Mandatory Clearing Regulation

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Gavel.png FINAL RULE: CFTC Final Rule: Process for Review of Swaps for Mandatory Clearing Approved at CFTC Open Meeting, July 19, 2011
Gavel.png FINAL RULE: Process for Submissions for Review of Security-Based Swaps for Mandatory Clearing, SEC Issued June 28, 2012.
Gavel.png FINAL RULES: Implementation Schedule for Clearing approved July 24, 2012. CFTC Final Determination: Clearing Requirement for Credit Default Swaps and Interest Rate Swaps approved November 28, 2012; entered Federal Register on December 13, 2013. Clearing for Category 1 entities began March 11, 2013; Category 2 June 10, 2013; Category 3, September 9, 2013.
Dodd-Frank Timeline, Process for Review of Swaps for Mandatory Clearing
Final Rule Issue Effective Date Compliance Date
November 2, 2010 September 26, 2011 September 26, 2011
Dodd-Frank Timeline, Process for Review of Swaps for Mandatory Clearing; Technical Amendments, SEC
Final Rule Issue Effective Date Compliance Date
June 28, 2012 August 13, 2012 December 10, 2012
Clearing Requirement Determination for Interest Rate and Credit Default Swaps
Final Determination Effective Date Compliance Dates
December 13, 2012 February 11, 2013 Categories I,II,III phased in - March 11/June 10/Sep. 9, 2013

One of the provisions of the Dodd-Frank Act is an amendment to the Commodity Exchange Act that would prohibit swap transactions unless it were submitted to a Derivatives Clearing Organization (DCO) for clearing, or if the swap met one of the requirements for exemption. In separate meetings, the SEC and CFTC issued final rules regarding the process for review of swaps for mandatory clearing.

According to Title VII of the Act, the creation and enforcement of swaps rules is divided between the SEC and CFTC. The SEC has authority over “security-based swaps,” and the CFTC has primary regulatory authority over all other swaps. The two commissions will share authority over “mixed swaps,” which are security-based swaps that also have a commodity component.

In November 2012, the CFTC set the timeline for mandatory clearing for interest rate and credit default swaps, the two asset classes that comprise approximately 90 percent of the swaps market.[1] Clearing for Category 1 entities began March 11, 2013; Category 2 is set for June 10, 2013, and Category 3 follows on September 9, 2013. For more information, click HERE.

In March 2013, the CFTC issued no-action relief from mandatory clearing for certain swaps that are generated as part of a multilateral portfolio compression exercise. Under the relief, swaps that are amended in order to reduce the notional value, as well as swaps that are newly-created as a result of a compression are not required to be cleared, so long as five conditions are met:

  • No cleared swaps can be part of the multilateral portfolio compression exercise.
  • No swap executed after an applicable compliance date that is subject to required clearing can be part of the multilateral portfolio compression exercise
  • All amended swaps and replacement swaps generated by the multilateral portfolio compression exercise must be entered into between the same counterparties as the original swap that is amended or terminated
  • With the exception of reducing the notional amount, the amended or replacement swaps must have the same material terms as the original swaps.
  • The amended or replacement swaps must be entered into for the sole purpose of reducing operational or counterparty credit risk.[2]


CFTC Final Rule

Process for Review of Swaps for Mandatory Clearing

At its July 19, 2011 open meeting, the Commodity Futures Trading Commission (CFTC) approved final rules regarding the process for review of swaps for mandatory clearing.[3]

As of the compliance date, September 26, 2011, derivatives clearing organizations (DCO)s must begin submitting to the Commission any swap, or group, category, type, or class of swaps that they plan to accept for clearing.

Under the final rules, a Derivatives Clearing Organization (DCO) seeking to clear a swap transaction must file a written request to the commission and submit proof of its ability to comply with DCO core principles, has sufficient financial reserves, and is capable of managing the risks associated with the swap. The DCO would also be required to provide "specific information relating to product specifications; participant eligibility standards; pricing sources, models, and procedures; risk management procedures; measures of market liquidity and trading activity; the effect of a clearing requirement on the market for the swap; applicable rules, manuals, policies, or procedures;terms and trading conventions on which the swap is currently traded; and a description of the manner in which the DCO has provided notice of the submission to its members and a summary of any opposition to the submission expressed by members."

The CFTC will now take five factors into consideration when reviewing a DCO's written request:

  • "The existence of significant outstanding notional exposures, trading liquidity, and adequate pricing data;
  • The availability of rule framework, capacity, operational expertise and resources, and credit support infrastructure to clear the contract on terms that are consistent with the material terms and trading conventions on which the contract is then traded;
  • The effect on the mitigation of systemic risk, taking into account the size of the market for such contract and the resources of the DCO available to clear the contract;
  • The effect on competition, including appropriate fees and charges applied to clearing; and
  • The existence of reasonable legal certainty in the event of the insolvency of the relevant DCO or one or more of its clearing members with regard to the treatment of customer and swap counterparty positions, funds, and property."

The final rules also set procedures for Commission-initiated reviews of swaps and stays of clearing.

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On October 26, 2010, the CFTC introduced the proposal for these final rules at an open meeting.[4] Proposed rules were added to the Federal Register on November 2, 2010.

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SEC Final Rule

Process for Submissions for Review of Security-Based Swaps for Mandatory Clearing and Notice Filing Requirements for Clearing Agencies
On June 28, 2012, the Securities and Exchange Commission issued a final rulemaking that establishes procedures for its review of certain clearing agency actions. The rules create a framework for determining which security-based swaps will be subject to the mandatory clearing requirement under Title VII of the Dodd-Frank Act, which mandated that swaps and security-based swaps "eligible for clearing" be cleared through a DCO.

Additionally, the final rule includes requirements that clearing agencies designated as "systemically important" submit changes in rules,operations, or procedures that could materially alter the nature or level of risk. [5]

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At its December 15, 2010 open meeting, the SEC approved a rule proposal regarding the submission to a clearing agency of a security-based swap for clearing.

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References

  1. OTC Derivatives Market Analysis, Year-end 2011. ISDA. Retrieved on April 9, 2013.
  2. CFTC’s Division of Clearing and Risk Issues Limited No-Action Relief from Required Clearing for Swaps Resulting from Multilateral Compression Exercises. CFTC. Retrieved on April 9, 2013.
  3. http://www.cftc.gov/PressRoom/Events/opaevent_cftcdoddfrank071911.html. CFTC. Retrieved on July 19, 2011.
  4. Open Meeting on Third Series of Proposed Rules under the Dodd-Frank Act. CFTC. Retrieved on March 3, 2011.
  5. SEC Adopts New Procedures for Reviewing Clearing Submissions Under Dodd-Frank Act. SEC. Retrieved on June 29, 2012.

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