CFTC Proposes First Clearing Mandate and Finalizes Phased Compliance Rules

Transcription

1 AUGUST 10, 2012 DERIVATIVES UPDATE CFTC Proposes First Clearing Mandate and Finalizes Phased Compliance Rules On July 24, 2012, the Commodity Futures Trading Commission ( CFTC ) proposed its first clearing mandate for swaps 1 under the Dodd-Frank Wall Street Reform and Consumer Protection Act ( Dodd-Frank ). Under a separate but contemporaneous release, the CFTC issued final rules providing for phased compliance with CFTC-issued clearing mandates. 2 The deadline for commenting on the proposed clearing mandate is September 6, At the close of this comment period, the CFTC will have up to 60 days to approve these products for clearing, although it may take less time to do so. The final phased compliance rules will be effective September 28, 2012, although in all likelihood, no clearing mandate will be in place at that time. Scope of Proposed Clearing Mandate The clearing mandate would not apply to market participants that are eligible for and elect to rely on the end-user exception. 3 The rules similarly will not mandate clearing of swaps entered into prior to enactment of Dodd-Frank or prior to the effective date of the proposed clearing mandate. The CFTC is proposing to mandate clearing of four classes of interest rate swaps and two classes of index credit default swaps ( CDS ). Swaps that meet the basic specifications provided under the rules would be required to be cleared, and those that do not meet those specifications would be outside of the scope of this clearing mandate. Note, however, that swaps designed in a manner intended to take them outside the scope of a clearing mandate with no legitimate business purpose may be determined to be unlawful. The basic specifications of the first six classes of swaps proposed to be subject to mandatory clearing are provided in tables included in the proposed rules implementing the clearing mandate, as well as in the CFTC s press release concerning the proposal, which is available at Those tables are reproduced at the end of this Sidley Update for convenience. The CFTC intends, at a later date, to consider whether to propose mandatory clearing for agricultural swaps, energy swaps, and broad-based equity swaps. The Securities and Exchange Commission has not yet proposed to mandate the clearing of any class of security-based swaps. 1 Available at 2 Available at 3 The CFTC has adopted final rules governing the end-user exception to mandatory clearing. For information concerning those rules, see our Sidley Update available at This Sidley update has been prepared by Sidley Austin LLP for informational purposes only and does not constitute legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers. Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, and One South Dearborn, Chicago, IL 60603, Prior results do not guarantee a similar outcome.

2 Page 2 Phased Compliance with Clearing Mandate The CFTC has now finalized rules that provide for phased compliance with a clearing mandate. While the phasing tranches may not be used in connection with every CFTC-issued clearing mandate, the rules are available for the CFTC to use in its discretion when issuing a mandate. The CFTC is proposing to use the phased compliance schedule described below in connection with the six classes of interest rate swaps and index CDS referred to above. The date on which clearing will be mandated under the final rules will be determined based on the types of market participants entering into the applicable swap. Market participants that opt to do so may begin clearing earlier than the date provided under the final rules. The dates on which clearing will be mandatory are: For swaps between Category 1 Entities, or between a Category 1 Entity and any other entity that desires to clear the swap, 90 days after the applicable clearing mandate is published in the Federal Register; 4 For swaps between a Category 2 Entity and a Category 1 Entity or Category 2 Entity, or between a Category 2 Entity and any other entity that desires to clear the swap, 180 days after the applicable clearing mandate is published in the Federal Register; and All other swaps (other than those for which the end-user clearing exception applies) must be cleared no later than 270 days after the applicable clearing mandate is published in the Federal Register. The Categories are defined as follows: Category 1 Entities include swap dealers, security-based swap dealers, major swap participants, major securitybased swap participants, and active funds. Entities that are considered third-party subaccounts will not be deemed Category 1 Entities. Category 2 Entities include commodity pools, most hedge funds (i.e., those that meet the definition of private fund under applicable rules, but excluding third-party subaccounts), and persons predominantly engaged in activities that are in the business of banking, or in activities that are financial in nature as defined in Section 4(k) of the Bank Holding Company Act of Entities that are considered third-party subaccounts will not be deemed Category 2 Entities. Category 3 Entities include all other entities, including employee benefit plans subject to the Employee Retirement Income Security Act of 1974 ( ERISA ). 5 Third-party subaccounts will be treated as Category 3 Entities, notwithstanding whether they otherwise meet the definition of a Category 1 Entity or Category 2 Entity provided above. The final rules define an active fund as any private fund other than a third-party subaccount that executes 200 or more swaps (disregarding security-based swaps) per month based on an average over the twelve months preceding the CFTC s issuance of the applicable clearing mandate. Note that the 200 swaps criterion applies on a per fund basis and is not determined on an aggregate basis at the manager level. A third-party subaccount is any account that is managed by an investment manager that is independent of and unaffiliated with the account s beneficial owner or sponsor, and is responsible for the documentation necessary for the account s beneficial owner to clear swaps. 4 Note that there is often a lag of several days or weeks between the CFTC s public announcement of a rulemaking or proposed rulemaking and its publication in the Federal Register. This could delay the compliance dates otherwise mandated under the final rules. 5 The CFTC had originally proposed to put ERISA plans in Category 2. See

