Swaps Between Company Affiliates Exempted Under CFTC Proposal

The U.S. Commodity Futures Trading Commission proposed exempting trades between units of the same company from Dodd-Frank Act clearinghouse rules designed to limit risk in the $648 trillion swaps market.

In a 3-2 private vote, CFTC commissioners proposed freeing so-called interaffiliate trades from requirements that swaps be guaranteed at central clearinghouses that protect buyers and sellers against defaults. The proposal would require collateral to be exchanged between affiliates to reduce trade risks.

“Though transactions between affiliates pose risk, much of the risk relates to their affiliates rather than external parties,” CFTC Chairman Gary Gensler said in a statement yesterday.

Lobby groups representing banks such as Barclays Plc (BARC), JPMorgan Chase & Co. (JPM) and Goldman Sachs Group Inc. (GS) have urged the CFTC to exempt the trades from Dodd-Frank rules enacted in response to the 2008 credit crisis. Prudential Financial Inc. (PRU) and a coalition of end-users -- commercial and manufacturing firms that use swaps to hedge risk -- also sought exemption.

“The devil is in the details here because there are lots of potential risks in an overly broad exemption for interaffiliate swaps,” Marcus Stanley, policy director for Americans for Financial Reform, a coalition including the AFL- CIO labor federation, said yesterday in a telephone interview.

The proposal, which will be open to public comment before the agency considers a final vote, would require centralized risk management and reporting requirements for the trades. The rule would also compel affiliates of financial entities to exchange so-called variation margin to limit risk.

“This process prevents uncollateralized exposures from accumulating over time and thereby reduces the size of any loss resulting from a default,” the agency said in the rule.

Republican commissioners Jill E. Sommers and Scott O’Malia opposed the measure, citing the variation margin requirement.

“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,” Sommers and O’Malia said in a dissent.

The proposal also includes an exception from the margin requirement for affiliates that are entirely commonly owned and commonly guaranteed.

“As part of the consideration of this rule proposal, it will be necessary for financial-entity affiliates to consider other regulatory regimes that would apply,” Andrew P. Cross, partner at law firm Reed Smith LLP, said yesterday in a telephone interview. “While the market will be digesting this rule, at an initial level this seems like the type of issue that could cause the exception to have limited usefulness.”

To contact the reporter on this story: Silla Brush in Washington at sbrush@bloomberg.net

To contact the editor responsible for this story: Gregory Mott at gmott1@bloomberg.net

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