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Mandatory Clearing Looms Even Larger: Resistance is Futile

As scheduled, the CFTC announced the second phase of compliance for mandatory derivatives clearing. From 10 June 2013, subject to certain (hedging and corporate) exemptions, it will become unlawful[1] for any Category 2 entity to engage in any Covered Swap (new swaps and novations), unless the swap in question is submitted for clearing to a registered or exempt derivatives clearing organization (DCO).

“Category 2 Entities” include:

  • those entities not classified as Category 1
  • Commodity Pools (including mutual funds)
  • Private funds (other than active funds)[2]
  • Other entities predominantly engaged in “financial activities”[3] (excluding “third-party subaccounts)[4]

The rules require market participants to submit an eligible swap for clearing to a DCO as soon as technologically practicable and no later than the end of the day of execution. The product classifications are necessarily the same as for the Category 1 entities and may be found in full here. However, broadly, the following types of swaps will be subject to the clearing requirement:

Rate Swaps

IRS Basis FRA

OIS

Currencies

USD,EUR,GBP, JPY

USD,EUR,GBP, JPY USD,EUR,GBP, JPY

USD,EUR,GBP

Floating Rates

LIBOR (Euribor for EUR) LIBOR (Euribor for EUR) LIBOR (Euribor for EUR)

Fed Funds, EONIA, SONIA

Date Range

28 days to 50 yrs.  (30yrs. JPY)

28 days to 50 yrs.  (30yrs. JPY) 3 days to 3 years

7 days to 2 yrs.

 CDS

Type Region Indices Tenor

Series

North   American Untranched

Corporate North   America CDX.NA.IGCDX.NA.HY

 

CDX.NA.IG: 3Y, 5Y, 7Y, 10YCDX.NA.HY: 5Y

 

CDX.NA.IG 3Y: Series 15 and all subsequent Series, up to and including the current SeriesCDX.NA.IG 5Y: Series 11 and all subsequent Series, up to and including the current Series

CDX.NA.IG 7Y: Series 8 and all subsequent Series, up to and including the current Series

CDX.NA.IG 10Y: Series 8 and all subsequent Series, up to and including the current Series

CDX.NA.HY 5Y: Series 11 and all subsequent Series, up to and including the current Series

 

European   Untranched Corporate Europe iTraxx   EuropeiTraxx   Europe Crossover

iTraxx   Europe HiVol

 

iTraxx Europe: 5Y, 10YiTraxx Europe Crossover: 5Y

iTraxx Europe HiVol: 5Y

 

iTraxx Europe 5Y: Series 10 and all subsequent Series, up to and including the current SeriesiTraxx Europe 10Y: Series 7 and all subsequent Series, up to and including the current   Series

iTraxx Europe Crossover 5Y: Series 10 and all subsequent Series, up to and including the current Series

iTraxx Europe HiVol 5Y: Series 10 and all subsequent Series, up to and including the current Series

The classifications denote “vanilla” instruments, of market standard tenor and reference rate, uniformly excluding optionality, dual currencies and conditional notionals. The CFTC estimate that, at least for IRS, these broad classifications will account for 90% of the existing notional volume. It should be noted that, despite eligibility according to the criteria, if no DCO clears a particular swap- then the clearing requirement will not apply. Idiosyncratic terms that complicate mechanical acceptance by a DCO may render a swap unacceptable for clearing.

The inclusion of this second tier has widened the scope of mandatory clearing beyond the “market professionals” that comprise Category 1. It will be of interest to both the market and regulators to assess initial readiness and compliance within this more disparate group.

The final announcement that will embrace Category 3 (effectively everyone else who is non-exempt, including typical “end-users”) is scheduled for 9 September 2013.


[1]   Pursuant to section 2(h) of the Commodity Exchange Act

[2]   “Active” funds are private funds that executed a monthly average of 200 or more swaps per month over the 12 months preceding the mandatory clearing determination and are classified Category 1

[3]   “Activities financial in nature” (broadly) defined in §4(k) of the Bank Holding Company Act of 1956

[4]   Accounts managed by an investment manager that (i) is independent of the account’s beneficial owner, and (ii) is responsible for the documentation necessary for the account’s beneficial owner to clear swaps. These will be Category 3.

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