The Commodity Futures Trading Commission has issued a proposed rule that would exempt inter-affiliate swaps from mandatory clearing requirements of the Dodd-Frank Act.

The proposal, approved by the CFTC on Thursday, asks the public to comment on whether inter-affiliate swaps pose less counterparty risk than swaps transactions with third parties. The Commission is considering whether alternative methods of counterparty risk mitigation may be appropriate for swaps between majority-owned affiliates of the same corporate group, a strategy often used to aggregate, manage and hedge risk. 

The exemption would be limited to swaps between majority-owned affiliates whose financial statements are included in the same consolidated financial statements. The rule would still require centralized risk management, swap trading relationship documentation, variation margin payments, and the satisfaction of reporting requirements.

The proposal would permit these affiliates to elect the exemption for inter-affiliate swaps if certain conditions are met. The affiliate is located in the United States or in a jurisdiction with a “comparable and comprehensive” clearing requirement. The affiliate must either not enter into swaps with non-affiliate counterparties, or be required to clear all swaps it enters into those it does.

The proposal was passed by a vote of 3 to 2. A comment period will be open for 30 days from publication in Federal Register.

Following the vote, CFTC Chairman Gary Gensler said he was among the majority that supported the exemption.

Among the benefits of swaps market reform is that standard swaps between financial firms will move into central clearing, which will significantly lower risks of the financial system, he said. Transactions between affiliates, however, are of a different nature than those between nonaffiliated parties. 

“Although transactions between affiliates pose risk, much of the risk relates to their affiliates rather than external parties,” he said, adding that the approach “largely aligns with the Europeans' approach” to an exemption for inter-affiliate clearing.

Dissenting were Commissioners Jill Sommers and Scott O'Malia who said the rule “may have the unintended consequence of imposing substantial costs on the economy and consumers.”

“We believe it is entirely appropriate that the Commission exempt inter-affiliate swaps from the clearing mandate,” they said in a joint statement. “Unfortunately, this proposal inserts a requirement that most financial entities engaging in inter-affiliate swaps post variation margin to one another. It is not clear that this requirement will do anything other than create administrative burdens and operational risk while unnecessarily tying up capital that could otherwise be used for investment.”

The variation margin requirement is also “largely inconsistent with the requirements included in the European Market Infrastructure Regulation,” an issue because “coordination with our global counterparts is critical to the success of this new framework,” they said.

They pointed out that “during the passage of the Dodd-Frank Act many Members' statements directly addressed the concerns regarding inter-affiliate swaps” and that the U.S. House of Representatives has passed, “by an overwhelming bi-partisan majority,” an inter-affiliate swap exemption that does not include a variation margin requirement.