Co-authored by Blake J. Brockway

On June 10, the CFTC issued a final rule implementing an exception to the mandatory clearing requirement for non-financial entities and small financial institutions that use swaps to hedge or mitigate commercial risk set out in Section 2(h)(1) of the Commodity Exchange Act (CEA). CEA Section 2(h)(1) makes it unlawful for any person to enter into a swap that is required to be cleared unless that person submits the swap to a derivatives clearing organization for clearing. CEA Section 2(h)(7) provides that the clearing requirement shall not apply if one of the swap counterparties: (1) is not a financial entity; (2) is using swaps to hedge or mitigate commercial risk; and (3) notifies the CFTC how it generally meets the financial obligations associated with non-financial swaps.

Under the final rule, the reporting counterparty must fulfill the notification requirement by reporting the election of the end-user exception and the identity of the electing counterparty to a swap data repository. Each electing counterparty must provide the following additional information on a swap-by-swap basis or through an annual filing: (1) whether the electing counterparty is a financial entity electing the exception on behalf of an affiliate or as a small financial institution; (2) whether the swap for which the exception is being elected is used to hedge or mitigate commercial risk; (3) information regarding how the electing counterparty generally meets its financial obligations associated with entering into non-cleared swaps; and (4) if the electing counterparty is an “SEC Filer,” whether its board of directors has approved generally the decision to enter into swaps that are exempt from the clearing and trading requirements.

For purposes of the end-user exemption, small financial institutions are exempt from the definition of financial entity. Financial entity is defined as a swap dealer, security-based swap dealer, major swap participant, major security-based swap participant, commodity pool, private fund, employee benefit plan, or banking entity. The small financial institutions exemption applies to banks, savings associations, farm credit system institutions, and credit unions with less than $10 billion of total assets.

The CFTC also proposed a rule that would exempt certain swaps executed by cooperatives from the swap clearing requirement. Under the proposed rule, a cooperative could elect this exemption if all of its members are non-financial entities, financial entities that are eligible for the small financial institutions exemption, or cooperatives whose members fall into the two prior categories. The cooperative exemption would only apply to swaps entered into with a member of the exempt cooperative in connection with originating loans for members or swaps entered into by a cooperative that hedge or mitigate risks associated with member loans or loan-related swaps.

To view the final rule related to the end-user exception, click here.

To view the proposed rule related to the cooperative exemption, click here.