CFTC Delays Reduction in Swap Dealer De Minimis Exception Threshold


On October 13, 2016, the Commodity Futures Trading Commission (the “CFTC”) approved an Order delaying for one year the reduction of the threshold for determining whether an entity constitutes a “swap dealer” for purposes of the U.S. Commodity Exchange Act.[1]  Currently, persons are not considered to be swap dealers unless their swap dealing activity in aggregate gross notional amount measured over the prior 12-month period exceeds a de minimis threshold of $8 billion.  This threshold had been scheduled to automatically decline to $3 billion on December 31, 2017, but the Order extended that date to December 31, 2018, absent further action from the CFTC. READ MORE

CFTC Expands Swap Clearing Requirement


On September 28, 2016, the Commodity Futures Trading Commission (the “CFTC”) unanimously approved the expansion of currencies of interest rate swaps subject to mandatory clearing under the U.S. Commodity Exchange Act (the “Act”).[1]  Subjecting standardized swaps to central clearing is intended to decrease risk in the financial system and has been a primary goal of global regulators for several years.

Section 2(h) of the Act makes it unlawful for any person to engage in a swap that is required to be centrally cleared unless that swap is submitted to a derivatives clearing organization (a “DCO”) that is either registered under the Act or exempt from registration under the Act.[2]  This same section of the Act sets forth the process through which the CFTC is to make determinations of whether a swap, or group, category, type or class of swaps should be subject to mandatory clearing.[3] READ MORE

ISDA Publishes White Paper on Future of Derivatives Processing and Market Infrastructure


In September 2016, the International Swaps and Derivatives Association, Inc. (“ISDA”) published a wide-ranging white paper entitled “The Future of Derivatives Processing and Market Infrastructure.”[1]  The white paper proposes a “path forward” from the new regulatory ecosystem created in response to the financial crisis and the resulting compliance burden on market participants.

As described in the white paper, tight time frames for complying with regulatory requirements prevented market participants in various jurisdictions from making necessary changes to compliance, operational risk management, and other processes in an optimal manner. The resulting complex workflows have created challenges.  The white paper’s proposals are intended to foster a “standardized, efficient, robust and compliant ecosystem that supports the needs of an array of market participants.”[2]  In particular, the white paper identifies three key areas for improvement: (i) standardization; (ii) collaboration; and (iii) technology. READ MORE

Proposed Regulations Under §385 Classifying Interests in a Corporation

Orrick attorneys authored an article, titled “Proposed Regulations Under §385 Classifying Interests in a Corporation,” addressing Section 385 regulations proposed by the Internal Revenue Service and the U.S. Treasury Department to address the excessive use of debt to reduce the U.S. tax base. The article was published in the Tax Management International Journal and is available here.

An Overview of Proposed Regulation AT

Orrick attorneys authored an overview of Regulation Automated Trading (known as “Regulation AT”) proposed by the Commodity Futures Trading Commission (“CFTC”) in the May/June 2016 issue of the Journal of Taxation and Regulation of Financial Institutions.  The “overarching goal” of proposed Regulation AT is to update the CFTC’s rules in response to the development and prevalence of electronic trading.  The article is titled “Regulation Automated Trading in Derivatives: An Overview of the CFTC’s Proposed Regulation AT” and is available here.

CFTC Considers Blockchain Technology

The disruptive effects of blockchain technology on the financial system may take several years to materialize. Nevertheless, in preparation, regulators are increasingly focused on understanding potential uses of blockchain technology and considering related legal issues.  Many regulators are already familiar with bitcoin, the popular virtual currency underpinned by blockchain technology.[1]  As discussed below, the bitcoin blockchain, which records and makes publicly available every transaction ever made in that virtual currency, is a “distributed ledger” created by a “consensus algorithm” that ensures that each local copy of the distributed ledger is identical to every other local copy.  It is widely expected that such distributed ledger technology (“DLT”) will be used in the future to track the ownership of financial, legal, physical, electronic, and other types of assets and, as discussed below, to automate the performance of certain contracts.

