October 5, 2011
Practice Groups:
Investment
Management
Derivatives and
Structured Products
Hedge Funds and
Venture Funds
Energy & Utilities
Timing is Key: CFTC Proposes Details for
the Phasing-in of Regulations for Clearing,
Margin and Documentation
By Gordon F. Peery, Lawrence B. Patent, Charles R. Mills
The Commodity Futures Trading Commission (“CFTC”) at its open meeting on September 8, 2011,
proposed regulations to establish a schedule to phase in the effective dates of future final rules
governing swap trading documentation, margin requirements for uncleared swaps, and mandatory
swap clearing and trade execution pursuant to the Dodd-Frank Wall Street Reform and Consumer
Protection Act (“Dodd-Frank”). Further, CFTC Chairman Gary Gensler announced that the agency
would not complete the adoption of all of the final rules implementing Dodd-Frank until at least the
first quarter of 2012. Chairman Gensler stated that among the rules that will not be adopted until the
first quarter of 2012 are those governing Swap Execution Facilities and the segregation of margin for
uncleared swaps. He also stated that the CFTC is considering further exemptive relief from DoddFrank’s requirements for swaps.
It currently appears that the CFTC in October may address the adoption of final rules in the following
areas: core principles governing derivative clearing organizations and members, recordkeeping, swap
entity definitions (e.g., swap dealers, major swap participants), business conduct requirements, and
real-time reporting, as well as the application of Dodd-Frank to transactions entered into outside of the
U.S., and possibly position limits. Whether all of these will be addressed in October, however, is
uncertain because the CFTC has now cancelled its last two scheduled meetings. The next CFTC
meeting is scheduled for October 18, 2011.
As background, Dodd-Frank was signed into law by President Obama on July 21, 2010. Title VII of
Dodd-Frank extensively amends the Commodity Exchange Act (“CEA”)1 and other federal law to
provide a completely new, comprehensive regulatory scheme for derivatives. The law gives the
CFTC regulatory and enforcement authority over the over-the-counter (“OTC”) swaps market. The
CFTC has spent the past year proposing almost all of the rules that will govern trading of swaps and
has stated that final rules will be phased-in over time to permit market participants time to come into
compliance with the new regulatory regime.
Clearing and Trade Execution
Section 723(a) of Dodd-Frank amended the CEA to establish mandatory clearing requirements for
virtually all swaps that are not entered into by a commercial end-user. New CEA Section 2(h)(2)
authorizes the CFTC to determine whether a swap is required to be cleared. New Section 2(h)(1) of
the CEA makes it illegal to engage in a swap that is required to be cleared unless that swap is
submitted for clearing to a derivatives clearing organization (“DCO”). Finally, Section 2(h)(8)
requires all swaps subject to the clearing requirement to be executed on a Designated Contract Market
(“DCM”) or a Swap Execution Facility (“SEF”), unless no DCM or SEF makes the swap available for
trading.
1
7 U.S.C. 1 et seq.
Timing is Key: CFTC Proposes Details for the Phasing-in of
Regulations for Clearing, Margin and Documentation
Based on the CFTC’s pronouncements to date regarding the implementation of its final swap rules, it
appears that mandatory clearing of swaps likely will not “go live” until late 2012. Pursuant to the
CFTC’s proposed schedule to phase in the swap clearing requirements, a market participant’s
compliance date will depend on the type of market participant it is. For these purposes, the CFTC has
grouped market participants into 4 categories:
 Category 1 Entities: Swap Dealers (“SDs”); Security-Based Swap Dealers; Major Swap
Participants (“MSPs”); Major Security-Based Swap Participants; and Active Funds. The CFTC’s
proposed creation of a new category of market participant known as an “Active Fund” is defined to
mean “any private fund as defined in section 202(a) of the Investment Advisors Act of 1940, that is
not a third-party subaccount and that executes 20 or more swaps per month based on a monthly
average over the 12 months preceding the CFTC issuing a mandatory clearing determination under
section 2(h)(2) of the Act.”2 The requirements of the proposed rules, of course, raise a new set of
issues for such entities.
