Central Clearing and Securitization SPEs

A fundamental component of the Dodd-Frank Act is to require central clearing of standard swaps in order to decrease systemic risk. Pursuant to Section 2(h) of the Commodity Exchange Act, the Commodity Futures Trading Commission (“CFTC”) may determine that a group, category, type, or class of swap must be centrally cleared by a derivatives clearing organization (“DCO”). The CFTC may then exercise its discretion in applying a compliance schedule in connection with a particular clearing requirement determination. To date, the CFTC has issued such a determination only with respect to certain classes of interest rate swaps and credit default swaps.[1] Pursuant to the relevant compliance schedule for this determination, subject swaps that are entered into between “financial entities” and swap dealers generally are required to be cleared beginning June 10, 2013.

Special purpose entity (“SPE”) issuers in securitizations often enter into interest rate swaps in connection with the securitizations. Most of these SPEs qualify as “financial entities,” which is generally defined to include, among others, commodity pools, “private funds,” as defined in section 202(a) of the Investment Advisers Act of 1940, and persons predominantly engaged in activities that are in the business of banking, or in activities that are financial in nature, as defined in section 4(k) of the Bank Holding Company Act of 1956. Industry group members and market participants have repeatedly requested an exemption or, at least, explicit interpretive guidance from the CFTC in connection with the applicability of the existing clearing mandate to securitization SPEs. So far, no such exemption or guidance has been provided.

As a practical matter, the two clearinghouses able to accept interest rate swaps for clearing in the United States are currently not able to accept swaps having “limited recourse” language and “non-petition” covenants, which are typical characteristics of securitization swaps required by rating agencies to make the SPEs bankruptcy-remote. However, if in the future this is no longer the case, the securitization market may need to renew its efforts for clarity on mandatory clearing, and may need to seek a stay of the clearing requirement pursuant to CFTC Regulation 39.5.


[1] Clearing Requirement Determination Under Section 2(h) of the CEA, 77 Fed. Reg. 74,284 (Dec. 13, 2012).

March 2013 Dodd-Frank Protocol – Protocol 2.0

The second and latest International Swaps and Derivatives Association, Inc. (“ISDA”) Dodd-Frank Protocol (“DF Protocol 2.0”) opened for adherence on March 22, 2013. DF Protocol 2.0 is intended to address the following requirements related to certain business conduct standards under the Dodd-Frank Act:

  • End-User Exception Documentation. If applicable, a swap dealer (“SD”) or major swap participant (“MSP”) must obtain documentation sufficient to form a reasonable belief that its counterparty meets the conditions required for election of the end-user exception.[1]
  • Documentation of Swap Trading Relationships. SDs and MSPs must establish, maintain, and follow written policies and procedures reasonably designed to ensure (1) that they execute a confirmation for each swap transaction that they enter into and (2) that swap trading relationship documentation meets certain specified criteria with all counterparties. Additionally, SDs and MSPs must acknowledge and document swap transactions within certain specific time periods.[2]
  • Portfolio Reconciliation. SDs and MSPs must establish, maintain, and follow written policies and procedures regarding portfolio reconciliation and the resolution of portfolio value discrepancies.[3]

These requirements were finalized by the CFTC after the August 2012 Dodd-Frank Protocol and, therefore, were not addressed by that Protocol. DF Protocol 2.0, although completely separate from the original Protocol, has the same structure and adherence process. That is, as with the earlier Protocol, adherence involves the submission of an adherence letter (which may be submitted through the online system “ISDA Amend” via the Markit portal), a protocol agreement, a protocol supplement, and the completion of a questionnaire. The relevant CFTC rules will become applicable to SDs and MSPs on July 1, 2013, after which customers may find that dealers are unwilling to enter into swaps with them unless they have adhered.

