Final Clearing Determination for CDS and Interest Rate Swaps Issued by CFTC

Practical Law Legal Update 3-522-7450 (Approx. 7 pages)

Final Clearing Determination for CDS and Interest Rate Swaps Issued by CFTC

by PLC Finance

Published on 29 Nov 2012 • USA (National/Federal)

The CFTC issued a final clearing determination under the Dodd-Frank Act and the Commodity Exchange Act (CEA) requiring that four classes of interest rate swaps and two classes of credit default swaps (CDS) be cleared through registered swaps clearinghouses (DCOs) beginning for swaps between certain parties, including swap dealers (SDs) and active funds, on March 11, 2013.

On November 28, 2012, the CFTC issued new rules requiring certain credit default swaps (CDS) and interest rate swaps to be cleared by registered derivatives clearing organizations (DCOs), which are registered swaps clearinghouses. This is the first final clearing determination by the CFTC under Title VII of the Dodd-Frank Act. Under these rules, beginning on March 11, 2013, swaps between certain parties, called Category 1 Entities, including swap dealers (SDs) and so-called "active funds," must submit swaps that are identified in the rules for clearing by a DCO as soon as technologically practicable and no later than the end of the day of execution of the swap. The classes of swaps that must be cleared under these rules are detailed below and are identical to those contained in the proposed determinations.

Category 1 Entities are SDs, major swap participants (MSPs), security-based swap dealers (SBSDs), major security-based swap participants (MSBSPs) and active funds.

Active funds include any private fund, as defined in Section 202(a) of the Investment Advisors Act of 1940, that is not a third-party subaccount and that executes 200 or more swaps per month based on a monthly average over the preceding 12 months. Note that the 200 swap threshold refers to "swaps" as defined in Section 1a(47) of the CEA, and not "swaps transactions." Consequently, assignments, novations, amendments or like events that occur with respect to existing swaps do not count towards the 200 swap threshold.

The clearing determination does not apply to parties that are eligible to elect an exception from clearing, such as non-financial commercial end users hedging commercial risk (see Practice Note, The Commercial End-user Exception to the Dodd-Frank Mandatory Swap Clearing Requirement). Additionally, any swaps entered into before the enactment of the Dodd-Frank Act or before the application of the clearing requirement need not be cleared.

Under the rules, DCOs must post on their websites a list of all swaps that they accept for clearing and to clearly indicate which of those swaps the CFTC has determined must be cleared. This initial clearing determination applies only to swaps currently cleared by four DCOs: CME, ICE Clear Credit, ICE Clear Europe and LCH.Clearnet Ltd. The CFTC is also issuing a rule that prevents evasion of the clearing requirement and related provisions.

The determinations require that swaps in four interest rate swap classes and two CDS classes be cleared under Section 2(h) of the CEA when entered into between two Category 1 Entities. The determinations identify these classes by using basic specifications. Therefore, counterparties contemplating entering into a swap can determine quickly whether or not the particular swap is subject to the clearing requirement.

Swap dealers and private funds active in the swaps market must comply with this determination beginning on March 11, 2013 for swaps they enter into on or after that date.

Mandatory clearing begins on June 10, 2013 for these swaps when entered into between two Category 2 Entities and between a Category 1 Entity and a Category 2 Entity. Category 2 Entities are commodity pools, hedge funds (other than active funds) and persons predominantly engaged in activities that are in the business of banking or in "activities that are financial in nature" excluding accounts managed by third-party investment managers.

Mandatory clearing for swaps involving Category 3 Entities begins on September 9, 2013. Category 3 Entities include accounts managed by third-party investment managers ERISA pension plans and non-financial commercial end users.

With respect to the iTraxx CDS index on European corporate names, if no DCO offers iTraxx for client clearing by February 11, 2013, the CFTC will delay compliance for those swaps until 60 days after an eligible DCO offers iTraxx indices for client clearing. Market participants electing an exception from mandatory clearing under Title VII and section 2(h)(7) of the CEA do not have to comply with the reporting requirements for electing the exception until September 9, 2013.

The table below identifies the six classes of swaps covered by the clearing determination:

Specification	Fixed-to-Floating Swap Class and Basis Swap Class
1. Currency	US Dollar (USD)	Euro (EUR)	Sterling (GBP)	Yen (JPY)
2. Floating Rate Indexes	LIBOR	EURIBOR	LIBOR	LIBOR
3. Stated Termination Date Range	28 days to 50 years	28 days to 50 years	28 days to 50 years	28 days to 30 years
4. Optionality	No	No	No	No
5. Dual Currencies	No	No	No	No
6. Conditional Notional Amounts	No	No	No	No

Specification	Forward Rate Agreement (FRA) Class
1. Currency	US Dollar (USD)	Euro (EUR)	Sterling (GBP)	Yen (JPY)
2. Floating Rate Indexes	LIBOR	EURIBOR	LIBOR	LIBOR
3. Stated Termination Date Range	3 days to 3 years	3 days to 3 years	3 days to 3 years	3 days to 3 years
4. Optionality	No	No	No	No
5. Dual Currencies	No	No	No	No
6. Conditional Notional Amounts	No	No	No	No

Specification	Overnight Index Swap Class
1. Currency	US Dollar (USD)	Euro (EUR)	Sterling (GBP)
2. Floating Rate Indexes	FedFunds	EONIA	SONIA
3. Stated Termination Date Range	7 days to 2 years	7 days to 2 years	7 days to 2 years
4. Optionality	No	No	No
5. Dual Currencies	No	No	No
6. Conditional Notional Amounts	No	No	No

Specification	North American Untranched CDS Indices Class
1. Reference Entities	Corporate
2. Region	North America
3. Indices	CDX.NA.IG CDX.NA.HY
4. Tenor	CDX.NA.IG: 3Y, 5Y, 7Y, 10Y CDX.NA.HY: 5Y
5. Applicable Series	CDX.NA.IG 3Y: Series 15 and all subsequent Series, up to and including the current Series CDX.NA.IG 5Y: Series 11 and all subsequent Series, up to and including the current Series CDX.NA.IG 7Y: Series 8 and all subsequent Series, up to and including the current Series CDX.NA.IG 10Y: Series 8 and all subsequent Series, up to and including the current Series CDX.NA.HY 5Y: Series 11 and all subsequent Series, up to and including the current Series
6. Tranched	No

Specification	European Untranched CDS Indices Class
1. Reference Entities	Corporate
2. Region	Europe
3. Indices	iTraxx Europe iTraxx Europe Crossover iTraxx Europe HiVol
4. Tenor	iTraxx Europe: 5Y, 10Y iTraxx Europe Crossover: 5Y iTraxx Europe HiVol: 5Y
5. Applicable Series	iTraxx Europe 5Y: Series 10 and all subsequent Series, up to and including the current Series iTraxx Europe 10Y: Series 7 and all subsequent Series, up to and including the current Series iTraxx Europe Crossover 5Y: Series 10 and all subsequent Series, up to and including the current Series iTraxx Europe Crossover 5Y: Series 10 and all subsequent Series, up to and including the current Series iTraxx Europe HiVol 5Y: Series 10 and all subsequent Series, up to and including the current Series
6. Tranched	No

Final Clearing Determination for CDS and Interest Rate Swaps Issued by CFTC | Practical Law