CFTC Proposes Clearing Determination for Certain Credit Default Swaps and Interest Rate Swaps

The Commodity Futures Trading Commission has proposed new rules to require certain credit default swaps (CDS) and interest rate swaps to be cleared by registered derivatives clearing organizations (DCOs).

The proposed rule is the first clearing determination by the Commission under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under the proposed rules, market participants would be required to submit a swap that is identified in the rule for clearing by a DCO as soon as technologically practicable and no later than the end of the day of execution. The proposed rule will be open for public comment after the rule has been published in the Federal Register, and the comment period will be open for 30 days.

The Dodd-Frank Act amends the Commodity Exchange Act (CEA) to prevent market participants from engaging in a swap that is required to be cleared unless that person submits the swap for clearing to a DCO. The Dodd-Frank Act also requires the Commission to determine whether a swap is required to be cleared by either a Commission-initiated review or a submission from a DCO for the review of a swap, or group, category, type, or class of swap. The proposed rule does not apply to those who are eligible to elect an exception from clearing, such as non-financial entities hedging commercial risk.

The proposed rules codify statutory provisions that make clear that any swaps entered into prior to the enactment of the Dodd-Frank Act or prior to the application of the clearing requirement are not required to be cleared. The Commission also is proposing regulations to prevent evasion of the clearing requirement and related provisions. The proposed rules aim to prevent evasion of the clearing requirement and prevent abuse of any exemption or exception to the clearing requirement under Dodd-Frank Act.

Finally, a DCO would be required to post on its website a list of all swaps that it will accept for clearing and clearly indicate which of those swaps the Commission has determined are required to be cleared.

Additional Information Regarding the Clearing Determination:

DCO Submissions under Section 2(h) and Regulation 39.5 Clearing Requirement

The Commission is proceeding with a clearing requirement proposal based on submissions from DCOs. Pursuant to § 39.5, the Commission received submissions from eight DCOs covering all the swaps that DCOs were offering for clearing as of February 1, 2012. The proposal addresses all CDS and interest rate swaps currently being cleared by DCOs. The Commission intends subsequently to consider other swaps submitted by DCOs, such as agricultural, energy, and equity indices. The decision to focus on CDS and interest rate swaps in the initial clearing requirement determination is a function of both the market importance of these swaps and the fact that a significant percentage of CDS and interest rate swaps already are being cleared. In addition, market participants recommended that the Commission take this approach.

Proposal for Classes of Swaps Required to be Cleared

The proposed determination would require that swaps in four interest rate swap classes and two CDS classes be required to be cleared under section 2(h) of the CEA. By using basic specifications to identify the swaps subject to the clearing requirement, counterparties contemplating entering into a swap would be able to determine quickly whether or not the particular swap may be subject to a clearing requirement. If the swap has the basic specifications of a class of swaps determined to be subject to a clearing requirement, the parties would know that they need to verify whether a DCO will clear that particular swap.

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