Broc Romanek of TheCorporateCounsel.net recently described a member’s concerns that some companies were having on relying on the Dodd-Frank Act’s exemption for end-users for swaps entered into by treasury subsidiaries and affiliates:
Many non-financial companies are planning to rely on the helpful End User Exception. Some of them do not have any problem satisfying the “non-financial entity” requirement, which is determined under a very complicated definition. Under the provision most relevant for non-financial public companies, if 85% or more of the entity’s annual gross revenues is derived from activities that are “financial in nature” (as defined by banking regs) or 85% or more of its consolidated assets are related to activities that are “financial in nature” (same), then the entity is deemed to be a “financial entity” that cannot use the End User exception (there’s a 2 year lookback for each test).
The problem arises for non-financial companies that have separate legal entities for their in-house treasury operations. Even though there’s no legal requirement to use a separate legal entity for treasury operations, many companies have historically taken that approach for a variety of reasons including centralization, i.e., having one group of treasury professionals available to interface with a variety of outside banks. These so-called “treasury subsidiaries” are wholly owned by the parent company. They are often the subsidiaries that non-financial companies use as their bank-facing parties to hedge or mitigate commercial risk for the company and its subsidiaries. Because of the nature of their activities, treasury subsidiaries often fail the 85% test, and therefore are “financial entities” that cannot elect as End Users.
The CFTC recently issued no-action relief to address this concern. Conditions to relying on the no-action relief include:
- The eligible treasury affiliate enters into the exempted swap for the sole purpose of hedging or mitigating the commercial risk of one or more related affiliates that was transferred to the eligible treasury affiliate by operation of one or more swaps with such related affiliates;
- The eligible treasury affiliate does not enter into swaps with its related affiliates or unaffiliated counterparties other than for the purpose of hedging or mitigating the commercial risk of one or more related affiliates;
- Neither any related affiliate that enters into swaps with the eligible treasury affiliate nor the eligible treasury affiliate, enters into swaps with or on behalf of any affiliate that is a financial entity (“financial affiliate”), or otherwise assumes, nets, combines, or consolidates the risk of swaps entered into by any financial affiliate;
- Each swap entered into by the eligible treasury affiliate is subject to a centralized risk management program that is reasonably designed to monitor and manage the risks associated with the swap; and
- The payment obligations of the eligible treasury affiliate on the exempted swap are guaranteed by its non-financial parent, an entity that wholly-owns or is wholly-owned by its non-financial parent, or the related affiliates for which the swap hedges or mitigates commercial risk.
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