The CFTC has begun to consider the implications of DLT with respect to the derivatives markets. For example, a meeting of the CFTC Technology Advisory Committee (the “TAC”) on February 23, 2016 featured a panel presentation, titled “Blockchain and the Potential Application of Distributed Ledger Technology to the Derivatives Markets.”[2]  In addition, CFTC Commissioner J. Christopher Giancarlo has recently given numerous speeches on the topic to various groups, including Markit Group and the Depository Trust & Clearing Corporation.[3]  An overview of DLT is provided below, followed by a summary of certain points, including legal considerations, from the TAC meeting and Commissioner Giancarlo’s speeches. READ MORE

SEC Amends Rules on Security-Based Swap Reporting

On July 13, 2016, the Securities Exchange Commission (“SEC”) approved certain amendments and guidance to the rules governing the reporting and public dissemination of security-based swaps (“SBS”), known as “Regulation SBSR,”[1] which were adopted in February 2015.  The amendments and guidance are intended to increase transparency in the SBS market.

Generally, Regulation SBSR provides for the reporting of SBS information to registered security-based swap data repositories (“SBSDRs”), as well as the public dissemination of SBS transaction data. The amendments and guidance address certain open issues in the Regulation SBSR adopting release, and also clarify how Regulation SBSR would apply to SBS activity engaged in by non-U.S. persons within the United States. READ MORE

Novo Banco and CDS – A Post-Mortem

In 2014, the International Swaps and Derivatives Association, Inc. (“ISDA”), published the 2014 ISDA Credit Derivatives Definitions (the “Definitions”), which updated the 2003 ISDA Credit Derivatives Definitions.[1]

One of the most significant changes in the Definitions was the inclusion of a new credit event for “Governmental Intervention.”[2]  This credit event was intended to address concerns expressed in the market that the credit event for “Restructuring” may not cover certain measures actually taken by governments to support struggling entities, especially banks.  Governmental Intervention[3] is generally defined to include actions or announcements by a “Governmental Authority”[4] that result in, inter alia, the reduction in the rate or amount of interest payable by a reference entity, an expropriation or other event which mandatorily changes the beneficial holder of the relevant obligation, or a mandatory cancellation, conversion or exchange.  This event is similar to Restructuring in certain respects (for example, the reduction in the rate or amount of interest of an obligation may trigger both events).  However, unlike Restructuring, deterioration in creditworthiness is not required to trigger a Governmental Intervention.

It did not take long for this new credit event to be probed and tested by a set of straightforward, but unusual, facts that apparently were not specifically considered by the drafters. In August 2014, Banco de Portugal, the central bank of Portugal, applied resolution measures to Banco Espírito Santo, S.A. (“BES”), a bank organized in Portugal that was experiencing distress.  These measures included a €4.9 billion rescue package for BES, and the transfer of numerous assets, liabilities and deposit-taking operations from BES to a new “good bank,” Novo Banco, S.A. (“Novo Banco”).  However, on December 29, 2015, Banco de Portugal announced the re-transfer of five senior Euro-denominated bonds (having almost €2 billion in principal) from Novo Banco back to BES.[5]  This re-transfer resulted in significant losses to bondholders, up to 90% in secondary market trading.

It was clear that Banco de Portugal constituted a “Governmental Authority” and that it had taken a binding action pursuant to its resolution law. However, irrespective of the undeniable losses suffered by creditors,[6] there was an issue as to whether the re-transfer of the bonds at issue from BES to Novo Banco affected creditors’ rights in one of the ways specified in Section 4.8(a) of the Definitions.

