In CFTC Letter 12-17 dated 12 October 2012, the CFTC clarified that, effective immediately, it was unlawful under Section 2(e) of the Commodity Exchange Act (“CEA”) for a person that is not an “eligible contract participant” (“ECP”) to guaranty the swap obligations of another party, unless the swap in question was executed on a designated contract market. The CFTC letter provided blanket no-action relief with respect to this issue until 31 March 2013, with the effect that, from that day, swap dealers now face risk in entering into swaps guaranteed by non-ECPs.
In response, ISDA has developed a set of provisions which can be incorporated by reference into any master agreement or confirmation as detailed below:
Broadly, this provision states that the benefit of any guarantee provided by a guarantor (the “Guarantor”) to a party (the “Beneficiary”) with respect to the obligations of the Beneficiary’s swap counterparty (the “Guaranteed Party”) does not extend to cover any “Excluded Swap Obligation”. An “Excluded Swap Obligation” means, with respect to the Guarantor, any obligation under the relevant swap if, and to the extent that, all or a portion of the relevant guaranty is illegal under the CEA or any CFTC rule by virtue of such Guarantor’s failure for any reason to qualify as an ECP.
This provision requires the parties to identify a “Qualified Keepwell Provider” (which by default is any guarantor of the relevant swap which qualifies as an ECP). Under the Keepwell Terms, the Qualified Keepwell Provider agrees to provide to each guarantor that would not otherwise qualify as an ECP (the “Specified Guarantor(s)”), such funds as are necessary in order to enable the Specified Guarantor(s) to honour any obligations with respect to the Guaranteed Party and the relevant swap.
From a legal point of view, the amendments necessary to incorporate the Exclusionary Terms and the Keepwell Terms are very straightforward and it would seem sensible to incorporate them at the Master Agreement level rather than on a per transaction basis within confirmations. However, from an administrative point of view, the resource required to identify counterparties and effect large-scale amendments to derivatives documentation should not be underestimated. Whilst firms should be aware of the fact that the no-action relief ended on 31 March 2013, the practical realities of the situation may mean that this is one requirement that, in the short term and with a view to agreeing multiple amendments in one go, they may wish to add to the growing list of outstanding counterparty documentation changes required as a result of the Dodd-Frank Act.