3 Page 3 Action Items For firms that are participants in the derivatives markets contemplating what steps to take in light of the clearing mandate, we set forth the following possible action plan: Step One: Identify whether the firm trades any of the products subject to the proposed clearing mandate. 6 If the answer to this question is no, no further action is required at this time. However, since this is merely the first wave of products that have been proposed for clearing, and we anticipate other products will be added soon, participants may consider negotiating clearing documents at this time. 7 Step Two: Determine whether the firm is a Category 1, 2, or 3 Entity. As noted above, the deadlines for compliance will vary depending on the Category to which a participant belongs. Step Three: Determine when the first wave of the clearing mandate will take effect for the firm. Note that once the 30-day public comment period has ended, the CFTC has up to an additional 60 days to make a final determination that a swap is subject to the clearing mandate. Note, however, that the CFTC is not required to allow the full 60 days to elapse. This means that the CFTC may make its final determination at any time during the 60-day period. Thus, by November 5, 2012 at the latest, the 90-, 180-, or 270-day period, as applicable, will begin running for those parties trading in products affected by the first wave of clearing mandates. Step Four: Start identifying counterparties for cleared swap transactions and negotiating clearing agreements. Trading swaps under an over-the-counter, bilateral ISDA Master Agreement is very different from trading cleared swap transactions. To be properly prepared, a firm must identify a clearing member and enter into a futures customer agreement and addendum to cover cleared swaps transactions. As a threshold issue, a firm will want to think about identifying prospective clearing members and whether it will have more than one clearing relationship. In addition, a firm will want to think about the types of trading terms that will apply to its swaps clearing relationship. One important change that the transition from bilateral, uncleared swaps settlement to central clearing of swaps brings is that firms will have less control over the amount and type(s) of collateral they are required to post. Similarly, market participants will find that, unlike swaps traded under the over-the-counter model, a clearing member typically has broad, unilateral discretion to terminate open positions for purposes of reducing its risk at the clearinghouse. Firms should begin developing a set of clear priorities about their clearing relationships and discussing these with their prospective clearing members. If you have questions concerning the CFTC s proposed clearing mandate or the final CFTC phased compliance rules, please contact the Sidley attorney with whom you usually work. Swaps Proposed to be Subject to Mandatory Clearing Fixed-to-Floating Swap Class 1. Currency U.S. Dollar (USD) Euro (EUR) Sterling (GBP) Yen (JPY) LIBOR EURIBOR LIBOR LIBOR 28 days to days to days to days to 30 6 Please refer to the chart at the end of this Sidley Update. 7 For more information on negotiating clearing documents, please see the Sidley Update available at

4 Page 4 4. Optionality No No No No 5. Dual Currencies No No No No No No No No Basis Swap Class 1. Currency U.S. Dollar (USD) Euro (EUR) Sterling (GBP) Yen (JPY) LIBOR EURIBOR LIBOR LIBOR 28 days to days to days to days to Optionality No No No No 5. Dual Currencies No No No No No No No No Forward Rate Agreement Class 1. Currency U.S. Dollar (USD) Euro (EUR) Sterling (GBP) Yen (JPY) LIBOR EURIBOR LIBOR LIBOR 3 days to 3 3 days to 3 3 days to 3 3 days to 3 4. Optionality No No No No 5. Dual Currencies No No No No No No No No Overnight Index Swap Class 1. Currency U.S. Dollar (USD) Euro (EUR) Sterling (GBP)

5 Page 5 FedFunds EONIA SONIA 7 days to 2 7 days to 2 7 days to 2 4. Optionality No No No 5. Dual Currencies No No No No No No North American Untranched CDS Indices Class 1. Reference Entities Corporate 2. Region North America 3. Indices 4. Tenor 5. Applicable Series CDX.NA.IG CDX.NA.HY CDX.NA.IG: 3Y, 5Y, 7Y, 10Y CDX.NA.HY: 5Y CDX.NA.IG 3Y: Series 15 and all subsequent Series, up to and including the current Series CDX.NA.IG 5Y: Series 11 and all subsequent Series, up to and including the current Series CDX.NA.IG 7Y: Series 8 and all subsequent Series, up to and including the current Series CDX.NA.IG 10Y: Series 8 and all subsequent Series, up to and including the current Series CDX.NA.HY 5Y: Series 11 and all subsequent Series, up to and including the current Series 6. Tranched No European Untranched CDS Indices Class 1. Reference Entities Corporate 2. Region Europe 3. Indices itraxx Europe itraxx Europe Crossover itraxx Europe HiVol 4. Tenor itraxx Europe: 5Y, 10Y

