CFTC Staff Letter 14-136: Extension of No-Action Relief from Trade Execution Requirement for Inter-Affiliate Swaps

U.S. COMMODITY FUTURES TRADING COMMISSION
Three Lafayette Centre
1155 21st Street, NW, Washington, DC 20581
Telephone: (202) 418-5000
Facsimile: (202) 418-5521 www.cftc.gov
Division of
Market Oversight
CFTC Letter 14-136
November 7, 2014
No-Action
Division of Market Oversight
Re: Extension of Time-Limited No-Action Relief from Commodity Exchange Act Section 2(h)(8) for Swaps Executed Between Certain Affiliated Entities that Are Not Exempt from Clearing Under Commission Regulation 50.52 Dear Mr. O’Connor:
This letter responds to a request received from the International Swaps and Derivatives Association, Inc. (“ISDA”) that the Commodity Futures Trading Commission (the “Commission” or “CFTC”) extend the relief provided in CFTC Letter No. 14-26. That letter provides no-action relief from the trade execution requirement of Commodity Exchange Act (“CEA”) section 2(h)(8) to eligible affiliate counterparties, as defined in § 50.52(a) of the Commission’s regulations. 1 The no-action relief will expire on 11:59 p.m. (Eastern Time) December 31, 2014. Background Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) 2 amended the CEA to establish a comprehensive new regulatory framework for swaps. Among other things, CEA section 2(h)(8) requires that transactions involving swaps subject to the CEA section 2(h)(1) clearing requirement be executed on or pursuant to the rules of a designated contract market (“DCM”) or swap execution facility (“SEF”), unless no DCM or SEF makes such swaps available to trade or such swaps qualify for the clearing exception under CEA
section 2(h)(7) (the “trade execution requirement”).
Swaps subject to the trade execution requirement must be executed in accordance with the execution methods described in § 37.9(a)(2) of the Commission’s regulations.

ISDA also requested that the Commission establish a permanent exemption from the trade execution requirement for inter-affiliate swaps. The Division has not made a determination at this time whether such relief should be provided. Pub. L. 111-203, 124 Stat. 1376 (2010). 7 U.S.C. § 2(h)(8).

Section 50.52 of the Commission’s regulations provides that a swap between affiliates is exempt
from the clearing requirement if (1) the counterparties are eligible affiliate counterparties as set forth in § 50.52(a) of the Commission’s regulations, and (2) the conditions set forth in § 50.52(b) of the Commission’s regulations are satisfied (the “inter-affiliate exemption”). In addition, the counterparties must satisfy reporting requirements set forth in §§ 50.52(c) and (d) of the Commission’s regulations. In the preamble to the rules setting forth a process for a DCM or SEF to make a swap available to trade, the Commission stated that inter-affiliate swaps that are exempt from clearing under § 50.52 of the Commission’s regulations are not subject to the trade execution requirement.

However, swaps involving eligible affiliate counterparties that do not satisfy § 50.52(b) of the Commission regulations are subject to the trade execution requirement. In its February 19, 2014 request for relief, ISDA asserted that applying the trade execution requirement to inter-affiliate swap transactions between eligible affiliate counterparties that do not satisfy § 50.52(b) of the Commission regulations would introduce unnecessary costs and inefficiencies without any benefits. ISDA noted that inter-affiliate transactions are intended to manage risk between affiliates and are not arms-length transactions. As a result, requiring that such transactions be executed on a SEF or DCM would not promote the pre-trade price transparency and price discovery goals associated with the trade execution requirement because affiliate counterparties are not primarily concerned with obtaining fully competitive pricing. Further, execution of such swaps through an order book or request for quote would not assure that the affiliates would be matched with one another as intended and thus preclude the intended inter-affiliate risk transfers. The Division granted ISDA’s request, acknowledging the adverse impact the trading execution requirement could have on the ability of companies to manage risk. In granting this relief, the Division was also mindful of the mandate under the Dodd-Frank Act and the intent of the Commission’s implementing regulations to promote pre-trade price transparency in the swaps