In accordance with the standard practice in the credit default swap (“CDS”) market, purchasers of protection asked the relevant 15-member Determinations Committee (the “Committee”) to determine whether the central bank’s actions amounted to a Governmental Intervention, hence triggering protection payments under CDS contracts.  Under the relevant rules, an 80% supermajority (12 of 15 members) is required for a Committee to decide whether or not a credit event has occurred.[7]   The Committee fell just short of the required percentage, with 11 members voting that there was no Governmental Intervention.  Although the Governmental Intervention event was generally intended to protect investors from governmental actions negatively affecting the value of obligations, the majority of the Committee concluded that the transfer of debt to another institution did not constitute a “mandatory cancellation, conversion or exchange” and did not have “an analogous effect” to the events specifically enumerated in the definition of Governmental Intervention.

Nevertheless, without the required supermajority, pursuant to the relevant rules governing Committees, the matter was referred for “external review.”[8]  External reviews of Committee decisions are quite rare and entail at least three “experts” nominated by Committee members deciding the issue.  A unanimous decision is needed to override the Committee’s original “No” vote where, as here, over 60% of Committee members voted against the occurrence of a credit event.  On February 15, 2016, the external review panel released a unanimous decision to uphold the negative determination.  In short, the panel decided that the central bank’s transfer did not constitute a mandatory cancellation, conversion or exchange of the obligations, and was not analogous to those types of event.[9]  On the latter point, the panel stated that taking a broader review of the word “analogous” would result in this clause “dominat[ing] the whole of the definition, which is inconsistent with [the] careful and detailed drafting” of the definition.[10]

In addition to seeking a determination that a Governmental Intervention had occurred, protection buyers pursued one more potential avenue for payout under the Definitions: seeking a determination that a “successor” event had occurred with respect to CDS naming Novo Banco as reference entity. A successor event occurs under the Definitions if, generally, more than 25% of the relevant obligations of a reference entity are transferred to another entity and more than 25% of the relevant obligations of the reference entity remain with the reference entity.[11]  The Committee sought additional information from Banco de Portugal and Novo Banco to determine whether this threshold had been exceeded.  After receiving this additional information, the Committee unanimously decided on March 3, 2016 that a successor event did not occur.[12]

Many industry participants believed that the Governmental Intervention was designed to protect against precisely the type of result that precipitated from Banco de Portugal’s actions.  Nevertheless, the Committee concluded, and the external review panel agreed, that the actions of Banco de Portugal did not align with the requirements of the Definitions.  Thus, one lesson from this situation is that Determinations Committees may take a formalistic view of requirements under the Definitions, regardless of the scope of losses incurred by creditors or the spirit or purpose of the language in the Definitions.  CDS purchasers should take note and not overlook the precise words of the Definitions.

[1] The implementation date for the updated Definitions was September 22, 2014.

[2] For a more complete description of the changes to ISDA Credit Derivatives Definitions, click here.

[3] “Governmental Intervention” is defined in full, as follows:

(a) “Governmental Intervention” means that, with respect to one or more Obligations and in relation to an aggregate amount of not less than the Default Requirement, any one or more of the following events occurs as a result of an action taken or an announcement made by a Governmental Authority pursuant to, or by means of, a restructuring and resolution law or regulation (or any other similar law or regulation), in each case, applicable to the Reference Entity in a form which is binding, irrespective of whether such event is expressly provided for under the terms of such Obligation:

(i) any event which would affect creditors’ rights so as to cause:

(A) a reduction in the rate or amount of interest payable or the amount of scheduled interest accruals (including by way of redenomination);

(B) a reduction in the amount of principal or premium payable at redemption (including by way of redenomination);

(C) a postponement or other deferral of a date or dates for either (I) the payment or accrual of interest, or (II) the payment of principal or premium; or

(D) a change in the ranking in priority of payment of any Obligation, causing the Subordination of such Obligation to any other Obligation;

(ii) an expropriation, transfer or other event which mandatorily changes the beneficial holder of the Obligation;

(iii) a mandatory cancellation, conversion or exchange; or

(iv) any event which has an analogous effect to any of the events specified in Sections 4.8(a)(i) to (iii).