 Category 2 Entities: Commodity pools; private funds as defined in Section 202(a) of the
Investment Advisers Act of 1940 other than active funds; employee benefit plans as defined in
paragraphs (3) and (32) of section 3 of the Employee Retirement Income Security Act of 1974
(“ERISA”);3 or 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 (provided that the entity is not a third-party subaccount).
 Category 3 Entities: This category appears to be a “catch-all” category that would include
Category 2 entities that are third-party subaccounts plus all other entities that do not fall into
Categories 1 or 2.
 Category 4 Entities: All other entities not excluded from the mandatory clearing requirement.
Pursuant to Section 2(h)(2) of the CEA, the CFTC will issue a mandatory clearing determination for a
swap that is under consideration for review. This will trigger the proposed compliance schedule as
follows (unless the CFTC, in its discretion, believes phasing is unnecessary for a particular swap):
 Phase 1: For swap transactions between Category 1 Entities, the mandatory clearing requirement
will take effect 90 days after the CFTC issues its determination;
 Phase 2: For swap transactions between Category 2 Entities, or between a Category 2 Entity and a
Category 1 Entity, the mandatory clearing requirement will take effect 180 days after the CFTC
issues its determination; and
 Phase 3: For all other swap transactions involving Category 3 or Category 4 Entities, the
mandatory clearing requirement will take effect 270 days after the CFTC issues its determination.
2
The CFTC believes the proposed numerical threshold for Active Funds is appropriate because a private fund that
conducts this volume of swaps would be likely to have: (1) sufficient resources to enter into arrangements that comply
with the clearing and trade execution requirement earlier than other types of market participants; and (2) sufficient market
experience to contribute meaningfully to the “buy-side” perspective as industry standards are being developed.
3
This phrase is another example of confusion caused by Dodd-Frank. All employee benefit plans are defined in
paragraph (3) of section 3 of ERISA. This includes many types of plans that are not subject to ERISA requirements, such
as governmental plans (i.e., employee benefit plans for government employees), which are more fully defined in
paragraph (32) of section 3 of ERISA. By including the separate reference to the more detailed definition of governmental
plans in section 3(32) of ERISA, a question has been raised, but not yet resolved by regulators, as to whether all
employee benefit plans are meant to be included in the phrase “employee benefit plans as defined in paragraphs (3) and
(32) of section 3 of ERISA,” or only those employee benefit plans “subject to” ERISA and governmental plans.
2
Timing is Key: CFTC Proposes Details for the Phasing-in of
Regulations for Clearing, Margin and Documentation
As set forth in Section 2(h)(8) of the CEA, all swaps that are subject to mandatory clearing will be
required to be executed on DCMs or SEFs. The CFTC proposes to phase in compliance with this
trade execution requirement at the same time as the clearing requirement is phased in or 30 days after
the swap is made available for trading, whichever is later.
When Does the Clearing Clock Begin to Tick?
The CFTC recognizes that the proposed compliance schedules depend on rules that are not yet
finalized. Accordingly, the CFTC has determined that, before market participants could be required to
comply with a mandatory clearing determination, the CFTC must:
 Adopt final rules related to the end-user exception to mandatory clearing established by Section
2(h)(7) of the CEA;
 Finalize rules jointly proposed with the Securities and Exchange Commission (“SEC”) that would
further define the terms “swap,” “swap dealer,” and “major swap participant;” and
 Adopt final rules relating to the protection of cleared swaps customer contracts and collateral.
Similarly, before market participants could be required to comply with a trade execution requirement,
the CFTC must:
 Finalize all of the above rules related to the clearing requirement; and
 Adopt final rules related to SEFs and DCMs, including registration rules for SEFs that provide
procedures for the provisional registration of SEFs.
