Daily Rules, Proposed Rules, and Notices of the Federal Government
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All comments must be submitted in English, or if not, accompanied by an English translation. "Inter-affiliate Clearing Exemption" must be in the subject field of responses submitted via email, and clearly indicated on written submissions. Comments will be posted as received to
Throughout this proposed rulemaking, the Commission requests comment in response to specific questions. For convenience, the Commission has numbered each of these comment requests. The Commission asks that, in submitting responses to these requests, commenters identify the specific number of each request to which their comments are responsive.
The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse, or remove any or all of a submission from www.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the Freedom of Information Act.
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act" or "DFA").
Section 723 of the Dodd-Frank Act added section 2(h) to the CEA, which establishes a clearing requirement for swaps.
A person may elect not to clear certain swaps if such person qualifies for an exception under CEA section 2(h)(7) and the Commission regulations issued in connection therewith (the "end-user exception").
Importantly, a counterparty to an inter-affiliate swap that qualifies for both the end-user exception and the inter-affiliate exemption may elect not to clear the inter-affiliate swap under either the end-user exception or the inter-affiliate exemption. As such, the Commission believes that the rule proposed in this rulemaking may not be necessary for the vast majority of inter-affiliate swaps involving a non-financial entity or a small financial institution because the end-user exception can be elected for those swaps. Accordingly, it is likely the proposed rule will be used for inter-affiliate swaps between two financial entities that do not qualify for the end-user exception or for swaps involving a non-financial entity that do not qualify for the end-user exception because the swaps do not hedge or mitigate commercial risk.
Finally, CEA section 4(c)(1), described in more detail below, grants the Commission general exemptive powers.
Except as provided with respect to certain financing affiliates as noted above, CEA section 2(h) does not provide any specific exception to swaps entered into by affiliates that are subject to a clearing requirement ("inter-affiliate swaps").
A number of commenters in a variety of Commission rulemakings have recommended that the Commission adopt an exemption to the clearing requirement for inter-affiliate swaps.
Prudential Financial, Inc. ("PFI"), stated that it employs a "conduit" structure where separate legal entities are commonly owned by PFI.
In a letter to Congress, the Coalition for Derivatives End-Users ("CDEU") asserted that inter-affiliate swaps do not create external counterparty exposure and, therefore, pose none of the systemic or other risks that the clearing requirement is designed to protect against.
These comments suggest that swaps entered into between corporate affiliates, if properly risk-managed, may be beneficial to the operation of the corporate group as a whole. They indicate that inter-affiliate swaps may improve a corporate group's risk management internally and allow the corporate group to use the most efficient means to effectuate swaps with third parties. While the Commission recognizes these potential benefits of inter-affiliate swaps, the Commission is also taking into account the systemic risk repercussions of inter-affiliate swaps as it considers and proposes an exemption to the CEA's clearing requirement applicable to those inter-affiliate swaps.
Section 4(c)(1) of the CEA empowers the Commission to "promote responsible economic or financial innovation and fair competition" by exempting any transaction or class of transactions, including swaps, from any of the provisions of the CEA (subject to exceptions not relevant here).
In order to promote responsible economic or financial innovation and fair competition, the Commission by rule, regulation, or order, after notice and opportunity for hearing, may (on its own initiative or on application of any person * * * ) exempt any agreement, contract, or transaction (or class thereof) that is otherwise subject to subsection (a) of this section * * * either unconditionally or on stated terms or conditions or for stated periods and either retroactively or prospectively, or both, from any of the requirements of subsection (a) of this section, or from any other provision of this Act.
By issuing a proposed exemptive rule, the Commission also is exercising its general rulemaking authority under CEA section 8a(5), 7 U.S.C. 12a(5).
The primary benefit of clearing is the reduction of counterparty risk. The Commission notes commenters' assertions that there is less counterparty risk associated with inter-affiliate swaps than swaps with third parties to the extent that affiliated counterparties internalize each other's counterparty risk because they are members of the same corporate group. This internalization can be demonstrated by the example of a swap entered into between affiliates A and B that are majority owned by the same person.