Definitions, §4.8(a) (emphasis added).

[4] The term “Governmental Authority” includes, inter alia, any de facto or de jure government (or agency, instrumentality, ministry or department thereof), any court, tribunal administrative or other governmental, inter-governmental or supranational body and any authority or other entity designated as a resolution authority or charged with the regulation or supervision of the financial markets of the “reference entity” or some or all of its obligations.  Definitions, §4.9(b).

[5] It appears from Banco de Portugal’s announcement of the measure that it specifically selected these bonds because they were “intended for institutional investors.” See Banco de Portugal, Banco de Portugal approves decisions that complete the resolution measure applied to BES (December 29, 2015) (available at: Among other things, the central bank stated that “[t]he selection of the above-mentioned bonds was based on public interest and aimed to safeguard financial stability and ensure compliance with the purposes of the resolution measure applied to Banco Espírito Santo, S.A. This measure protects all depositors of Novo Banco, the creditors for services provided and other categories of unsecured creditors.” Id.

[6] Some US$430 million in net protection payments would be triggered if it was determined that a credit event had occurred.

[7] ISDA supported a decision of a Governmental Intervention having occurred, arguing that the re-transfer of the bonds at issue constituted a “conversion or exchange” or had “an analogous effect” to an exchange, and that a negative determination “would lead to an illogical outcome.” See ISDA Determinations Committee Request, Has a Governmental Intervention Credit Event occurred with respect to Novo Banco, S.A.? (December 30, 2015) (available at Specifically, ISDA argued as follows:

A decision that a Governmental Intervention has not occurred would lead to an illogical outcome where holders of the Transferred Bonds suffer a near complete economic loss for the arbitrary reason that they are institutional investors, but this loss is not mitigated by their CDS protection despite paying a higher premium for protections against the risk of governmental interventions.  This outcome will further diminish CDS’s efficacy as a tool to hedge credit risk and further erode confidence in the product. . . .  This action is taken under the “bail in” regime that the European banking regulators seek to implement, and is precisely the type of governmental intervention risk that the Definitions were designed to cover.

[8] Specifically, Section 4.1(a) of the 2014 ISDA Credit Derivatives Determinations Committees Rules (available at provides that “[a]ny DC Question relating to DC Resolutions to be made by Supermajority under . . . 3.1(c) (Credit Event Resolution) . . . shall be referred to the external review process described in this Section 4 (External Review) . . . if a Convened DC . . . holds a binding vote on, but is unable to Resolve by a Supermajority, such DC Question.”

[9] Among other things, the panel pointed to the use of the word “transfer” elsewhere in the Definitions and concluded that “it would seem . . . that the draftsman has deliberately decided not to include the expression of ‘transfer’ as an event within the definition of a [Governmental Intervention].”  Novo Banco External Review; Decision and Analysis of the External Review Panel of the ISDA EMEA Determinations Committee with respect to DC issue Number 2015123002 pursuant to Section 4 of the 2016 ISDA Credit Derivatives Determination Committees Rules, at 4 (February 15, 2016) (available at

[10] Id. at 6.

[11] Definitions, at §2.2(a). More specifically, in this case, if the Committee concluded that BES succeeded to more than 25% of Novo Banco’s relevant obligations but more than 25% of relevant obligations remained with Novo Banco, then the CDS would be divided accordingly into new CDS transactions with each of BES and Novo Banco, respectively, as the reference entity. See id. at §2.2(a)(iv) and 2.2(n).

[12] See ISDA EMEA Credit Derivatives Determinations Committee, Statement (March 3, 2016) (available at: It appears that, in addition to Novo Banco’s €7.35 billion of outstanding senior debt, the European Central Bank had provided Novo Banco with some €7 billion in loans. Therefore, €2 billion of re-transferred bonds constituted less than 25% of Novo Banco’s aggregate obligations at the time.

