The CFTC issued a final rule to exempt swaps between certain affiliated entities within a corporate group from the clearing requirement under section 2(h)(1)(A) of the Commodity Exchange Act (“CEA”) and CFTC regulations, subject to a number of conditions. On November 29, 2012, the CFTC had adopted its first clearing requirement determination, requiring that swaps meeting the specifications outlined in four classes of interest rate swaps and two classes of credit default swaps (“CDS”) be cleared.  On March 11, 2013, swap dealers, major swap participants, and private funds active in the swaps market were required to begin clearing certain index CDS and interest rate swaps which they entered into on or after March 11, 2013.

Swaps with Affiliates

Pursuant to its authority under section 4(c)(1) of the CEA, the CFTC approved a rule that permits affiliated counterparties to elect not to clear a swap that woud be otherwise subject to the clearing requirement if those counterparties are majority-owned affiliates whose financial statements are included in the same consolidated financial statements. The exemption is subject to the following additional conditions: (i) both affiliated counterparties must elect not to clear the swap; (ii) the terms of the swap must be documented in a swap trading relationship document (or comply with the requirements of CFTC regulation 23.504, if one of the affiliated counterparties is a swap dealer or a major swap participant); (iii) the swap must be subject to a centralized risk management program that is reasonably designed to monitor and manage the risks associated with the swap (or if one of the affiliated counterparties is a swap dealer or a major swap participant, the requirements of CFTC regulation 23.600 must be met); (iv) and each swap entered into by the affiliated counterparties, of a type that would be subject to the clearing requirement, with unaffiliated counterparties must be cleared or exempt from clearing (as described in the next paragraph).

Related Swaps with Unrelated Parties

The above-mentioned requirement to “clear” swaps entered into with unaffiliated counterparties may be met by: (1) complying with the CFTC’s clearing requirement or an exception therefrom; (2) complying with a foreign jurisdiction’s clearing mandate or with an exception therefrom that the CFTC has determined is acceptable; or (3) clearing such swaps through a registered derivatives clearing organization or a clearing organization that is subject to supervision by appropriate government authorities in the home country of the clearing organization and has been assessed to be in compliance with the Principles for Financial Market Infrastructures.  These conditions limit the jurisdictional scope of the clearing exemption.

Reporting Requirements

The final rule requires the reporting counterparty to report to a swap data repository or the CFTC the following information for each swap for which the inter-affiliate exemption applies: (1) confirmation that both affiliated counterparties to the swap are electing not to clear the swap and that each of the electing eligible affiliate counterparties satisfies the requirements of the rule; (2) information regarding how both affiliated counterparties generally meet their financial obligations associated with entering into non-cleared swaps; and (3) certain information, if the affiliated counterparties are issuers of securities registered under section 12, or are required to file reports under section 15(d), of the Securities Exchange Act of 1934.

Timing

The Rule sets out timing requirements, effectively delaying the requirements of the rule. 

The Rule sets out timing requirements for mandatory clearing of certain CDS indices on European corporate names.

Lofchie Comment:  This is an important exemption because it provides not only a means for affiliates to trade without clearing, but also a means by which business may be done across national borders without subjecting non-U.S. entities to the full burden of U.S. regulation.  It may be expected that non-U.S. entities that want to trade with a U.S. swap dealer will likely instead trade with the U.S. firm’s foreign affiliate, and that the affiliate in turn can transfer any risk back to the swap dealer in the United States.  This will at least allow U.S.-based firms to be competitive in non-U.S. markets, although, it likely will continue to encourage the steady movement of financial jobs outside the United States.

The Rule is also significant because it represents a fairly significant retreat by the CFTC from its position that its swaps rules would govern the world markets.  This position was not workable in light of opposition from non-U.S. regulators.  Now, it will be interesting to see how both the process of determining comparability works and what jurisdictions are deemed comparable. 

Many corporate groups that do not act as swap dealers centralize their external swaps activities in one (or a few) members of the corporate group.  Such corporate grops that are not subject to CFTC registration should be aware that various conditions in the exemptive order apply to them if they wish to avoid clearing intra-group swaps with their affiliates; e.g., the documentation requirement and the requirement of a risk management program.  As to the requirement of a risk managemenet program, the rule states that the CFTC anticipates that it would include “rigorous valuaton provisions” and “procedures for elevating and resolving disputes.”  Corporate groups should also be aware that the exemption is subject to various jurisdictional limitations.

See:  Final Rule (links to the CFTC’s website).
See also:  CFTC Press Release; Statement from CFTC Chairman Gensler.

The CFTC Division of Swap Dealer and Intermediary Oversight (“DSIO”) issued time-limited no-action relief for swap dealers (“SDs”) and major swap participants (“MSPs”) concerning certain recordkeeping obligations under Part 23 of the CFTC regulations. The no-action letter is an extension of relief previously granted to SDs and MSPs which was scheduled to have expired on March 31, 2013.  See CFTC Letter No. 12-29 (October 26, 2012).

