The letter modifies previous No-Action Letter 13-22, to expand relief for treasury affiliates entering into swaps on behalf of non-financial end-user affiliates that could otherwise elect the exception in section 2(h)(7) of the CEA and section 50.50 of the Commission’s regulations.
On November 26, the U.S. Commodity Futures Trading Commission’s (CFTC’s) Division of Clearing and Risk (Division) issued No-Action Letter 14-144. The letter provides further relief for eligible treasury affiliates that enter into swaps that are subject to a mandatory clearing requirement under section 2(h)(1) of the Commodity Exchange Act (CEA) and part 50 of the CFTC’s regulations. In seeking to address “certain challenges faced by treasury affiliates in undertaking hedging activities on behalf of non-financial affiliates within a corporate group,” the new no-action letter expands prior relief granted under No-Action Letter 13-22, issued on June 4, 2013.
Section 2(h)(1)(A) of the CEA and part 50 of the CFTC regulations establish a clearing mandate for certain classes of swaps, unless an exception or an exemption applies. Since the adoption of the Dodd-Frank Act, the CFTC has adopted one exception and one exemption from the clearing requirement. Section 2(h)(7) of the CEA and § 50.50 of the CFTC’s regulations provide an “end-user exception” from clearing requirements to a counterparty, where such counterparty (a) is not a “financial entity,” (b) is using swaps to hedge or mitigate commercial risk, and (c) satisfies certain reporting requirements.
Defined in section 2(h)(7)(C) of the CEA, the term “financial entity” includes, among other entity categories, persons predominantly engaged in activities that are financial in nature, as defined in section 4(k) of the Bank Holding Company Act of 1956. An exception from the clearing mandate is available, however, to certain “financial entities” that meet the requirements outlined in section 2(h)(7)(D)(i) of the CEA, which provides that an affiliate of a person who qualifies for the end-user exception may also qualify for the exception, but only if the affiliate, acting on behalf of the person and as an agent, uses the swap to hedge or mitigate the commercial risk of the person or other affiliate of the person that is not a financial entity. In the adopting release for the end-user exception, the CFTC took the view that treasury affiliates that are separate legal entities and whose sole or primary function is to undertake activities that are primarily financial in nature are financial entities because they are “predominately engaged” in such activities and, therefore, are not eligible for the end-user exception, except as provided in CEA section 2(h)(7)(D). Because treasury affiliates often enter into swaps on behalf of their non-financial affiliates as principal to the swap and not as agent, under CEA section 2(h)(7)(D)(i), treasury affiliates are unable to take advantage of the statutory exception to the clearing mandate. However, in response to a number of inquiries from market participants and in recognition of “the benefits that arise from the use of treasury affiliates within corporate groups,” the Division issued No-Action Letter 13-22, which grants conditional relief from clearing requirements for such treasury affiliates. Nonetheless, market participants have found that several conditions in No-Action Letter 13-22 have rendered the relief impractical.
Review of No-Action Letter 13-22
No-Action Letter 13-22 provides relief from the clearing mandate to “eligible treasury affiliates” that meet a number of qualifications, including (a) the person is directly wholly owned by a non-financial entity or another eligible treasury affiliate and not indirectly majority-owned by a financial entity; (b) the person’s ultimate parent is not a financial entity and is able to identify all of its wholly and majority-owned affiliates and ensure that a majority qualifies for the exception; (c) the person is a financial entity solely as a result of acting as principal to swaps with, or on behalf of, one or more of its related affiliates, or providing other services that are financial in nature to such related affiliates; (d) the person is not and is not affiliated with a swap dealer, major swap participant, systematically important nonbank financial company, or certain other types of entities; and (e) the person is not a private fund, commodity pool, ERISA plan, or certain other types of entities. Additionally, No-Action Letter 13-22 specifies several general conditions relating to exempted swaps, which, in summary, require that
The relief also imposes certain reporting obligations that require a reporting counterparty to provide information to a registered swap data repository.
Overview of No-Action Letter 14-144
No-Action Letter 14-144 is an attempt to rectify some of the issues faced by treasury affiliates under the requirements of No-Action Letter 13-22. However, for an eligible treasury affiliate that seeks to elect the exception, the swap activity must still meet a number of conditions, as described below.
Conditions for the Relief
As a general matter, the relief granted in No-Action Letter 14-144 is only available to “eligible treasury affiliates” and their “related affiliates,” as such terms are defined in the letter, that meet the following conditions:
Furthermore, as with prior relief granted under No-Action Letter 13-22, with respect to each swap that an eligible treasury affiliate elects not to clear in reliance on the relief, the reporting counterparty must provide certain information to a registered swap data repository. The requirements and conditions for the relief are described more fully in No-Action Letter 14-144.
Improvements Contained in No-Action Letter 14-144
The following are material improvements contained in No-Action Letter 14-144:
In light of the expanded relief provided in No-Action Letter 14-144, corporate groups that use treasury affiliates to hedge or mitigate commercial risk across their enterprise should review their activities to determine whether they may qualify for the treasury affiliate exception. Additionally, all affected parties should review and update relevant documentation as may be necessary to elect the end-user exception from clearing.
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:
Michael M. Philipp
Joshua B. Sterling
. Pub. L. No. 111-203, 124 Stat. 1376 (2010).
. See Clearing Exemption for Swaps Between Certain Affiliated Entities, 78 Fed. Reg. 21,749 (Apr. 11, 2013) (codified at 17 C.F.R. § 50.52).
. See End-User Exception to the Clearing Requirement for Swaps, 77 Fed. Reg 42,559 (July 19, 2012) (codified at 17 C.F.R. § 50.50).
. 12 U.S.C. §§ 1841 et seq.