ISDA Publishes 2016 Variation Margin Credit Support Annex (NY Law)

On April 14, 2016, the International Swaps and Derivatives Association, Inc. (“ISDA”) published the 2016 Variation Margin Credit Support Annex (New York Law) (the “2016 VM Annex (NY)”). The purpose of this document is to facilitate compliance with margin requirements for non-cleared derivatives scheduled to be phased in shortly in the United States.[1]

In the United States, by the end of 2015, both the prudential regulators[2] and the Commodity Futures Trading Commission (“CFTC”) had approved final rules generally imposing initial margin and variation margin requirements on certain regulated entities and their counterparties in connection with non-cleared derivatives.[3]  These rules incorporate compliance dates that depend on the type of margin (initial or variation),[4] the types of counterparties and, generally, the volume of transactions entered into by the counterparties.  The first of these compliance dates, which applies to trades between the largest derivatives users, is September 1, 2016.  Specifically, beginning on this date, the final rules impose initial margin and variation margin requirements where both the registered swap dealer or other entity subject to regulation (combined with its affiliates) and the counterparty (combined with its affiliates) have an average daily aggregate notional amount of non-cleared swaps, non-cleared security-based swaps, foreign exchange forwards, and foreign exchange swaps (“covered swaps”) for March, April, and May of 2016 exceeding $3 trillion.

The collateral calculation and transfer mechanics of the 2016 VM Annex (NY) are fairly similar to those in existing credit support annexes published by ISDA, including the standard 1994 ISDA Credit Support Annex (New York law) (the “Existing NY Annex”).  However, under the 2016 VM Annex (NY), the only transactions under an ISDA Master Agreement that are relevant for purpose of determining “Exposure” (generally, the mid-market estimate of what would be paid or received for replacement transactions to outstanding transactions) are to be specified by the parties as “Covered Transactions” in the Paragraph 13 to the 2016 VM Annex (NY).  Moreover, initial margin (known as “Independent Amount” in the Existing NY Annex) is not relevant for purposes of the 2016 VM Annex (NY), although such margin may be calculated and collected pursuant to another credit support annex or similar document (defined in the 2016 VM Annex (NY) as an “Other CSA”).  Similarly, the concept of a threshold of uncollateralized exposure (known as “Threshold” in the Existing NY Annex) is not relevant for purposes of the 2016 VM Annex (NY).

The 2016 VM Annex (NY) also tightens the timing for collateral transfers by one business day.  For example, if a collateral call is made by the “Notification Time” specified by the parties, then transfer of any delivery amount by the pledgor must be made by the close of business on the same business day (as opposed to by the close of business on the next business day under the Existing NY Annex).

Moreover, the 2016 VM Annex (NY) allows parties to address negative interest rate environments by agreeing to make “Negative Interest” applicable.  If the parties do not agree to make “Negative Interest” applicable and a negative interest amount is calculated on collateral posted in the form of cash for an interest period, then there is no interest payable by either party on the posted cash.

The 2016 VM Annex (NY) also allows parties to offset transfers of credit support due under the 2016 VM Annex (NY) against transfers of credit support due on the same date under any Other CSA, provided that the credit support items are fully fungible and are not segregated in an account maintained by a third party custodian or for which offsets are prohibited, by specifying that “Credit Support Offsets” is applicable.

Among other changes, the 2016 VM Annex (NY) also includes a mechanism by which posted collateral is deemed to have a value of zero if the secured party provides written notice to the pledgor in which, inter alia, the secured party represents that it has determined that one or more items of eligible credit support under the agreement has ceased to satisfy (or will cease to satisfy) collateral eligibility requirements under law applicable to the secured party requiring the collection of variation margin.

[1] This Client Alert focuses exclusively on U.S. regulatory requirements and compliance dates.

[2] The prudential regulators are the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Farm Credit Administration, and the Federal Housing Finance Agency.

