’s final rule provides that the “reporting counterparty” is responsible for providing the required information, although the Commercial End-User may also choose to report the information. The reporting counterparty for this purpose is generally the SD.7 ISDA has developed a streamlined method by which an SD can obtain the information it must report on behalf of a Commercial End-User in its March 2013 DF Protocol. (For information on this Protocol, please see our May 7 alert.)
A Commercial End-User would not need to claim the exception and comply with these reporting requirements until it becomes subject to a clearing determination. As a result, Commercial End-Users that trade interest rate swaps or index credit defaults subject to the first mandatory clearing determination noted above will need to be prepared to claim the exemption by September 9, 2013. A Commercial End-User that is an issuer of securities registered under the Securities Exchange Act of 1934 or that files reports under the Exchange Act must have its board, or an appropriate board committee, take certain corporate actions before it can rely on this exemption. Commercial End-Users subject to these requirements under the Securities Exchange Act may wish to consider the appropriate time ahead of September 9 for their boards or committees to take the necessary actions.
It should also be noted that the CFTC staff has issued no-action relief that provides exceptions from mandatory clearing for swaps traded by “treasury affiliates” of Commercial End-Users.8 The CFTC has also adopted a separate exception with respect to certain inter-affiliate swaps.9
III. Business Conduct and Relationship Documentation Requirements
The CFTC has issued final rules implementing business conduct standards and swap trading relationship documentation requirements applicable to SDs under Dodd-Frank. These requirements generally came into effect on May 1 and July 1, 2013, although as noted in the accompanying timeline the CFTC has deferred compliance with certain of these requirements until later this year. SDs generally seek to address their business conduct and relationship documentation requirements by working with End-Users to complete ISDA’s August 2012 and March 2013 DF Protocols, although in some cases firms will use bilateral agreements to satisfy their obligations.
IV. Other Pending Developments
The CFTC recently adopted a series of final rules that establish the framework within which certain cleared swaps will be traded on organized facilities.10 It is expected that these swap execution facilities will begin registering with the CFTC in August. At that time, they will be able to specify the swaps that they will make available to trade and that therefore must be traded on a facility. It is widely anticipated that at least some swaps will start trading on these platforms by the end of 2013. While this development will have a significant impact on the swaps markets, Dodd-Frank provides that swaps subject to the clearing exception provided in the statue needed not be traded on a facility (e.g., swaps traded by Commercial End-Users).
Finally, firms should bear in mind that, in 2011, the CFTC proposed rules governing minimum initial and variation margin requirements for swaps that are not required to be cleared.11 It remains unclear when the CFTC will finalize these requirements, but once adopted and effective they will bear considerably on the costs associated with trading swaps bilaterally.
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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. In addition, you are welcome to contact the members of the Firm’s Derivatives/CFTC Group set forth above.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:Arnholz-John
1 This alert assumes that End-Users do not generally trade with major swap participants (“MSPs”), given that only two MSPs are registered with the CFTC. Thus, in many cases this alert does not refer to MSPs when discussing a particular Dodd-Frank requirement that applies both to SDs and to MSPs.
2 The CFTC has adopted a “U.S. person” definition for purposes of a final order on the cross-border application of its swaps rules; that definition is narrower than the “U.S. person” definition the CFTC has proposed for purposes of its forthcoming final guidance on cross-border matters. See 77 Fed. Reg. 41214 (July 12, 2012) (proposed interpretive guidance and policy statement); 78 Fed. Reg. 858 (Jan. 7, 2013) (final order); 78 Fed. Reg. 909 (further proposed guidance).
3 An “active fund” is any private fund that is not a third-party subaccount and has executed 200 or more swaps per months based on a monthly average over the 12 months preceding November 1, 2012.
4 The Commodity Exchange Act defines term “financial entity” to include commodity pools, private funds, and persons that are primarily engaged in activities that are financial in nature. Determining whether a particular company is a financial entity can involve a detailed factual analysis.
5 The term “third-party subaccount” includes an account that is managed by an investment adviser 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.
6 17 C.F.R. § 50.50.
7 CFTC Regulation 50.50 provides that the “reporting counterparty” for purposes of reporting election of the end-user exception is as determined in accordance with Regulation 45.8.
8 CFTC Letter No. 13-22 (June 4, 2013).
9 17 C.F.R. § 50.52; see also CFTC Letter No. 13-09 (Apr. 5, 2013).
10 8 Fed. Reg. 33476 (June 4, 2013) ; 78 Fed. Reg. 36606 (June 4, 2013); 78 Fed. Reg. 32866 (May 31, 2013).
11 76 Fed. Reg. 58176 (Sept. 20, 2011) ; 76 Fed. Reg. 27802 (May 12, 2011); 76 Fed. Reg. 23732 (April 28, 2011).