Ever since testifying before the Senate Agriculture Committee on the plight of the end-user, I couldn’t rest easy until the regulators shed some light on how they were going to actually write the rules. Last week, the CFTC held a public hearing, and the staff shed light on the proposed draft rules that would define any clearing exemptions.
As a reminder: In order to obtain an exemption from clearing a swap, the counterparty cannot be a Swap Dealer, MSP or Financial Entity; the swap must be used to hedge or mitigate commercial risk; and the counterparty must be able to demonstrate that it can meet its financial obligations. The CFTC should be commended for not trying to narrow the definition of commercial hedge as it has proposed an expansive definition. Mirroring the approach for defining position limits set for the Major Swap Participant definition, the proposed definition says that the hedge should qualify as a hedge mitigating commercial risk as long as the hedge either meets the criteria for an effective hedge under ASC 815 (it’s still FAS 133 to me!), meets the definition of a bona fide hedge under the Commodities Exchange Act, or generally reduces risks in conduct and management of a commercial enterprise.
The big fear of just relying on FAS 133 was for all of the end-users who would not get the clearing exemption because either they could not be bothered to comply with FAS 133 or because their hedging programs did not work well under FAS 133, like many commodity hedges. The CFTC’s approach does allow the flexibility to leverage FAS 133 documentation where a company can and use other approaches where a company cannot. It does not prescribe how the end-user is supposed to document using the other choices, so companies should start thinking about how to document and record the linkage between the hedge and the exposure, of course a main principle under FAS 133.
The CFTC also recognized the importance of relieving the burden of excessive reporting on the end-user and is allowing a “check-the-box” approach to show that the end-user can meet its financial obligations. The end user simply has to check if it has CSA, pledge or guarantee in place, or if it is going to use its own means, along with a few other pieces of information associated with the swap. It is presumed that the Swap Dealer will gather this information from the end-user and report it on its behalf to the Swap Data Repository (SDR) and to the Commission to demonstrate that the trade is exempt from clearing, but the end-user will have to provide the information.
Unfortunately, small banks are still not resting easy as the CFTC decided to ask for public comments on what other types of end-users should be allowed to be exempted from clearing and still meet the intent of the Dodd-Frank bill. It is unclear if this means some banks over $10bn in assets have a chance but interesting to see the delay in this part of the rule, so stay tuned to http://www.cftc.gov.