Section 50.52(a) of the Commission’s regulations defines eligible affiliate counterparties to
be related entities, in which (1) one counterparty, directly or indirectly, holds a majority ownership interest in the other counterparty, and the counterparty that holds such majority interest reports its financial statements on a consolidated basis under Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), and the statements include the financial results of the majority-owned counterparty; or (2) a third party, directly or indirectly, holds a majority ownership interest in both counterparties, and the third party reports its financial statements on a consolidated basis under GAAP and IFRS, and the statements include the financial results of both counterparties. 17 C.F.R. § 50.52(a)(1)(i)-(ii). A counterparty or third party directly or indirectly holds a “majority ownership interest” if it directly or indirectly holds a majority of the equity securities of an entity, or the right to receive upon dissolution, or the contribution of, a majority of the capital of a partnership.” 17 C.F.R. § 50.52(a)(2)(i). See 78 Fed. Reg. 33606 n.1.

market. The Division stated that it would assess whether applying the trade execution requirement to inter-affiliate swap transactions would promote pre-trade price transparency in the swaps market during the period of relief. Request for Extension of No Action Relief On October 2, 2014, ISDA requested that the Commission exercise its authority pursuant to CEA
section 4(c) to establish a permanent exemption for inter-affiliate swaps from the trade execution
requirement under CEA section 2(h)(8). In addition, ISDA requested that the Commission extend CFTC No Action Letter No. 14-26 to allow time for Commission action and to forestall market uncertainty. Extension of Time-Limited No-Action Relief for Eligible Affiliate Counterparties from the Trade Execution Requirement The Division has determined to extend the no-action relief granted by CFTC No Action Letter No. 14-26 until 11:59 p.m. (Eastern Time) December 31, 2015. The rationale for the relief remains unchanged. The Division recognizes the impact that the trade execution requirement would have on the ability of companies to manage risk. In addition, the Division is continuing its assessment as to whether applying the trade execution requirement to inter-affiliate swap transactions would promote pre-trade price transparency in the swap market. The Division will grant the above time-limited no-action relief and will not recommend that the Commission take enforcement action against any eligible affiliate counterparty that executes a swap transaction with another eligible affiliate counterparty without complying with CEA section 2(h)(8). Market participants should be aware that the no-action positions taken herein do not excuse affected persons from compliance with any other applicable requirements of the CEA or the Commission’s regulations thereunder, in particular, the applicable swap reporting requirements and clearing requirements, including the requirements and conditions for eligible affiliate counterparties not to clear a swap pursuant to § 50.52 of the Commission’s regulations or the requirements to clear a swap pursuant to §50.2 and §50.4 of the Commission’s regulations. This letter, and the no-action positions taken herein, represent the views of the Division only, and do not necessarily represent the positions or views of the Commission or of any other division or office of the Commission’s staff. As with all no-action letters, the Division retains the authority to condition further, modify, suspend, terminate or otherwise restrict the terms of the no-action relief provided herein, in its discretion.

The applicable swap reporting requirements are set forth under parts 43, 45, and 50 of the Commission’s regulations. The applicable clearing requirements are set forth under CEA
section 2(h)(1) and part 50 of the Commission’s regulations. Eligible affiliate counterparties
that wish to avail themselves of the inter-affiliate clearing exemption must fulfill additional conditions and requirements set forth in § 50.52(b)-(d) of the Commission’s regulations.

If you have any questions concerning this correspondence, please contact Nancy Markowitz, Deputy Director, Division of Market Oversight, at (202) 418-5453 or nmarkowitz@cftc.gov, or Jonathan Lave, Associate Director, Division of Market Oversight, at (202) 418-5983 or jlave@cftc.gov. Sincerely, Vincent A. McGonagle Director Division of Market Oversight