The new no-action letter extends until June 30, 2013, the compliance date for the following provisions:

(1) For landline telephones that are not located in one of the following geographic jurisdictions: United States, United Kingdom, Singapore, Hong Kong, Japan, Australia, Switzerland, or Canada, the requirement that SDs and MSPs make and keep records of all oral communications related to pre-execution swap trade information (and communications that lead to the conclusion of a related cash or forward transaction) pursuant to Regulations 23.202(a) and (b);

(2) The requirement that SDs and MSPs maintain all transaction records and daily trading records in a manner “identifiable and searchable” by transaction and counterparty pursuant to Regulations 23.201(a)(1), 23.202(a) and 23.202(b), subject to the condition that the Firms continue to maintain such records using existing search capabilities in their relevant systems;

(3) The requirement that SDs and MSPs use a Coordinated Universal Time (“UTC”) timestamp when recording quotations prior to and at the time of execution of a swap pursuant to Regulations 23.202(a)(1)(ii), (a)(2)(iv), (a)(3)(ii), (b)(3), and (b)(4), subject to the condition that the data recorded in local time is convertible to UTC within a reasonable timeframe after a regulatory request for such time data, and subject to the condition that the Firms will continue to commit to using a UTC time standard in newly installed or upgraded systems; and

(4) The requirement that SDs and MSPs retain swap records at their principal places of business or such other principal offices as designated by the SD or MSP, subject to the condition that records otherwise subject to Regulation 23.203(a)(1) be promptly available at the designated principal place of business or other such principal office located in the United States, its territories, or possessions within 72 hours upon request of a CFTC representative.

Lofchie Comment:  While this relief will clearly be welcomed by the market, it is disappointing that, yet again, the CFTC has issued a no-action position as to a rule, which no one is technologically able to comply with, after the effective date of the rule.  Further, the CFTC has only made the relief available for three months, even though it is clearly impossible that the market will be in a position to comply with the relevant rules within that period.  When the CFTC issues its next no-action letter on this topic, I hope it will be prospective rather than retrospective.  A consistent pattern of adopting rules that are impossible to fulfill, and then issuing temporary exemptions after the rules have become effective, lessens confidence in the regulatory system.

Click here to view CFTC Letter 13-06 (links externally to CFTC website).
Related News: “CFTC Issues Time-Limited No-Action Relief Regarding Certain Recordkeeping Obligations” (October 29, 2012).  (This story links to CFTC Letter No. 12-29.)

The CFTC has approved final regulations governing dual and multiple associations of associated persons (“APs”) of swap dealers (“SDs”), major swap participants (“MSPs”) and other CFTC registrants (e.g., FCMs, IBs, CPOs and CTAs). The regulations provided that each SD, MSP and other CFTC registrant with whom an AP is associated is required to supervise the AP and is jointly and is severally responsible for the activities of the AP with respect to customers common to it and any other SD, MSP or other CFTC registrant.  This rule is based on the CFTC’s current rule governing APs associated with more than one CFTC-registered firm. 

Effective Date: [60 DAYS AFTER DATE OF PUBLICATION IN THE FEDERAL REGISTER].

Lofchie Comment:  The CFTC’s new rule seems problematic.  The CFTC asserts that imposing several liability is necessary to assure that improper sales practices do not escape responsibility, with each employer of a dual registrant disclaiming responsibility, but there are other ways to accomplish this same end.   That is, each employer may enter into an agreement with the other as to which employer is responsible for which product.  If it is clear that one employer, e.g., the “swap dealer,” is responsible for the employee’s activities in respect of the sale of swaps, there is no reason why the other employer, e.g., the FCM, should be responsible for the employee’s violation of a rule related to swaps. 

This should be doubly the case because only the swaps dealer will have compliance procedures that relate to swaps and only the FCM will have compliance procedures relating to futures. 

This should be triply the case because the separation of various types of CFTC-regulated activities, e.g., swaps and futures, into different legal entities, is largely mandated by the government-established regulatory structure.  Given that Congress in adopting the Dodd-Frank regulatory structure has effectively forced the separation of activities in regard to related products, it seems inappropriate for the CFTC to mandate joint liability of these separate entities.   

Notwithstanding the CFTC’s rule, I would strongly suggest that affiliated firms that have dual employees enter into agreements among themselves establishing which is responsible for which activities conducted by an employee who is associated with more than one CFTC registrant.

See: Dual and Multiple Associates of Persons Associated with Swap Dealers, Major Swap Participants and other Commission Registrants; Final Rule (Pre Fed. Reg. Version).

The Securities and Futures Commission (SFC) has conducted its fourth fact-finding survey on the Hong Kong hedge fund industry in conjunction with a data collection exercise coordinated by IOSCO concerning global hedge fund activities.  The attached report aims to provide an update on the Hong Kong hedge fund industry and hedge fund assets under management (AUM) as of September 30, 2012.

From 2010 to September 2012 hedge fund industry and AUM increased almost 38% to $87.1 billion.  The total number of hedge funds managed by licensed hedge fund managers in Hong Kong also increased, from 538 in 2010 to 676 in September of 2012.

Click here to view report in full (links externally to Securities and Futures Commission website).

The ABA Federal Regulation of Securities Committee submitted a comment letter to the SEC on crowdfunding.  Because the SEC has not yet issued any proposed regulations concerning crowdfunding, the Drafting Committee took an expansive view of what the SEC might propose and offered 15 principal recommendations on the various issues potentially arising in connection with Title III (Crowdfunding) of the JOBS Act.   Many of the recommendations are requests that the SEC “clarify” a point, “provide guidance,” or “consider” an issue.  Once regulations are actually proposed by the SEC, the Committee expects to prepare and file a comprehensive letter reviewing and commenting on the proposed regulations.

View letter in full here.