New CFTC swap clearing rules will force non-financial entities to stop uncleared trading of certain interest-rate swaps (IRS) and index credit default swaps (index CDS) starting on September 9, 2013, unless such entities qualify for and claim the “commercial end-user exception” included in those rules. According to a memo I just received from Skadden’s Brian Breheny, corporations will need to take certain steps before the September deadline if they want to avail themselves of the commercial end user exception. Here is more from the Skadden memo:
The CFTC adopted the swaps clearing rules to implement the Dodd-Frank Act provision that requires that any swap of a group, type or category of swaps that the CFTC requires to be cleared to be submitted for clearing to a clearinghouse, also referred to as a derivatives clearing organization or “DCO.” So far, the CFTC has required that only specific types of IRS and index CDS be cleared under a phased-implementation schedule that runs over the course of 2013, with non-financial entities required to begin clearing on September 9, 2013. The CFTC’s swaps clearing rules also implement a significant statutory exception to the mandatory clearing requirement — the commercial end-user exception.
Commercial end-user exception. A company will be eligible to claim the commercial end-user exception if it satisfies the following criteria:
- It is not a “financial entity”;
- It enters into the swap to “hedge or mitigate its commercial risk”;
- It provides (or its counterparty provides) certain information to a swap data repository (SDR), or if no SDR is available, to the CFTC; and
- If it is a reporting company, an “appropriate committee” of the company’s board or governing body reviews and approves the decision to claim the end-user exception for swaps that are subject to the clearing mandate and exchange trading mandate.
Board or committee approval. Although the commercial end-user exception specifically states that an “appropriate committee” of the company’s board must review and approve the decision to claim the exemption, CFTC staff has indicated that review and approval by either an appropriate committee or the full board will satisfy the requirements of the exception. The CFTC will consider a committee to be “appropriate” if it is specifically authorized to review and approve the company’s decision to enter into swaps.
Approval by the board or committee to enter into swaps subject to the commercial end-user exception can be done either on a swap-by-swap basis or on a general basis. If the approval is general, it must be reviewed no less than annually. Although not required by the rules, the CFTC also expects a board or committee that approves the use of the exception to set appropriate policies governing the use of swaps subject to the exception and to review those policies at least annually and, as appropriate, more often upon the occurrence of a triggering event (such as the implementation of a new hedging strategy that was not previously contemplated by the board or committee). Subsidiaries and other controlled persons of reporting companies also must obtain board or committee approval in order to rely on the exception.
Next steps. Reporting companies that intend to rely on the commercial end-user exception should begin to develop and implement approval policies and procedures so that they are in place prior to September 9, 2013. Among other things, companies should:
- Determine whether the board or a committee of the board will review and approve the decision to claim the exception;
- If a board committee will perform the requisite functions,
- review the charters of existing committees to determine if any committee is currently authorized to review and approve swaps; and
- if necessary, establish a new committee or delegate authority to an existing committee to review and approve the company’s decision to enter into swaps (by a board resolution and/or an amendment to such committee’s charter);
- Have the board or committee review and discuss with management the company’s current and proposed hedging strategies and use of swaps and review and set policies governing the use of the end-user exception;
- Have the board or committee approve a resolution that the company may enter into swaps that are excepted from the clearing and execution requirements; and
- Have the board or committee add to its annual schedule a review of the company’s policies and renewing its approval to use the end-user exception.
Click here for the complete Skadden publication (including footnotes).