The Commission does not believe there is significantly reduced counterparty risk with respect to swaps between affiliates that are not majority-owned by the same person because there is less economic feedback. If A is a majority-owned affiliate and B is a minority-owned affiliate, then any harm that B experiences as a consequence of A's failure to perform is likely to have a less adverse impact on the profits of A's corporate group than if B was a majority-owned affiliate. In addition, the Commission believes that B's failure to perform would be significantly less likely to drive A's corporate group into bankruptcy than if B were majority-owned.
On the basis of reduced counterparty risk, the Commission has determined preliminarily that inter-affiliate swap risk may not need to be mitigated through clearing, but can be reduced through other means. The Commission also believes at the proposal stage that exempting inter-affiliate swaps would enable corporations to structure their groups so that corporate risk is concentrated in one entity--whether it be at a treasury- or conduit-type affiliate, or at the parent company.
The Commission, nevertheless, believes that uncleared inter-affiliate swaps could pose risk to corporate groups and market participants, generally. Uncleared inter-affiliate swaps also may pose risk to other market participants, and therefore the financial system, if the treasury/conduit affiliate enters into swaps with third parties that are related on a back-to-back or matched book basis with inter-affiliate swaps. To continue the above example, if A's failure to perform (for whatever reason) makes it impossible for B to meet its third-party swap obligations, then those third parties would be harmed and risk could spread into the marketplace. However, A's risk of nonperformance is less than it would be if B were a third party to the extent A internalizes B's counterparty risk.
To address these concerns, the Commission is proposing rules that would exempt inter-affiliate swaps from clearing if certain conditions are satisfied. First, the proposed exemption would be limited to swaps between majority-owned affiliates whose financial statements are reported on a consolidated basis. Second, the proposed rules would require the following: Centralized risk management, documentation of the swap agreement, variation margin payments (for financial entities), and satisfaction of reporting requirements. In addition, the exemption would be limited to swaps between U.S. affiliates, and swaps between a U.S. affiliate and a foreign affiliate located in a jurisdiction with a comparable and comprehensive clearing regime or the non-United States counterparty is otherwise required to clear the swaps it enters into with third
Q1. The Commission requests comment on whether it should exercise its authority under CEA section 4(c).
Q2. Do inter-affiliate swaps pose risk to the corporate group? If so, what risk is posed? In particular, do inter-affiliate swaps pose less risk to a corporate group than swaps with third parties? If so, why is that the case?
Q3. Do inter-affiliate swaps pose risk to the third parties that have entered into swaps that are related to the inter-affiliate swaps? If so, what risk is posed?
Q4. Would the proposed exemption promote responsible economic or financial innovation and fair competition?
Q5. Would the proposed exemption promote the public interest?
Q6. Inter-affiliate swaps that do not meet the conditions to the proposed exemption would be subject to the clearing requirement under CEA section 2(h)(1)(A) and, potentially, the trade execution requirement under CEA section 2(h)(8) as well. What would be the costs and benefits of imposing the trade execution requirement on these inter-affiliate swaps? Should the Commission exempt some or all inter-affiliate swaps from the trade execution requirement regardless of whether the conditions to the proposed inter-affiliate clearing exemption are met?
Under proposed SS 39.6(g)(1), the inter-affiliate clearing exemption would only be available for swaps between majority-owned affiliates. As explained above, the Commission believes there is reduced counterparty risk with respect to such swaps. Under the proposed rule, affiliates would be majority-owned if one affiliate directly or indirectly holds a majority ownership interest in the other affiliate, or if a third party directly or indirectly holds a majority ownership interest in both affiliates and the financial statements of both affiliates are reported on a consolidated basis. A majority-ownership interest would be based on holding a majority of the equity securities of an entity, or the right to receive upon dissolution, or the contribution of, a majority of the capital of a partnership.
The Commission is not proposing to extend the exemption to affiliates that are related on a minority-owned basis. As explained above, the Commission does not believe there is significantly reduced counterparty risk with respect to swaps between such affiliates. The Commission also believes it is important for the proposed inter-affiliate clearing exemption to be harmonized with foreign jurisdictions that have or are developing comparable clearing regimes consistent with the 2009 G-20 Leaders' Statement.
Q7. The Commission requests comments on all aspects of the Commission's proposed requirement that the inter-affiliate clearing exemption be available to majority-owned affiliates.
Q8a. Should the Commission consider requiring a percentage of ownership greater than majority ownership to qualify for the inter-affiliate clearing exemption?
