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Congress Codifies End Users Exemption from Mandatory Margin Requirements for Swaps

January 12, 2015

Co-Authors: Mike Gill and Jenny E. Cieplak.

As a part of the Terrorism Risk Insurance Act (TRIA) that passed the U.S. House of Representatives and the U.S. Senate (H.R. 26) on January 7th and 8th respectively, Congress included a section that would codify a recent proposal from the Commodity Futures Trading Commission (CFTC) on swap margin requirements as they relate to transactions with end users. Specifically, Section 302 of the Act amends Section 4s(e) of the Commodity Exchange Act to exempt the following transactions from the requirement to post and collect initial and variation margin:
  • Swaps for which a counterparty is not a financial entity, and that qualify for the end-user exception from mandatory clearing;
  • Swaps for which a counterparty is a financial entity that is acting on behalf of, and as agent for, a non-financial entity that qualify for the end-user exception from mandatory clearing; and
  • Swaps for which a counterparty is a cooperative entity that qualify for an exemption from mandatory clearing.
Swaps are agreements between two parties to exchange cash flows in the future based on an underlying price or instrument. They are used by banks, corporations, farmers, utilities and pension funds to hedge risk or speculate on price fluctuations related to interest rates, commodity prices and other asset values. Under the Wall Street Reform and Consumer Protection Act, each SD and MSP for which there is a prudential regulator must comply with margin rules established by that prudential regulator. All other swap dealers and major swap participants must comply with margin rules established by the CFTC.

In September, 2014, the prudential regulators and the CFTC proposed rules to implement margin requirements, but such rules have yet to be adopted. Each set of proposed rules would establish initial and variation margin requirements for Swap Dealers (“SD”) and Major Swap Participants (MSP) but would not require SDs and MSPs to collect margin from counterparties that are “non-financial end users” as defined in the proposed rules. Section 302 of the legislation codifies this exemption, preventing regulators from rescinding this exemption in later rulemaking. However, market participants should note the differences between the types of entities that qualify for clearing exemptions (as used in the legislation) and the definition of “non-financial end user” as used in the proposed rules.

The proposed rules still require SDs and MSPs to perform a credit analysis to determine if the collection of initial and variation margin is warranted. Under certain circumstances, SDs and MSPs may require initial and variation margin from end-users due to overall counterparty credit risk or other unique characteristics of a particular transaction, but there would be no regulatory mandate to do so.

The legislation, which passed with veto-proof majorities, now moves to the President’s desk and it is expected to be signed and enacted into law the week of January 12th 2015.
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Jenny E. Cieplak
Counsel – Washington, D.C.
Phone: +1 202.624.2542