The Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act) included a mandate for new clearing requirements
for swaps. While these requirements will have the biggest impact on
financial institutions that act as counterparties to swaps, there
are aspects of the new requirements that will impact all companies
that enter into swaps. In particular, as described below, a public
company will want to make sure that it obtains specific board
approval prior to entering into any swaps under the new regime.
The new regulatory structure will require swaps to be cleared
through a derivatives clearing organization (DCO), reported to a
swap data repository (SDR) or the Commodities Futures Trading
Commission (CFTC), and executed on a designated contract market
(DCM) or swap execution facility (SEF), unless the swap
has been exempted by CFTC rules. Meeting these new requirements
will be burdensome to swap participants. The good news is that
final rules published by the CFTC this summer clarify and give form
to a relatively broad exemption that will provide a less burdensome
alternative for most businesses that use swaps solely to hedge
their business risks, as long as those businesses meet the criteria
for the "end user exception."
The end-user exception may be elected if one of the
counterparties to the swap (1) is not a financial entity,
(2) is using the swap to hedge or mitigate commercial risks (such
as interest rate changes or currency fluctuations), (3) notifies
the CFTC how it meets its financial obligations associated with
non-cleared swaps, and (4) elects not to clear the swap.
"Financial entity" includes any entity that is a swap
dealer, major swap participant, security-based swap dealer or
participant, commodity pool, private fund, ERISA plan, as well as
certain banks, but any bank, savings institution or credit union
with total assets of less than $10 billion is not a
financial entity for purposes of this rule. Certain foreign
entities and certain financing affiliates of non-financial entities
may also be eligible for the end user exemption.
If at least one party is eligible for the end user exception,
the parties may take advantage of the exception by reporting notice
of election and the identity of the eligible counterparty to a swap
data repository (SDR) or, if no SDR is available, to the CFTC. A
reporting counterparty must provide the following information:
whether the electing counterparty is a financial entity but
eligible for the exception as a small financial institution or as a
financial entity acting as an affiliate of a non-financial
whether the swap for which the end user exception is being
elected is used to hedge or mitigate commercial risk;
information regarding how the electing counterparty generally
meets its financial obligations with respect to non cleared swaps;
if the electing counterparty is a public company, whether its
board of directors has approved the decision to enter into swaps
that are exempt from the swap clearing requirements.
Nothing in the rule prohibits a reporting party from providing
the information above on a swap by swap basis, but as a practical
matter most companies wishing to rely on the end user exception
will prefer to provide this information on an annual basis (an
improvement upon the initial proposal, which required notification
of each and every swap transaction).
The final rule went into effect on September 17, 2012, but
reporting obligations will not begin until the swap clearing
regimen is put into place. This will occur in stages beginning
early in 2013 (with reports from end users not due until at least
the third quarter of 2013), and for now, there is not much to do
except plan ahead. Each public company that expects to take
advantage of the end user exception should make sure that its board
of directors (or an appropriate committee of the board) has
explicitly approved the use of swaps for hedging or mitigating risk
and the use of the end user exception for non-cleared swaps, and
identified the means through which the issuer meets its financial
obligations with respect to non-cleared swaps. This approval and
identification should be scheduled at least annually.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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