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SEC Proposes End-User Requirements Under Dodd-Frank Act for Security-Based Swaps Exempt From Mandatory Clearing

By | December 15, 2010

The SEC has proposed requirements of end-users when they engage in a security-based swap transaction that is not subject to mandatory clearing. The proposed rule, required under the Dodd-Frank Act, specifies the steps that end-users must follow to notify the SEC of how they generally meet their financial obligations when engaging in a security-based swap transaction exempt from the mandatory clearing requirement.

 The Dodd-Frank Act creates an “end-user clearing exception” that exempts clearing for a security-based swap transaction if one party to the transaction:

  • Is not a financial entity.
  • Is using the swap to hedge or mitigate commercial risk.
  • Notifies the SEC (in a manner set forth by the SEC) how it generally meets its financial obligations associated with entering into non-cleared security-based swaps (the “end-user clearing exception”).

 Title VII of the Dodd-Frank Act requires that a counterparty electing to use the end-user clearing exception must notify the SEC of how it generally meets its financial obligations associated with non-cleared security-based swaps.

The proposed rule would require that a counterparty relying on the end-user clearing exception submit information to the SEC regarding how it generally expects to meets its financial obligations associated with a security-based swap by using one of the following:

  • A written credit support agreement.
  • A written agreement to pledge or segregate assets.
  • A written third-party guarantee.
  • Solely the counterparty’s available financial resources.
  • Means other than those described above.

 The proposed rule also requires counterparties relying on the end-user clearing exception to submit additional information to the SEC intended to aid the SEC in its efforts to prevent abuse of the end-user clearing exception. The information required includes:

  • The identity of the counterparty relying on the clearing exception;
  • Whether the counterparty invoking the clearing exception is a “financial entity” as defined in the Dodd-Frank Act;
  • Whether the counterparty invoking the clearing exception is a finance affiliate meeting certain requirements described in the Dodd-Frank Act;
  • Whether the security-based swap is used by the counterparty invoking the clearing exception to hedge or mitigate commercial risk as defined in the Exchange Act and through rules separately proposed by the SEC; and
  • Whether the counterparty electing to use the clearing exception is an issuer of securities registered under Section 12 of the Exchange Act or subject to reporting requirements pursuant to Section 15(d) of the Exchange Act. SEC filers are also required to provide  additional information.

The information reported to the SEC under this proposed rule would be delivered to a security-based swap data repository together with other information that will be required to be submitted to a security-based swap data repository concerning all non-cleared security-based swaps.  The rules detailing how data will be reported to a security-based swap data repository are the subject of a separate SEC proposal published last month.

 The SEC is required under the Dodd-Frank Act to consider whether to allow small banks, savings associations, farm credit system institutions and credit unions with total assets under $10 billion to use the end-user clearing exception on the same terms as end-users. The SEC is considering a proposed rule that would implement such a proposal.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

Contact Steve Quinlivan for more information.