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Legislative History Clarifies Dodd-Frank Derivatives End User Exemption

By Jim Hamilton

The Dodd-Frank Act derivatives end user exemption gives commetcial end users the option, but not the obligation, to clear or not clear their swaps and security-based swaps that have been determined to be required to clear, as long as those swaps are being used to hedge or mitigate commercial risk. Senator Blanche Lincoln has noted that this option is solely the end users? right. If the end user opts to clear a swap, the end user also has the right to choose the clearing house where the swap will be cleared. Further, the end user has the right, but not the obligation, to force clearing of any swap or security-based swap which is listed for clearing by a clearing house or clearing agency but which is not subject to mandatory clearing requirement. Again the end user has the right to choose the clearing house or clearing agency where the swap or security-based swap will be cleared. The option to clear is meant to empower end users and address the disparity in market power between the end users and the swap dealers. (Cong. Record, July 15, 2010, S5921).

Under the Act, specified financial entities are prohibited from using the end user exemption. While most large financial entities are not eligible to use the end user exemption for standardized swaps entered into with third parties, it would be appropriate for the SEC and CFTC to exempt from mandatory clearing and trading inter-affiliate swap transactions between wholly-owned affiliates of a financial entity. Congress also believes that small financial entities, such as banks, credit unions and farm credit institutions below $10 billion in assets, and possibly larger entities, will be permitted to utilize the end user clearing exemption with approval from the SEC and CFTC. The Act also includes an anti-evasion provision which provides the CFTC and SEC with authority to review and take action against entities which abuse the end user exemption. (Cong. Record, July 15, 2010, S5921).

A colloquy between Senator Susan Collin and Senator Chris Dodd revealed that it is the intent of Congress that an end user does not become a swap dealer by virtue of using an affiliate to hedge its own commercial risk. Thus, end users that execute swaps through an affiliate should not be deemed to be swap dealers under Dodd-Frank just because they hedge their risks through affiliates. (Cong. Record, July 15, 2010, p. S5907).

Full post as published by Jim Hamilton's World of Securities Regulation on August 17, 2010 (boomark / email).