CFTC and SEC Propose Rules Governing the Exception to Mandatory Clearing of Swaps and Securities-Based Swaps Available for Counterparties Meeting Certain Conditions

in Asset-Backed Securities, Broker-Dealers, Commodity Futures Trading Commission, Derivatives, Hedge Funds, Payment, Clearing & Settlement, Recent Posts, Recent Posts, Securities and Exchange Commission, Systemic Risk Management, Uncategorized

The Dodd-Frank Wall Street Reform and Consumer Protection Act provides that a swap or security-based swap (collectively, “Swaps”) otherwise subject to mandatory clearing is not required to be cleared if one party to such Swap (1) is not a financial entity, (2) is using such Swap to hedge and or mitigate commercial risks, and (3) notifies the Commodity Futures Trading Commission (the “CFTC”) or Securities and Exchange Commission (the “SEC” and, together with the CFTC, the “Commissions”), as applicable, how it generally meets its financial obligations associated with entering into non-cleared Swaps (such exception, the “End-User Clearing Exception”). 

The Commissions have each proposed new rules to specify requirements for using the End-User Clearing Exception.  The CFTC’s and the SEC’s proposed rules were published in the Federal Register on December 23, 2010 and December 21, 2010, respectively.  Additional provisions, which would provide an exemption for small banks, savings associations, farm credit system institutions and credit unions with total assets of $10,000,000,000 or less, are also under consideration.

Notification Requirements

Under the proposed rules, a counterparty to a Swap that invokes the End-User Clearing Exception shall deliver or cause to deliver the following information to a registered Swap data repository (or, if none is available, to the applicable Commission):

(1)        The identity of the counterparty relying on the End-User Clearing Exception (the “Invoking Party”);

(2)        Whether the Invoking Party is a financial entity;

(3)        Whether the Invoking Party is a finance affiliate that meet certain requirements[1];

(4)        Whether the Invoking Party is using the Swap to hedge or mitigate commercial risks;

(5)        Whether Invoking Party generally expects to meet its financial obligations associated with the Swap by using any of the following:

(i)         A written credit support agreement;

(ii)        Pledged or segregated assets;

(iii)       A written third-party guarantee;

(iv)       Solely the counterparty’s available financial resources; or

(v)        Means other than those described above.

(6)        Whether the Invoking Party is an issuer of securities registered under Section 12 (15 U.S.C. 78l) or subject to reporting requirements pursuant to Section 15(d) (15 U.S.C. 780(d)) of the Securities Exchange Act of 1934, and if so:

(i)         The relevant Commission Central Index Key number for the Invoking Party; and

(ii)        Whether an appropriate committee of the board of directors (or equivalent body) of the Invoking Party has reviewed and approved the decision to enter into a Swap subject to the clearing exception.

The End-User Clearing Exception needs to be invoked on a transaction-by-transaction basis, as a notification containing the information described above is required each time the End-User Clearing Exception is used. 

Hedging or Mitigating Commercial Risk

            In the joint rules proposed by the Commissions that would further define a series of terms related to the Swaps market, the Commissions stated that they intend to interpret the phrase “hedging or mitigating commercial risk” with respect to the participant definitions in the same manner as the phrase “hedge or mitigate commercial risk” in the End-User Clearing Exception context.  For a detailed discussion on the interpretation of the phrase “hedge or mitigate commercial risk, please see Weil’s article titled “CFTC and SEC Propose Joint Rule re Further Definition of “Swap Dealer” and “Major Swap Participant.”

*          *          *

The comment period for the rules proposed by the SEC expired on February 4, 2011 and the comment period for the rules proposed by the CFTC and the interpretation of “hedging or mitigating commercial risk” expired on February 22, 2011.

[1] These requirements are:

(1) it is an affiliate of a person that qualifies for the End-User Clearing Exception;

(2) it acts on behalf of such person and as agent;

(3) it uses the security-based swap to hedge or mitigate commercial risk of that person or another affiliate of that person that is not a financial entity; and

(4) it is not itself (i) a swap/security-based swap dealer, (ii) a major swap/security-based swap participant, (iii) an issuer that would be an investment company, but for Section 3(c)(1) or (7) of the investment Company Act; (vi) a commodity pool; or (vii) a bank holding company with over $50,000,000,000 in consolidated assets.

The Working Group will continue to monitor any developments and provide timely coverage at Weil’s Financial Regulatory Reform Center.  If you are interested in discussing the Dodd-Frank Act or regulatory issues, please contact Working Group members  Heath Tarbert (202-682-7177) (, or Alex Radetsky (212-310-8905 or

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