New rules could add to costs and operational burdens for many companies.
The Commodity Futures Trading Commission has issued a proposed rule on inter-affiliate derivatives transactions allowing counterparties not to clear a swap under some circumstances. But the rule requires variation margin to be paid between affiliates, something that will add to costs and operational burdens.
The proposed rule, Clearing Exemption for Swaps Between Certain Affiliated Entities, issued August 16, says that “Counterparties to inter-affiliate swaps that qualify for the end-user exception would be able to elect to not clear swaps pursuant to the end-user exception or the proposed rule.”
The transaction would qualify for the clearing exception if neither counterparty is a financial entity, one counterparty directly or indirectly holds a majority ownership interest in the other or a third party directly or indirectly holds a majority ownership interest in both counterparties. The financial statements of both counterparties must be reported on a consolidated basis.
The affiliated counterparties need to meet certain requirements:
- both counterparties must elect not to clear the swap;
- the swap trading relationship must be adequately documented;
- a centralized risk management program must be used to monitor and manage the risks of the swap;
- the swap reporting requirements must be fulfilled;
- both counterparties must be located in the United States or, if not, the foreign affiliate must be located in a jurisdiction that has a comparable and comprehensive clearing requirement, be required to clear swaps with non-affiliated counterparties under US law, or not enter into swaps with non-affiliated parties; and
- variation margin must be collected unless there is 100% common ownership of the counterparties.
The variation margin was a sticking point for two of the commissioners, Sommers and O’Malia, who voted against the proposed rule.
The rule does not address swaps that an affiliate enters into with a third party that are related to inter-affiliate swaps that are subject to the end-user exception. The CFTC intends separately to propose a rule addressing swaps between an affiliate and a third party where the swaps are used to hedge or mitigate commercial risk arising from inter-affiliate swaps for which the end-user exception has been elected.