There are four Schedules to DF Protocol 2.0. A party adhering to the Protocol Agreement would automatically agree to incorporate Schedule 1 (defined terms) and Schedule 2 (general agreements regarding the creation of transaction confirmations, mandatory clearing, and the end-user exception to clearing). Schedules 3 and 4 are applicable unless the adhering party opts out of them. Schedule 3 generally contains provisions regarding daily valuation of swaps and dispute resolution mechanics (to the extent the parties do not otherwise address these issues in a written agreement, such as an ISDA Credit Support Annex), and Schedule 4 generally contains portfolio reconciliation procedures.


[1] 17 C.F.R. § 23.505.

[2] 17 C.F.R. §§ 23.501, 23.504.

[3] 17 C.F.R. § 23.502.

Financial Transaction Tax Developments

In recent years, the governments of Europe have repeatedly considered and debated the application of a financial transaction tax (“FTT”) on bond, equity and derivatives transactions for purposes of generating revenue and discouraging excessive risk-taking.[1]  Most recently, the European Commission (“EC”) published an FTT directive on February 14, 2013.[2] This directive follows the FTT directive initially published by the EC on September 28, 2011, which failed to attract the necessary unanimous support of the twenty-seven European Union (“EU”) member-states. Eleven EU member-states subsequently applied, through an “enhanced cooperation procedure” approved by the European Parliament on December 12, 2012, to impose an FTT themselves, which resulted in the revised directive.[3]

The revised directive is to become effective on January 1, 2014. However, the participating member-states themselves continue to debate fundamental points regarding its scope and substance. Moreover, the United Kingdom has filed a lawsuit challenging the enhanced cooperation procedure used by the participating member-states, arguing that, under the Treaty on the Functioning of the European Union, use of this procedure requires, among other things, that the cooperation not distort competition with non-participating member-states.

If implemented as currently proposed, the FTT would apply, generally, to each financial transaction (whether traded on exchange or over-the-counter) in which at least one party is a financial institution and either (i) at least one party is “established”[4] in a participating member-state or (ii) the financial transaction is in respect of a financial instrument issued by an entity established in a participating member-state. The revised directive proposes that participating member-states set tax rates of at least 0.1% of the consideration paid or owed in a financial transaction other than a derivative transaction, and at least 0.01% of the notional amount of a derivative transaction; individual participating member-states would be able to apply higher rates if they elected to do so. The FTT would be payable by each financial institution involved in a relevant transaction and would be payable to the participating member-state in which the financial institution is deemed to be established; the same transaction would be taxed twice if between two financial institutions.

For purposes of the revised directive, the term “financial institution” generally includes banks, investment firms, regulated markets, insurers and reinsurers, undertakings for collective investment in transferable securities, alternative investment funds, pension funds, and securitization special purpose entities. However, transactions with the European Central Bank, the central banks of EU member-states, the European Financial Stability Facility and the European Stability Mechanism are excluded from the scope of the directive.

The term “financial transaction” includes the purchase and sale of a “financial instrument”[5] before netting or settlement; the conclusion of a derivative contract before netting or settlement; repurchase agreements, reverse repurchase agreements, securities lending and borrowing agreements; certain intra-group transactions transferring risk associated with a financial instrument but not constituting a purchase or sale; the exchange of a financial instrument; and material modifications of any of the foregoing. Certain transactions, however, are excluded, including credit and loan transactions, primary market transactions, spot foreign exchange transactions, physical commodity transactions, and the underwriting of shares, mortgages, and consumer credit.

In light of the ongoing and active debate surrounding the revised directive and the legal challenge against it, the FTT ultimately may become effective, if at all, in a form substantially different from that currently contemplated, and perhaps well after the proposed January 1, 2014 effective date.[6]

In the United States, bills were introduced in both the House and the Senate on February 28, 2013 that would impose a tax of 0.03 percent on certain financial transactions.[7] Both bills remain in committee and face opposition. Moreover, concern exists in the United States over the possible extraterritorial reach of a European FTT. In response to a question from the House Ways and Means Committee in April, Treasury Secretary Jack Lew expressed his concern over the application of such a tax on transactions in the United States, stating: “I think the design element you’re describing is a very troubling one.”