Documentation and Margin Requirements
Section 731 of Dodd-Frank amended the CEA by adding Section 4s, which sets forth registration and
regulation provisions to govern SDs and MSPs. Pursuant to Section 4s(i), the CFTC released
proposed rules (§23.504) governing documentation standards for SDs and MSPs on January 13,
2011.4 Pursuant to Section 4s(e), the CFTC released proposed rules (§§23.150-23.158) establishing
margin requirements for SDs and MSPs that are not banks (and therefore are not under the oversight
of a prudential regulator) for all uncleared swaps.5
Mirroring the phasing schedule for clearing discussed above, the CFTC proposes to phase in
compliance with documentation standards on a 90/180/270 day timeline, depending on the category of
the entities that are involved in the swap transaction:
 Phase 1: For swap transactions between Category 1 Entities, compliance with proposed §23.504
and §§23.150-23.158, no later than 90 days from the date of adoption of final rules;
 Phase 2: For swap transactions between Category 2 Entities, or a Category 2 Entity and a
Category 1 Entity, compliance with proposed §23.504 and §§23.150-23.158 no later than 180 days
from the date of adoption of final rules; and
4
17 CFR Part 23 “Swap Trading Relationship Documentation Requirements for Swap Dealers and Major Swap
Participants,” 76 Fed. Reg. 6715 (Feb. 8, 2011).
5
17 CFR Part 23 “Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants,” 76 Fed.
Reg. 23732 (Apr. 28, 2011).
3
Timing is Key: CFTC Proposes Details for the Phasing-in of
Regulations for Clearing, Margin and Documentation
 Phase 3: For all other swap transactions involving Category 3 or Category 4 Entities, compliance
with proposed §23.504 and §§23.150-23.158 no later than 270 days from the date of adoption of
final rules.
When Does the Documentation Clock Begin to Tick?
Before SDs and MSPs could be required to comply with trading documentation (§23.504)
requirements, the CFTC must:
 Adopt final rules for trading documentation;
 Adopt regulations governing confirmation of swap transactions and the protection of collateral for
uncleared swaps;
 Finalize rules jointly proposed with the SEC that would further define the terms “swap,” “swap
dealer,” and “major swap participant;” and
 Adopt registration rules, including procedures for the provisional registration of SDs and MSPs.
Before SDs and MSPs could be required to comply with margin requirements (§§23.150-23.158), the
CFTC must:
 Adopt final rules for trading documentation (the proposed margin requirement rules crossreference provisions in the trading documentation proposed rule, and as such the final trading
documentation rule must be published before requiring compliance with margin requirements);
 Adopt final rules for margin requirements;
 Finalize rules proposed with the SEC that would further define the terms “swap,” “swap dealer,”
and “major swap participant;” and
 Adopt registration rules, including procedures for the provisional registration of SDs and MSPs.
The CFTC’s proposed schedules are dependent on a host of other rulemakings becoming final – for
the clearing compliance schedule, five rulemakings must first be finalized. As such, the effective
dates of these schedules are difficult to pin down, but we continue to monitor for purposes of
providing as clear a timetable for compliance as possible. These phase-in proposals illustrate the
interconnectedness of the various rulemakings authorized by Dodd-Frank and the fact that, if any
rulemaking is delayed or stayed by an agency or a reviewing court, the impact on the new regulatory
framework could be widespread.
Market participants should continue following the CFTC regulation developments closely. In the
event that you have any questions regarding the foregoing, please do not hesitate to contact one of the
authors. The authors would also like to thank Jonathan Wallace for his contributions to this alert.
Authors:
Gordon F. Peery
gordon.peery@klgates.com
+1.949.623.3535
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Timing is Key: CFTC Proposes Details for the Phasing-in of
Regulations for Clearing, Margin and Documentation
Lawrence B. Patent
lawrence.patent@klgates.com
+1.202.778.9219
Charles R. Mills
charles.mills@klgates.com
+1.202.778.9096
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