Monday, July 19, 2010

Lincoln-Stabenow Colloquy Clarifies Captive Finance Affiliate Derivatives Risk Hedging Exemption in Dodd-Frank

In a colloquy with Senator Stabenow on the day the Senate passed the Dodd-Frank Act, Senator Blanche Lincoln confirmed that the legislation ensures that clearing and margin requirements would not be applied to captive finance or affiliate company transactions that are used for legitimate, non-speculative hedging of commercial risk arising from supporting their parent company's operations. But the Chair of the Agriculture Committee also noted that all swap trades, even those which are not cleared, would still be reported to regulators, a swap data repository, and subject to the public reporting requirements under the legislation. Senator Stabenow noted, and Senator Lincoln agreed, that the legislation recognizes the unique role that captive finance companies play in supporting manufacturers by exempting transactions entered into by such companies and their affiliate entities from clearing and margin so long as they are engaged in financing that facilitates the purchase or lease of their commercial end user parents products and these swaps contracts are used for non-speculative hedging. (Cong. Record, July 15, 2010, p. S5905).

According to Senator Lincoln, the two captive finance provisions in the legislation work together in the following way. The first captive finance provision, codified in section 2(h)(7) of the Commodity Exchange Act, deals with the treatment of affiliates provision in the end-user clearing exemption and is entitled transition rule for affiliates. This provision is available to captive finance entities which are predominantly engaged in financing the purchase of products made by its parent or an affiliate. The provision permits the captive finance entity to use the clearing exemption for not less than two years after the date of enactment. The exact transition period for this provision will be subject to rulemaking. The second captive finance provision differs in important ways from the first provision.

The second captive finance provision does not expire after 2 years. The second provision is a permanent exclusion from the definition of financial entity for those captive finance entities who use derivatives to hedge commercial risks 90 percent or more of which arise from financing that facilitates the purchase or lease of products, 90 percent or more of which are manufactured by the parent company or another subsidiary of the parent company. It is also limited to the captive finance entity's use of interest rate swaps and foreign exchange swaps. The second captive finance provision is also found in Section 2(h)(7) of the CEA at the end of the definition of financial entity. Together, these two provisions provide the captive finance entities of manufacturing companies with significant relief which will assist in job creation and investment by manufacturing companies. (Cong. Record, July 15, 2010, p. S5905).