U.S. Loan Market Adjusts to Address Swaps-Related Rules Issued Under Dodd-Frank
New provisions in U.S. loan agreements are quickly becoming a common market practice to address swaps-related rules issued by U.S. regulators in the wake of the Dodd-Frank Act.
Under Dodd-Frank and the new rules, it is "unlawful" for any person other than an "eligible contract participant" ("ECP") to enter into a swap unless the swap is entered into on, or subject to the rules of, a board of trade that the Commodity Futures Trading Commission ("CFTC") has designated as a contract market. The ECP requirement applies both to swap providers and their counterparties. In addition, the CFTC has stated that guarantees of swaps are themselves swaps, which means that guarantors of swaps must themselves be ECPs in order to avoid the burdensome board of trade requirements otherwise necessary to ensure the guarantees are not unlawful. The definition of "swap" in the Commodity Exchange Act is lengthy and includes many instruments commonly used to hedge risks associated with lending transactions.
The good news is that, if you're reading this, there is a very good chance that your company or institution is an ECP. Broadly speaking, ECP status is determined based on an entity's status and assets. Many regulated institutions (such as banks, insurance companies, employee benefit plans, governmental entities, and broker-dealers) are ECPs, as are entities (i) that have total assets exceeding $10 million, (ii) whose obligations are guaranteed or otherwise supported by an ECP with total assets exceeding $10 million, by certain regulated or governmental entities, or by a person that the CFTC deems to be eligible based on its financial or other qualifications, or (iii) that have a net worth exceeding $1 million and that enter into an agreement in connection with the conduct of their business or to manage risk associated with an asset or liability. High net worth individuals (i.e., those with amounts invested on a discretionary basis that exceed $10 million or, if they have an agreement in place to manage business conduct or risk, $5 million) are also ECPs. ECP status is measured each time parties enter into a swap, regardless of when the primary transaction, such as a credit facility, is consummated.
Borrowers and guarantors do not need to be ECPs to enter into lending agreements or to guarantee loan obligations. However, many lending facilities include swap obligations, as well as loan obligations, in the obligations guaranteed and secured in connection with the facility. Additionally, loan facilities often involve multiple borrowers and guarantors, as well as cross-guaranteed or cross-collateralized obligations. As a result, the parties need to be mindful about drafting loan documents to minimize the risk that a borrower or guarantor that is not an ECP becomes obligated in respect of swaps. Possible measures to address the new rules include conferring ECP status on an entity that is not otherwise an ECP through the use of a cross-guaranty, keepwell agreement, or other credit support document, as well as adding language to loan documents to carve out non-ECPs from any swap-related obligations. Some examples are provided below.
New Definitions to Carve Out Non-ECPs
"Commodity Exchange Act" means the Commodity Exchange Act (7 U.S.C. § 1 et seq.) and any successor statute, and any rule, regulation, or order promulgated thereunder, in each case as amended from time to time.
"Excluded Swap Obligation" means, with respect to any Credit Party, any Swap Obligation if, and to the extent that, all or a portion of the Loan Documents to which such Credit Party is party with respect to, or the grant by such Credit Party of a security interest to secure, such Swap Obligation (or any Guarantee thereof) is or becomes unlawful under the Commodity Exchange Act or any rule or regulation promulgated thereunder (or the application or official interpretation of any provision thereof) by virtue of such Credit Party's failure for any reason not to constitute an "eligible contract participant" as defined in the Commodity Exchange Act at the time any such Loan Document becomes effective with respect to such related Swap Obligation.
"Swap Obligation" means, with respect to any Credit Party, any obligation to pay or perform under any agreement, contract, or transaction that constitutes a "swap" within the meaning of section 1a(47) of the Commodity Exchange Act.
Terms utilized in the loan documents, such as "Obligations," "Guaranteed Obligations," and "Secured Obligations," to identify the obligations guaranteed or secured should specifically exclude all Excluded Swap Obligations. The term "Credit Party" includes Guarantors as well as Borrowers.
For further information, please contact your principal Firm representative or one of the lawyers listed below. General email messages may be sent using our "Contact Us" form, which can be found at www.jonesday.com.
Glenn S. Arden
Ronald S. Gross
Vanessa G. Spiro
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