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2013-07970a

2013-07970a

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Vol. 78 Thursday,No. 70 April 11, 2013Part III
Commodity Futures Trading Commission
17 CFR Part 50Clearing Exemption for Swaps Between Certain Affiliated Entities; FinalRule
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21750
Federal Register
/Vol. 78, No. 70/Thursday, April 11, 2013/Rules and Regulations
1
Clearing Exemption for Swaps Between CertainAffiliated Entities, 77 FR 50425 (Aug. 21, 2012).
2
For ease of reference, the Commission is re-codifying proposed §39.6(g) as §50.52 so thatmarket participants are able to locate all rulesrelated to the clearing requirement in one part of the Code of Federal Regulations.
3
Section 2(h)(7) of the CEA provides anexception to the clearing requirement when one of the counterparties to a swap (i) is not a financialentity, (ii) is using the swap to hedge or mitigatecommercial risk, and (iii) notifies the Commissionhow it generally meets its financial obligationsassociated with entering into a non-cleared swap.
4
Clearing Requirement Determination UnderSection 2(h) of the CEA, 77 FR 74284 (Dec. 13,2012) (hereinafter ‘‘Clearing RequirementDetermination’’).
5
See
Clearing Requirement Determination at74319–21.
6
The first compliance date for required clearingapplies to Category 1 Entities, as defined in§50.25(a). SDs and MSPs and private funds activein the swaps market are defined as Category 1Entities. Security-based swap dealers and majorsecurity-based participants also are included in thedefinition. However, as the Commission has stated,if a security-based swap dealer or a major security- based swap participant is not yet required toregister with the Securities and ExchangeCommission (SEC) at such time as the Commissionissues a clearing determination, then the security- based swap dealer or a major security-based swapparticipant would be treated as a Category 2 Entity,as defined in §50.25(a).
See
Swap TransactionCompliance Implementation Schedule: Clearingand Trade Execution Requirements under Section2(h) of the CEA, 76 FR 58186, 58190 n.38 (Sept. 20,2011).
7
Clearing Requirement Determination at 74319–21.
COMMODITY FUTURES TRADINGCOMMISSION17 CFR Part 50
RIN 3038–AD47
Clearing Exemption for SwapsBetween Certain Affiliated Entities
AGENCY
:
Commodity Futures TradingCommission.
ACTION
:
Final rule.
SUMMARY
:
The Commodity FuturesTrading Commission (Commission orCFTC) is adopting regulations to exemptswaps between certain affiliated entitieswithin a corporate group from theclearing requirement under theCommodity Exchange Act (CEA or Act),enacted by Title VII of the Dodd-FrankWall Street Reform and ConsumerProtection Act (Dodd-Frank Act). Theregulations include specific conditions,as well as reporting requirements, thataffiliated entities must satisfy in order toelect the inter-affiliate exemption fromrequired clearing.
DATES
:
This final rule is effective June10, 2013.
FOR FURTHER INFORMATION CONTACT
:
Sarah E. Josephson, Deputy Director,202–418–5684,
Nadia Zakir, Associate Director, 202–418–5720,
EricLashner, Special Counsel, 202–418–5393,
Meghan Tente,Law Clerk, 202–418–5785,
Division of Clearingand Risk, Erik Remmler, AssociateDirector, 202–418–7630,
Camden Nunery,Economist, 202–418–5723,
Office of the Chief Economist, Commodity Futures TradingCommission, Three Lafayette Centre,1155 21st Street NW., Washington, DC20581.
SUPPLEMENTARY INFORMATION
:
Table of Contents
I. BackgroundII. Comments on the Notice of ProposedRulemakingA. Overview of Comments ReceivedB. Section 4(c) AuthorityC. Definition of Affiliate StatusD. Inter-Affiliate Swap DocumentationE. Centralized Risk Management ProgramF. Variation MarginG. Treatment of Outward-Facing Swapsand Relief H. Reporting Requirements and AnnualElectionI. ImplementationIII. Cost-Benefit ConsiderationsA. Statutory and Regulatory BackgroundB. Costs and Benefits of Exemption forEligible Affiliate CounterpartiesC. Costs and Benefits of Exemption’sConditionsD. Costs and Benefits to MarketParticipants and the PublicE. Costs and Benefits Compared toAlternativesF. Consideration of CEA Section 15(a)FactorsIV. Related MattersA. Regulatory Flexibility ActB. Paperwork Reduction Act
I. Background
On August 21, 2012, the Commissionpublished a notice of proposedrulemaking proposing to exempt swaps between certain affiliated entities fromthe clearing requirement under section2(h)(1)(A) of the CEA (NPRM).