6 Page 6 itraxx Europe Crossover: 5Y itraxx Europe HiVol: 5Y 5. Applicable Series itraxx Europe 5Y: Series 10 and all subsequent Series, up to and including the current Series itraxx Europe 10Y: Series 7 and all subsequent Series, up to and including the current Series itraxx Europe Crossover 5Y: Series 10 and all subsequent Series, up to and including the current Series itraxx Europe HiVol 5Y: Series 10 and all subsequent Series, up to and including the current Series 6. Tranched No The Derivatives Practice of Sidley Austin LLP Sidley s derivatives lawyers in numerous worldwide offices advise clients on a broad range of domestic and international derivatives transactions involving swaps, commodity futures contracts and options. Our clients, located in the U.S. and outside the U.S., include commercial banks, investment banks, insurance companies, hedge funds and mutual funds and their advisers, commodity and options exchanges, clearing organizations and other participants in the OTC and exchange-traded derivatives markets. In serving our derivatives clients, our internationally-based group utilizes the extensive experience of lawyers in Sidley s other practice areas, including tax, banking, insurance, investment funds, litigation, bankruptcy, employee benefits, securitization and financial regulatory practices. We act for our clients in a wide variety of settings, including initial transaction and product structuring, negotiation and execution; post-trade operation, modification, work-out, dispute resolution, remedies and recovery; practice before regulatory authorities; and general consultation. The Investment Funds Practice of Sidley Austin LLP Sidley has a premier, global practice in structuring and advising investment funds and advisers. We advise clients in the formation and operation of all types of alternative investment vehicles, including hedge funds, fund-of-funds, commodity pools, venture capital and private equity funds, private real estate funds and other public and private pooled investment vehicles. We also represent clients with respect to more traditional investment funds, such as closed-end and open-end registered investment companies (i.e., mutual funds) and exchange-traded funds (ETFs). Our advice covers the broad scope of legal and compliance issues that are faced by funds and their boards, as well as investment advisers to funds and other investment products and accounts, under the laws and regulations of the various jurisdictions in which they may operate. In particular, we advise our clients regarding complex federal and state laws and regulations governing securities, commodities, funds and advisers, including the Dodd-Frank Act, the Investment Company Act of 1940, the Investment Advisers Act of 1940, the Securities Act of 1933, the Securities Exchange Act of 1934, the Commodity Exchange Act, the USA PATRIOT Act and comparable laws in non-u.s. jurisdictions. Our practice group consists of approximately 120 lawyers in New York, Chicago, London, Hong Kong, Singapore, Shanghai, Tokyo, Los Angeles and San Francisco. To receive future copies of this and other Sidley updates via , please sign up at BEIJING BRUSSELS CHICAGO DALLAS FRANKFURT GENEVA HONG KONG HOUSTON LONDON LOS ANGELES NEW YORK PALO ALTO SAN FRANCISCO SHANGHAI SINGAPORE SYDNEY TOKYO WASHINGTON, D.C. Sidley Austin LLP, a Delaware limited liability partnership which operates at the firm s offices other than Chicago, New York, Los Angeles, San Francisco, Palo Alto, Dallas, London, Hong Kong, Houston, Singapore and Sydney, is affiliated with other partnerships, including Sidley Austin LLP, an Illinois limited liability partnership (Chicago); Sidley Austin (NY) LLP, a Delaware limited liability partnership (New York); Sidley Austin (CA) LLP, a Delaware limited liability partnership (Los Angeles, San Francisco, Palo Alto); Sidley Austin (TX) LLP, a Delaware limited liability partnership (Dallas, Houston); Sidley Austin LLP, a separate Delaware limited liability partnership (London); Sidley Austin LLP, a separate Delaware limited liability partnership (Singapore); Sidley Austin, a New York general partnership (Hong Kong); Sidley Austin, a Delaware general partnership of registered foreign lawyers restricted to practicing foreign law (Sydney); and Sidley Austin Nishikawa Foreign Law Joint Enterprise (Tokyo). The affiliated partnerships are referred to herein collectively as Sidley Austin, Sidley, or the firm.