[1] FTT initiatives and developments have been addressed previously in Derivatives in Review. See Europe Proposes Financial Transaction Tax” posted on October 11, 2011; “Financial Transaction Tax” posted on February 15, 2012.

[2] European Commission, Proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax, 2013/0045 (CNS), Brussels, 14.2.2013.

[3] These eleven member-states are: Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovenia, Slovakia and Spain. These states account for the vast majority of the Eurozone’s gross domestic product.

[4] “Establishment” is broadly defined to include having a registered seat, a branch, authorization, or a permanent address in a member-state or certain other types of connections with a member-state.

[5] “Financial instruments” generally include transferable securities such as shares and bonds, money-market instruments like commercial paper, units or shares in alternative investment funds, structured securitization products, and financial derivatives.

[6] Austrian coalition parties recently argued that the FTT should be adopted to avoid impending budget shortfalls. The revenue that the FTT would generate has been estimated between €30 billion and €35 billion.

[7] Wall Street Trading and Speculators Tax Act, H.R. 880, 113th Congress (2013); Wall Street Trading and Speculators Tax Act, S. 410, 113th Congress (2013).

The New CFTC Regulatory Regime for Private Fund Managers; First Quarter 2013 Update

The enactment of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and its implementation by the Commodity Futures Trading Commission (“CFTC”) has ushered in a new era of regulation of managers of “private funds.” This White Paper provides a survey of some of the most significant aspects of the new swaps regulatory regime mandated by the Dodd-Frank Act that directly impact private fund managers. Specifically, this White Paper focuses on the regulatory actions of the CFTC, many of which have been taken in close coordination with the SEC.  Click here to read more

Bloomberg Case Against CFTC Dismissed

On June 7, 2013, a federal district court dismissed a lawsuit[1] brought by Bloomberg L.P. (“Bloomberg”) against the Commodity Futures Trading Commission (“CFTC”) challenging the recent adoption of CFTC Rule 39.13(g)(2)(ii) (the “Rule”), which establishes minimum initial margin requirements to be assessed by derivatives clearing organizations (“DCOs”) on customers. The court ruled that Bloomberg lacked standing because it had failed to demonstrate an actual or imminent injury-in-fact caused by the Rule that the court could redress.[2] The court also stated that Bloomberg, apart from its lack of standing, could not satisfy the “high standard for irreparable injury” required for a preliminary injunction.

In its complaint, filed on April 16, 2013, Bloomberg claimed that the adoption of the Rule violated the Commodity Exchange Act and the Administrative Procedure Act because of the insufficient evaluation of its costs and benefits, failure to provide interested persons sufficient opportunity to participate in the rulemaking, and arbitrary and capricious agency action.

Bloomberg operates an electronic service that, among other things, facilitates the trading and processing of over-the-counter (“OTC”) swaps, and Bloomberg intends to operate a swap execution facility (“SEF”), a platform on which swaps can be listed and executed. The Rule requires DCOs to establish initial margin requirements for customers using a minimum “liquidation time” of one day for futures and five days for financial swaps. (Under the Dodd-Frank Act, a swap must be cleared by a DCO if the CFTC determines that the swap is required to be cleared, absent an exception.) “Liquidation time” is the estimated amount of time needed to offset a defaulted position in a product; the longer the liquidation time for a transaction, the more margin a clearing member must collect from its customer.


[1] Bloomberg L.P. v. Commodity Futures Trading Comm’n, No. 13-cv-00523 (D.D.C. filed Apr. 16, 2013).

[2] Bloomberg L.P. v. Commodity Futures Trading Comm’n, No. 13-523 (BAH), 2013 U.S. Dist LEXIS 80275 (D.D.C. June 7, 2013).