1
Asproposed, §39.6(g) provides thatcounterparties to a swap may elect aninter-affiliate exemption from theclearing requirement if: (1) The financialstatements of both counterparties arereported on a consolidated basis, andeither one counterparty directly orindirectly holds a majority ownershipinterest in the other, or a third partydirectly or indirectly holds a majorityownership interest in bothcounterparties; (2) both counterpartiescomply with the conditions set forth inthe proposed rule; and (3) one of thecounterparties provides certaininformation on behalf of both affiliatedcounterparties to either a registeredswap data repository (SDR) or theCommission if a registered SDR does notaccept the information. TheCommission is hereby adoptingproposed §39.6(g), finalized as §50.52,
2
 subject to the changes discussed below.Section 723(a)(3) of the Dodd-FrankAct amended the CEA to provide, undernew section 2(h)(1)(A) of the CEA, thatit shall be unlawful for any person toengage in a swap unless that personsubmits such swap for clearing to aderivatives clearing organization (DCO)that is registered under the CEA or aDCO that is exempt from registrationunder the CEA if the swap is requiredto be cleared.
3
Section 2(h)(2) of theCEA charges the Commission with theresponsibility for determining whether aswap is required to be cleared, throughone of two means: (1) Pursuant to aCommission-initiated review; or (2)pursuant to a submission from a DCO of each swap, or any group, category, type,or class of swaps that the DCO ‘‘plansto accept for clearing.’’ On November29, 2012, the Commission adopted itsfirst clearing requirementdetermination, requiring that swapsmeeting the specifications outlined infour classes of interest rate swaps andtwo classes of credit default swaps(CDS) are required to be cleared.
4
 The Clearing RequirementDetermination adopting releaseprovided a specific complianceschedule for market participants to bring their swaps into compliance withthe clearing requirement.
5
Swap dealers(SDs), major swap participants (MSPs),and private funds active in the swapsmarket were required to comply beginning on March 11, 2013, for swapsthey enter into on or after that date.
6
 Accounts managed by third-partyinvestment managers, as well as ERISApension plans, have until September 9,2013, to begin clearing swaps enteredinto on or after that date. All otherfinancial entities are required to clearswaps beginning on June 10, 2013, forswaps entered into on or after that date.With regard to the CDS indices onEuropean corporate names, iTraxx, theClearing Requirement Determinationprovided that, if no DCO offered iTraxxfor client clearing by February 11, 2013,the Commission would delaycompliance for those swaps until 60days after an eligible DCO offers iTraxxindices for client clearing. On February25, 2013, the Commission receivednotice from ICE Clear Credit LLC that ithad begun offering customer clearing of the iTraxx CDS indices that are subjectto the clearing requirement under§50.4(b). In accordance with thetimeframe previously set forth by theCommission,
7
the following compliance
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/Vol. 78, No. 70/Thursday, April 11, 2013/Rules and Regulations
8
See
Press Release, CFTC’s Division of Clearingand Risk Announces Revised Compliance Schedulefor Required Clearing of iTraxx CDS Indices (Feb.25, 2013), available at
9
Cravath, Swaine & Moore LLP (Cravath), theCoalition for Derivatives End-Users (CDEU), theFinancial Services Roundtable (FSR), ChrisBarnard, the Commercial Energy Working Group(The Working Group), the Edison Electric Institute(EEI), The Prudential Insurance Company of America (Prudential), Metropolitan Life InsuranceCompany (MetLife), the International Swaps andDerivatives Association and Securities Industry andFinancial Markets Association, (together, ISDA &SIFMA), and DLA Piper.
10
EEI commented that ‘‘corporate familiestypically face bankruptcy together’’ and that it is‘‘unusual for only one member of a corporate groupto go bankrupt.’’ EEI also noted that a bankruptcycould cause increased risk to clearinghouses thatwould face multiple entities going into default atthe same time if all affiliates of one corporate groupwere required to clear their inter-affiliate swaps.
11
ISDA & SIFMA commented that inter-affiliateswaps do not introduce risk into a corporate group,stating, ‘‘[b]ecause capital, liquidity and riskallocation decisions, as well as the exercise of default remedies between group members are underunified management, group entities do not facedefault risk of other group entities, so long as thegroup as a whole is solvent.’’
dates shall apply to the clearing of iTraxx indices: Category 1 Entities:Friday, April 26, 2013; Category 2Entities: Thursday, July 25, 2013; andall other entities: Wednesday, October23, 2013.