Q8b. If so, what percentage should be used and what are the benefits and burdens of such ownership requirements?
Q8b. Should the Commission require a 100% ownership threshold for the inter-affiliate clearing exemption? Would a 100% ownership threshold reduce counterparty risk and protect minority owners better than the proposed threshold. Are there other means to lessen risk to minority owners, such as consent?
Q9. Should the Commission consider an 80% ownership threshold based on section 1504 of the Internal Revenue Code, which establishes an 80% voting and value test for an affiliate group.
(a) Affiliated group defined for purposes of this subtitle--
(1) In general. The term "affiliated group" means--
(A) 1 or more chains of corporations connected through stock ownership with a common parent corporation which is a corporation, but only if--
(B) (i) the common parent owns directly stock meeting the requirements of paragraph (2) in at least 1 of the other corporations, and
(ii) stock meeting the requirements of paragraph (2) in each of the includible corporations (except the common parent) is owned directly by 1 or more of the other includible corporations.
(2) 80-percent voting and value test The ownership of stock of any corporation meets the requirements of this paragraph if it--
(A) possesses at least 80 percent of the total voting power of the stock of such corporation, and
(B) has a value equal to at least 80 percent of the total value of the stock of such corporation.
(3) Stock not to include certain preferred stock
For purposes of this subsection, the term "stock" does not include any stock which--(A) is not entitled to vote,
(B) is limited and preferred as to dividends and does not participate in corporate growth to any significant extent,
(C) has redemption and liquidation rights which do not exceed the issue price of such stock (except for a reasonable redemption or liquidation premium), and
(D) is not convertible into another class of stock.
The Commission believes that affiliates within a corporate group may make independent determinations on whether to submit an inter-affiliate swap for clearing. Ostensibly, each affiliate may reach different conclusions regarding the appropriateness of clearing. Given this possibility, proposed SS 39.6(g)(2)(i) would require that both counterparties elect the proposed inter-affiliate clearing exemption (each, an "electing counterparty").
Q10. Would this requirement create any operational issues?
The Commission understands that affiliates may enter into swaps with
Proposed SS 39.6(g)(2)(iii) would address these concerns by requiring affiliates to enter into swaps with a swap trading relationship document.
Q11. The Commission requests comment as to the burden or cost of the proposed rule requiring documentation of inter-affiliate swaps.
Q12. The Commission also requests comment as to whether its risk tracking and management and proof-of-claim concerns could be addressed by other means of documentation.
Q13. The Commission requests comment as to whether the Commission should create a specific document template. Should the industry do so?
Proposed SS 39.6(g)(2)(iii) would require inter-affiliate swaps to be subject to a centralized risk management program reasonably designed to monitor and manage the risks associated with the inter-affiliate swaps. As noted in Part I.B. above, inter-affiliate swaps may pose risk to third parties if risks are not properly managed. Accordingly, to encourage prudent risk management, the proposed inter-affiliate clearing exemption would be conditioned on a corporate group's evaluation, measurement and control of such risks. The Commission anticipates that the program would be implemented and run by the parent company or the treasury/conduit affiliate, but the rule provides flexibility to determine how best to satisfy this requirement.
The Commission understands that some groups that use inter-affiliate swaps, particularly large financial entities, already have a centralized risk management program.
Q14. The Commission requests comments that explain how current centralized risk management programs operate.
Q15. The Commission requests comment on whether it should promulgate additional regulations that set forth minimum standards for a centralized risk management program. If so, what should those standards be? Is there a consistent industry practice which could be observed?
Q16. Is the proposed rule in line with industry practice?
Proposed SS 39.6(g)(2)(iv) would require that variation margin be collected for swaps between affiliates that are financial entities, as defined in CEA section 2(h)(7)(C), in compliance with the proposed variation margin requirements set forth in proposed SS 39.6(g)(3).
The Commission understands that a number of financial entities currently
The proposed requirement would not apply to 100% commonly-owned and commonly-guaranteed affiliates, provided that the common guarantor is also under 100% common ownership. As discussed above, the risk of an inter-affiliate swap may be mitigated through the posting of variation margin. The Commission believes that when the economic interests of two affiliates are both (i) fully aligned and (ii) a common guarantor bears the ultimate risk associated swaps entered into with a third party, non-affiliated counterparty, the posting of variation margin does not substantially mitigate the risk of an inter-affiliate swap. This exception is intended to apply to swaps between two wholly-owned subsidiaries of a common parent or in instances where one affiliate is wholly owned by the other.
