On July 11, the CFTC approved its much awaited final rule implementing the end-user exception from mandatory clearing of swaps. The new ruleslay out parameters of the end-user exception by (1) defining the term “hedging or mitigating commercial risk” and
(2) establishing certain reporting requirements for end-users electing to make use of the end-user exception. In addition, these new rules finalize the definition of "swaps" and trigger compliance requirements under several major CFTC swap market regulations.
Dodd-Frank makes it illegal in most circumstances for parties to enter into swap transactions unless the swap is cleared through a central counterparty (CCP). Under the exception, as provided by the Act, a swap counterparty may elect not to submit a swap for CCP clearing if the counterparty:
(i) Is not a “financial entity” (e.g., swap dealer, major swap participant, investment fund, bank, or pension plan);
(ii) Is using the swap to “hedge or mitigate commercial risk,” as further defined; and
(iii) Provides certain information along with the swap to a swap data repository or the Commission.
Definitions to the key terms are vital to who may take advantage of the exemption.
Section 723 of the Dodd-Frank Act defines "financial entity" as swap dealers, security-based swap dealers, major swap participants, major security-based swap participants, commodity pools, private funds, employee benefit plans and persons predominantly engaged in activities that are in the business of banking or that are “financial in nature” (as defined in section 4(k) of the Bank Holding Company Act of 1956).
The CFTC chose to define “hedging or mitigating commercial risk” virtually identically to the definition in the major swap participant regulations finalized earlier this year. Under this definition, the facts and circumstances surrounding the swap transaction and consideration of the party's overall hedging and risk mitigation strategy at the time the swap is entered into will determine whether a swap hedges or mitigates commercial risk. In addition, the term includes bona fide hedging transactions, as defined in CFTC Rule 1.3(z) ("Bona fide hedging transactions and positions for excluded commodities").
Once the first two conditions to the exemption are met, when taking advantage of the end-user exemption for each swap, the final rules require a reporting counterparty to report to a swap data repository (1) the election of the exception and (2) the identity of the electing counterparty. The CFTC also anticipates adding some annual reporting requirements.
The rule also allows financial entities to take advantage of the exception with respect to certain narrow classes of activities related to financing manufacturing activities and hedging the risks of affiliates, as provided for by the Dodd-Frank Act. Also, the CFTC provided an exemption for small banks, savings associations, farm credit system institutions, and credit unions having less than $10 billion in total assets.
To help users understand the end-user exemption, the CFTC has published a fact sheet and an FAQ. The CFTC also issued an
unofficial version of the rule while publication in the Federal Register remains pending
The rules approved on July 11 start the clock on an aggressive and quite challenging new compliance regime for swaps and those who use and trade them. Sixty days after the new swap regulations are published in the Federal Register, swap dealers and majors swap participants must comply with new registration requirements, internal and external business conduct standards, and certain reporting and recordkeeping requirements. In addition, all market participants will be subject to spot-month position limits with respect to certain energy and agricultural commodities related swaps. Swap dealers and majors swap participants
must also begin reporting all of their swaps after an additional 90 days, and, 90 days beyond that date that, all swaps regardless of counterparty-type must be reported.