CFTC Split Over Inter-Affiliate Clearing Exemptions

Regulators support proposal in principle, but divided over variation margin payments.

The US Commodity Trading Futures Commission (CFTC) has proposed clearing exemptions for inter-affiliate trading of swaps under Title VII of the Dodd-Frank Act, but has sought public consultation to amend an internal split.

Under the proposal, the trading of swap contracts inter-affiliate, that is, within the same corporate group, would be exempt from the clearing requirements due to come into force with the establishment of Swap Execution Facilities (SEFs) this year. However, the proposal states that the trades must be documented and reported as normal, with variation margin payments included.

CFTC chairman Gary Gensler supported the move, saying that the rules fell in line with what European regulators were proposing under the European Market Infrastructure Regulation (EMIR).

"One of the primary benefits of swaps market reform is that standard swaps between financial firms will move into central clearing, which will significantly lower the risks of the highly interconnected financial system," he said in a statement. "Transactions between affiliates, however, are of a different nature than transactions between nonaffiliated parties. Though transactions between affiliates pose risk, much of the risk relates to their affiliates rather than external parties."

Dissent
However, commissioners Jill Sommers and Scott O'Malia opposed aspects of the proposed rules, saying that the payment of variation margins inter-affiliate placed unnecessary financial and administrative burdens on firms.

"We believe it is entirely appropriate that the Commission exempt inter-affiliate swaps from the clearing mandate," they said. "Unfortunately, this proposal inserts a requirement that most financial entities engaging in inter-affiliate swaps post variation margin to one another. It is not clear that this requirement will do anything other than create administrative burdens and operational risk while unnecessarily tying up capital that could otherwise be used for investment."

Variation margins are typically intra-day payments made by clearing members to the house, in order to provide a capital cushion against significant devaluations of risky positions. The commissioners also disagreed with Gensler's assertion of compatibility with European regulation.

"The variation margin requirement is also largely inconsistent with the requirements included in EMIR. As we have both made clear during the implementation process, we believe coordination with our global counterparts is critical to the success of this new framework."

Although the proposal was passed by a seratim vote of three to two, it will be open for comment from 30 days after publication in the Federal Register. Ongoing reforms of the swaps market will institute centralized clearing of standard derivatives contracts as defined by the CFTC, and their trading on electronic platforms known as SEFs in the interests of reducing systemic risk.