The first of the conditions required to claim the exception to the requirement under proposed regulation 39.6(g)(2)(iv) to post variation margin relates to complete common ownership. When two affiliates are owned by the same owner or one is wholly owned by the other, the underlying owners are the same and the economic interests of the two affiliates are aligned.
A person would not be able to claim 100 percent ownership for the purposes of this provision based on a contingent right or obligation, by contract or otherwise, to take ownership of the equity interest in the affiliate by purchase or otherwise.
Q17a. The Commission requests comment as to whether it should promulgate regulations that set forth minimum standards for variation margin. If so, what should those standards be?
Q17b. The Commission requests comment as to whether it should promulgate regulations that set forth minimum standards for initial margin. If so, what should those standards be?
Q17c. The Commission requests comment as to whether it should promulgate regulations that set forth minimum standards for both initial and variation margin for inter-affiliate swaps. If so, what should those standards be?
Q17d. The Commission's proposed rule "Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants"--17 CFR Part 23--would require initial and variation margin for certain swaps that are not cleared by a registered designated clearing organization. Should inter-affiliate swaps that are not subject to the clearing requirement of CEA section 2(h)(1)(A) be subject to the margin requirements as set out in proposed Part 23 or otherwise?
Q18. The Commission requests comment on the costs and benefits of requiring variation margin for inter-affiliate swaps, both in general and specifically, regarding corporate groups that do not currently transfer variation margin in respect of inter-affiliate swaps.
Q19. The Commission requests comment on whether 100% commonly-owned affiliates sharing a common guarantor--that is, a guarantor that is also 100% commonly owned--should be exempt from the requirement to transfer variation margin. Please explain the impact on the corporate group, if any, if the described affiliates are required to transfer variation margin.
Q20a. Should any other categories of entities or corporate groups, such as non-swap dealers and non-major swap participants, be exempt from the variation margin requirement for their inter-affiliate swaps? If so, which categories and why?
Q20b. Should the Commission limit the variation margin requirements to those inter-affiliate swaps for which at least one counterparty is a swap dealer, major swap participant, or financial entity, as defined in paragraph (g)(6) of the proposed rule text, that is subject to prudential regulation?
Q21. The Commission requests comment as to whether it should eliminate the proposed exemption's variation margin condition for swaps between 100% owned affiliates.
Q22. The Commission requests comment as to whether it should eliminate the proposed exemption's
Q23. The Commission requests comment on whether all types of financial entities identified in CEA section 2(h)(7)(C) should be subject to the variation margin requirement. Should entities that are part of a commercial corporate group and are financial entities solely because of CEA section 2(h)(7)(C)(i)(VIII) be excluded from such requirement? Why?
The Commission is proposing to limit the inter-affiliate clearing exemption to inter-affiliate swaps between two U.S.-based affiliates or swaps where one affiliate is located abroad in a jurisdiction with a comparable and comprehensive clearing regime or the non-United States counterparty is otherwise required to clear swaps with third parties in compliance with United States law or does not enter into swaps with third parties. The limitation in SS 39.6(g)(2)(v) is designed to address the Commission's concerns about risk and to deter evasion as directed by CEA section 2(h)(4)(A).
Under section 2(h)(4)(A), the Commission must prescribe rules necessary to prevent evasion of the clearing requirement.
The Commission recognizes that there may be a legitimate reason for an inter-affiliate swap where one affiliate is located in a country that does not have a comparable clearing regime. However, the Commission believes that financial markets may be at risk if the foreign affiliate enters into a related third-party swap that would be subject to clearing were it entered into in the United States, but is not cleared. On balance, the Commission believes that the risk of evasion and the systemic risk associated with uncleared swaps necessitates that the exemption be limited to swaps between affiliates located in the United States or in foreign countries with comparable clearing regimes or the non-United States counterparty is otherwise required to clear swaps with third parties in compliance with United States law or does not enter into swaps with third parties.