8
 
II. Comments on the Notice of ProposedRulemaking
The Commission received 13comments during the 30-day publiccomment period following publicationof the NPRM on August 21, 2012, andone additional comment after thecomment period ended. TheCommission considered each of thesecomments in formulating the finalregulation, §39.6(g) (finalized as§50.52).During the process of proposing andfinalizing this rule, the Chairman andCommissioners, as well as Commissionstaff, participated in informationalmeetings with market participants, tradeassociations, public interest groups, andother interested parties. In addition, theCommission has consulted with otherU.S. financial regulators including: (i)The SEC; (ii) the Board of Governors of the Federal Reserve System; (iii) theOffice of the Comptroller of theCurrency; and (iv) the Federal DepositInsurance Corporation (FDIC). Staff fromeach of these agencies has had theopportunity to provide oral and/orwritten comments to this adoptingrelease, and the final regulationsincorporate elements of the commentsprovided.The Commission is mindful of the benefits of harmonizing its regulatoryframework with that of its counterpartsin foreign countries. The Commissionhas therefore monitored global advisory,legislative, and regulatory proposals,and has consulted with foreignauthorities in developing the finalregulations.
A. Overview of Comments Received 
Of the 14 comment letters received bythe Commission in response to itsNPRM, ten commenters expressedgeneral support for the concept of aninter-affiliate exemption from theclearing requirement.
9
Thesecommenters offered commentsaddressing the proposed rule generallyand comments addressing specificprovisions of the proposed rule.Comments addressing specificprovisions of the proposed rule arediscussed in detail below.A number of commenters requested a broader exemption with few or noconditions. Cravath and DLA Piperrequested that the Commission exemptswaps between affiliates from allclearing, margining, and reportingobligations. The Working Group,Cravath, CDEU, ISDA & SIFMA, DLAPiper, and EEI
10
recommended that theCommission eliminate, simplify orminimize the conditions imposed, orunconditionally exempt inter-affiliateswaps from clearing. These commentersstated that inter-affiliate swaps poselittle or no risk to the U.S. financialsystem and do not increase theinterconnectedness between majorfinancial institutions, particularly if affiliates’ financial statements areconsolidated for accounting purposes.The Working Group commented thatentities use inter-affiliate trades not onlyto net risk related to market-facingswaps, but also to transfer physicalcommodity or futures exposure betweenaffiliates for compliance withinternational tax law, customs, oraccounting laws. Similarly, MetLife andPrudential supported the proposedexemption and noted that transactions between affiliates do not present thesame risks as market-facing swaps.ISDA & SIFMA commented that inter-affiliate swaps provide important benefits to corporate groups by enablingcentralized management of market,liquidity, capital, and other risks, andallowing affiliated groups to realizeassociated hedging efficiencies andnetting benefits. Imposing mandatoryclearing on inter-affiliate swaps,according to ISDA & SIFMA, couldcompromise the ability of affiliatedgroups to realize these benefits.
11
ISDA& SIFMA also commented that thirdparties face no increased risk from inter-affiliate swaps. In their view, the creditrisks faced by a third party entering intoan uncleared swap with a groupmember are a function of the groupmember’s entire portfolio of assets andliabilities and other credit factors.Along the same lines, CDEUcommented that non-financial entitiestypically enter into external swaps withswap dealers and other large banks thattypically evaluate the risks of enteringinto swaps based on the overallcreditworthiness of their counterparties.These financial entity counterparties,according to CDEU, have theopportunity to review financialstatements, the creditworthiness of anyguarantor, and a number of other credit-related items. After the credit review,according to CDEU, the counterpartiesmay request credit risk mitigants suchas corporate parent guarantees,collateral, and credit-based legal terms.On the other hand, Americans forFinancial Reform (AFR) commented thata wide-ranging exemption for inter-affiliate swaps could create systemicrisk and threaten the U.S. financialsystem. AFR cited a number of reasonsfor its concern such as: the risk transfer between separate corporate entities; thepossibility for financial contagion to betransferred from one part of a largefinancial institution to different groupswithin the institution; restrictions onaccess to affiliate assets across national boundaries; and reduction in volumes atDCOs that could hurt liquidity and riskmanagement. AFR further noted that because the end-user exception isavailable for non-financial and smallfinancial entities in connection withswaps that hedge or mitigate systemicrisk, the inter-affiliate exemption isprimarily available for large financialinstitutions and speculative trades bylarge commercial institutions with manyaffiliates.Better Markets Inc. (Better Markets)also expressed concern that an inter-affiliate exemption could be contrary toCongressional intent, as expressed inthe Dodd-Frank Act, if it is not a verynarrow and strictly implementedexemption.Two individual persons commentedagainst the proposed exemption. SteveWentz requested that the Commissionnot issue any exemptions because theexemptions ‘‘would just open the doorto divert trades through that open doorto avoid protective oversight.’’ Aaron D.Small commented that the ‘‘unregulatedderivatives market has been a disasterfor the U.S. and world economy andmust be reined in.’’Having considered these comments,and the specific comments discussed below, the Commission is adopting the
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