[3] See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Participants, 81 Fed. Reg. 636 (January 2, 2016); Margin and Capital Requirements for Covered Swap Entities, 80 Fed. Reg. 74,840 (November 30, 2015).  For a summary of these final rules, please click here. European Union and Japanese regulators published their final rules in March 2016.

[4] Note that ISDA has been developing a “standard initial margin model” (“SIMM”), which is a standardized method for calculating initial margin on uncleared swaps.  Using a standard framework to calculate initial margin is expected to reduce the potential for disputes. The SIMM was discussed in a previous Derivatives in Review posting (available here).

Trade Options: Recent End-User Developments

On March 16, 2016, the Commodity Futures Trading Commission (“CFTC”) approved a final rule (“Final Rule”) eliminating certain reporting and recordkeeping requirements for “trade option”[1] counterparties that are neither “swap dealers” nor “major swap participants” (“Non-SD/MSPs”).[2]  The Final Rule is briefly summarized below.

Commodity options are included in the definition of “swap” under the Commodity Exchange Act, as amended by the Dodd-Frank Act (“CEA”),[3] and, as such, absent an exemption, are subject to the various requirements thereunder applicable to swaps.  However, a CFTC interim final rule issued in April 2012 (the “2012 Trade Option Exemption”) exempts a commodity option transaction from certain swap requirements if the following conditions are satisfied: (i) the offeror of the option is either an “eligible contract participant” as defined in section 1a(18) of the CEA or a commercial participant (a producer, processor, commercial user of, or merchant handling, the underlying physical commodity and be entering into the option solely related to its business as such); (ii) the offeree of the option is a commercial participant; and (iii) the parties intend to physically settle the option so that, if exercised, the option would result in the sale of a nonfinancial commodity for immediate (i.e., spot) or deferred (i.e., forward) shipment or delivery.[4]

The 2012 Trade Option Exemption did not exempt a qualifying commodity option (a “trade option”) from all swap requirements; rather, reporting, recordkeeping, position limits, and certain other requirements generally remained applicable.  In fact, these requirements continued to exist even for qualifying trade options between Non-SD/MSPs.  However, No-Action Letter No. 13-08, which was issued after the 2012 Trade Option Exemption, provided the following relief with respect to a trade option between Non-SD/MSPs:

  1. In lieu of the reporting requirements that would otherwise apply, a counterparty may report the trade option transaction on Form TO by March 1 following the calendar year in which the trade option was entered into.
  2. As a condition for the foregoing reporting relief, the counterparty must notify the CFTC, through an email to [email protected], no later than 30 days after entering into trade options having an aggregate notional value in excess of $1 billion during any calendar year.[5]
  3. Each counterparty may comply with the recordkeeping requirements by keeping basic business records (i.e., “full, complete and systematic records, together with all pertinent data and memoranda, with respect to each swap in which they are a counterparty”).

The Final Rule eliminates various requirements from the 2012 Trade Option Exemption and withdraws No-Action Letter No. 13-08 in its entirety. Specifically, pursuant to the Final Rule, a Non-SD/MSP counterparty entering into a trade option is no longer required to: (i) report the trade option on Form TO; (ii) notify the CFTC after entering into trade options exceeding $1 billion in aggregate notional value; or (iii) comply with any recordkeeping requirements (other than obtaining and providing a legal entity identifier to any SD or MSP counterparty).  Additionally, the Final Rule eliminates the requirement that trade options are subject to position limits.  The Final Rule became effective upon its March 21, 2016 publication in the Federal Register.

[1] A “trade option” is defined in the CFTC’s glossary as “[a] commodity option transaction in which the purchaser is reasonably believed by the writer to be engaged in business involving use of that commodity or a related commodity.” CFTC Glossary (available at

[2] Trade Options, 81 Fed. Reg. 14,966 (March 21, 2016).

[3] CEA, § 1a(47).

[4] Commodity Options, 77 Fed. Reg. 25,320 (April 27, 2012).

[5] CFTC Letter No. 13-08 (April 5, 2013).