Q24a. The Commission requests comment on proposed SS 39.6(g)(2)(v). Is the proposed condition that both affiliates must be located in the United States or in a country with a comparable and comprehensive clearing jurisdiction or the non-United States counterparty is otherwise required to clear swaps with third parties or does not enter into swaps with third parties a necessary and appropriate means of reducing risk and evasion concerns related to inter-affiliate swaps? If not, how should these concerns be addressed?
Q24b. Should the Commission limit the inter-affiliate clearing exemption to foreign affiliates that only enter into inter-affiliate swaps if such foreign affiliates are not located in a jurisdiction with a comparable and comprehensive clearing requirement or are otherwise required to clear swaps with third parties in compliance with United States?
Q24c. Should the Commission limit the inter-affiliate clearing exemption to foreign affiliates that enter into swaps with third parties on an occasional basis if such foreign affiliates are not located in a jurisdiction with a comparable and comprehensive clearing requirement or are otherwise required to clear swaps with third parties in compliance with United States. What would constitute an occasional basis? For example, would once a year be an appropriate time frame?
Q25. The Commission requests comment on (1) the prevalence of cross-border inter-affiliate swaps and the mechanics of moving swap-related risks between U.S. and non-U.S. affiliates for risk management and other purposes (including an identification of such purposes); (2) the risk implications of cross-border inter-affiliate swaps for the U.S. markets; and (3) specific means to address the risk issues potentially presented by cross-border inter-affiliate swaps.
Q26. The Commission recently adopted anti-evasion provisions relating to cross-border swap activities in its new rule 1.6.
Q27. The Commission also is considering an alternative condition to address evasion. That condition would require non-U.S. affiliates to clear all swap transactions with non-U.S. persons, provided that such transactions are related to inter-affiliate swaps which would be subject to a clearing requirement if entered into by two U.S. persons.
As explained in more detail below, the Commission has preliminarily determined that it must receive certain
Proposed SS 39.6(g)(3) would set forth the requirements for transferring variation margin. Proposed SS 39.6(g)(3)(i) would require that if both counterparties to the swap are financial entities, each counterparty shall pay and collect variation margin for each inter-affiliate swap for which the proposed exemption is elected. Proposed SS 39.6(g)(3)(ii) would require that the swap trading relationship document set forth and describe the methodology to be used to calculate variation margin with sufficient specificity to allow the counterparties, the Commission, and any appropriate prudential regulator to calculate the margin requirement independently. The Commission believes that the proposed rule would help ensure that affiliates have a written methodology. The proposed rule also would allow affiliates to manage their risks more effectively throughout the life of the swap and to avoid disputes regarding issues such as valuation.
Pursuant to CEA section 4r,
Proposed SS 39.6(g)(4)(ii)-(iii) would require the reporting counterparty to provide certain information, unless such information had been provided in a current annual filing pursuant to proposed SS 39.6(g)(5). Proposed SS 39.6(g)(4)(ii) would require the reporting counterparty to submit information regarding how the financial obligations of both counterparties are generally satisfied with respect to uncleared swaps. The information is valuable because it would provide the Commission a more complete view of the risk characteristics of uncleared swaps. The information also would enhance the Commission's efforts to identify and reduce potential systemic risk.
Proposed SS 39.6(g)(4)(iii) would implement CEA section 2(j) for purposes of the inter-affiliate exemption.
Exemptions from the requirements of subsection (h)(1) to clear a swap and subsection (h)(8) to execute a swap through a board of trade or swap execution facility shall be available to a counterparty that is an issuer of securities that are registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is required to file reports pursuant to section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o) only if an appropriate committee of the issuer's board or governing body has reviewed and approved its decision to enter into swaps that are subject to such exemptions.
Proposed SS 39.6(g)(4)(iii)(A) would require an electing SEC Filer to notify the Commission of its SEC Filer status by submitting its SEC Central Index Key number. This information would enable the Commission to cross-reference materials filed with the relevant SDR with information in periodic reports and other materials filed by the electing SEC Filer with the U.S. Securities and Exchange Commission ("SEC"). In addition, proposed SS 39.6(g)(4)(iii)(B) would require the counterparty to report whether an appropriate committee of its board of directors (or equivalent governing body) has reviewed and approved the decision to enter into the inter-affiliate swaps that are exempt from clearing.