On March 20, the Commodity Futures Trading Commission (CFTC) adopted a final rule regarding customer clearing documentation for swaps. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, requires that many swaps be cleared through derivatives clearing organizations (DCOs). When a swap is cleared, the original swap is extinguished and is replaced by equal and opposite swaps between each counterparty (or their clearing members) and the DCO. This enables each counterparty to substitute the credit of the other party for that of the DCO through the process of novation.
The final rule sets forth certain policies for the documentation associated with the clearing procedure and effectively prohibits certain types of trilateral agreements (so-called because they would permit one or both of the parties’ clearing members to become party to the original agreement) between a swap dealer (SD) or major swap participant (MSP), customer and a futures commission merchant (FCM). Clearing members are typically FCMs.
The final rule does not prohibit trilateral agreements, but it prohibits any agreement or arrangement that would:
- Disclose the identity of a customer’s original executing counterparty to any FCM, SD or MSP
- Limit the number of counterparties with whom a customer may trade
- Restrict the size of a position that the customer may take with any individual counterparty apart from the overall limit for all positions held by the customer at the FCM
- Limit a customer’s access to trades on terms that have a reasonable relationship to the best terms available
- Prevent compliance with other regulations requiring rapid processing and acceptance or rejection from clearing.
Clarifications. Several clarifications to this rule should be noted.