Member Article

Pursuant to new rules and interpretations issued by the U.S. Commodity Futures Trading Commission (the “CFTC”) and the Securities Exchange Commission under the Dodd-Frank Wall Street Reform and Consumer Protection Act¹(together with related rules, regulations and interpretations, the “Dodd-Frank Act”), a “swap” has been interpreted to include any guarantee of a swap.² Therefore, the guarantor thereunder must be an “eligible contract participant” as defined in the Commodity Exchange Act (“ECP”).³ 

This will likely impact borrowers, lenders, swap providers and other parties to credit facility transactions because, in connection with such facilities, it is typical for one or more subsidiaries and affiliates of a borrower to enter into guarantees of, or to provide other support for, borrowers’ obligations thereunder, including swap obligations owed to the lenders or their affiliates. Some of these subsidiaries and affiliates may not be ECPs when the guarantee becomes effective as to a swap obligation (which may occur on or after the date that the guarantee is entered into). 

Absent a further rule making or interpretation, guarantees provided by non-ECP parties will need to be limited to credit agreement obligations unrelated to swap obligations in order to avoid violating requirements under the Dodd-Frank Act. 

Even if a guarantee is so limited, waterfall and “pro rata” sharing provisions should be examined so that payments by a non-ECP under the guarantee would not be required to be shared with a hedge provider. In addition, while market practice is still developing in this area, one approach is to attempt to make each such guarantor an ECP through “keepwell” arrangements, as described in Section 1a(18)(A)(v)(II) of the Commodity Exchange Act.⁴ Under a “keepwell” arrangement, qualifying ECP affiliates would be obligated to provide funds as required for non-ECP parties to honor their obligations under the guarantee in respect to swap obligations.

So far, the rules and interpretations by the CFTC have only addressed whether a swap includes a guarantee of a swap and have not addressed any other credit support arrangements.⁵ Therefore, it is not clear if other credit documents such as mortgages, security agreements, pledges, capital contribution agreements or other types of credit support arrangements would be similar enough to a guarantee to require the guarantor or obligor thereunder to be an ECP. A footnote to a recent interpretation suggests that some types of collateral arrangements may be permitted and future guidance may be issued.⁶ 

Guarantors who are ECPs may continue to be parties to these comprehensive guarantees. Note, however, that these entities would then be parties to a swap, which could trigger additional compliance obligations under the Dodd-Frank Act. For example, the borrower may have been the only party to the swap documentation and the only party entering into the August 2012 ISDA Protocol at the request of one or more swap dealers. Because swap dealers are now required to verify that all counterparties meet the definition of an ECP prior to offering to enter into or entering into a swap, going forward, guarantors could be similarly requested to enter into such swap documentation as a means for such swap dealers to comply with such verification obligations.⁷

Swap dealers are permitted to rely on reasonable written representations of a potential counterparty to establish its eligibility as an ECP.⁸ Counterparties will be able to make representations about their ECP status at the outset of a transaction and update those representations if there is a change in status.⁹ However, parties will not be required to terminate a swap based solely on a change in the counterparty’s ECP status during the term of the swap.¹⁰ If entry into a guarantee would constitute entry into a swap and deem the guarantor a counterparty thereto, then the guarantee should contain an ECP representation similar to those found currently in most ISDA Schedules. 

Lenders, borrowers and swap participants should monitor developments in this area. For more information, please contact one of the lawyers listed below.