Cleared derivatives are generally characterized as being either “collateralized-to-market” (“CTM”) or “settled-to-market” (“STM”) in connection with the mitigation of counterparty credit risk resulting from movements in mark-to-market value. Under the CTM approach, transfers of variation margin are characterized as daily “collateral” transfers, with the transferring party having a right to reclaim the collateral (a financial asset) and the receiving party having the obligation to return the collateral (a financial liability), as well as a legal right to liquidate the collateral in the event of a close-out.
Under the STM approach, variation margin reflects daily “gain” to the receiving party that is actually settled. Despite the settlement of the gain on a daily basis, the derivative’s underlying economic terms remain the same (in other words, there is no amendment or recouponing of the trade). However, unlike the CTM approach, variation margin transferred is not regarded as pledged collateral securing obligations between the parties. Rather, variation margin is deemed to “settle outstanding exposure” between them (with no right to reclaim or obligation to return the variation margin) and, after that settlement, the mark-to-market between the parties resets to zero. READ MORE
Beginning on December 15, 2017, amendments approved by the Securities and Exchange Commission (“SEC”) last year to FINRA Rule 4210 will require U.S. registered broker-dealers to collect (but not post) daily variation margin and, in some cases, initial margin, from their customers on specified transactions.
These new margin requirements apply to “Covered Agency Transactions,” which include: (i) “to-be-announced” (or “TBA”) transactions on mortgage-backed securities (“MBS”) and specified pool transactions for which the settlement date is more than one business day after the trade date; and (ii) U.S. agency collateralized mortgage obligations for which the settlement date is more than three business days after the trade date. TBA transactions account for the vast majority of trading in the sizable agency MBS market. READ MORE
On April 18, 2017, the Commodity Futures Trading Commission (“CFTC”) issued a no-action letter extending until November 7, 2017 the relief provided under CFTC Letter No. 17-05 (“Letter 17-05”), which was scheduled to expire on May 8, 2017. Letter 17-05 provides relief from certain CFTC margin requirements to certain swap dealers (“SDs”) in connection with swaps subject to the margin requirements under the European Market Infrastructure Regulation (“EMIR”). READ MORE
J. Christopher Giancarlo, the acting chairman of the CFTC, has diverged from other U.S. federal regulators, signaling he favors “regulatory sandboxes” in which fintech companies may experiment with new ideas. Unlike the Office of the Comptroller of the Currency and the Federal Reserve, Mr. Giancarlo’s approach is to “do no harm” to early-stage technology such as blockchain, and is in line with proposals by regulators in the U.K. and Singapore, among other fintech hubs.
In a recent Bloomberg BNA article, Nikiforos Mathews, partner and global co-head of Derivatives at Orrick, Herrington & Sutcliffe, gives his take on the acting chairman’s position, noting that “I see a focus on trying to understand the technology and its potential benefits and fostering the advancement of the fintech sector in a way that it’s under the watchful eye of the regulators,” and suggesting that the agency may designate technology focused specialists to work with fintech innovators such that there is “breathing room” for growth and experimentation. “At the end of the day, with early regulatory involvement, regulators are going to understand the market better and put out smarter rules,” Mathews said.
From the time Regulation AT was initially proposed by the Commodity Futures Trading Commission (“CFTC”) over a year ago, the CFTC has solicited and considered numerous comment letters, held a public roundtable, supplemented the proposed regulation, and, on January 23, 2017, extended the comment period for that supplemental proposal. However, although the substance of the regulation has evolved in certain respects, its future remains uncertain. READ MORE
Internal Revenue Code Section 871(m) and the regulations thereunder treat “dividend equivalent payments” on certain equity derivatives as dividends from sources within the United States.  That is, federal withholding tax applies to such payments made to non-U.S. parties. READ MORE
Blockchain and distributed ledger technology (“DLT”) applications outside of the bitcoin context are attracting the attention of financial entities, prompting regulators to become increasingly focused on these possible applications. Recently, for example: (i) potential financial and securities applications of DLT were discussed in depth at a “FinTech Forum” held at the Securities and Exchange Commission (“SEC”); (ii) the Federal Reserve Board published a paper titled “Distributed Ledger Technology in Payments, Clearing, and Settlement”; and (iii) the Financial Industry Regulatory Authority (“FINRA”) published a paper titled “Distributed Ledger Technology: Implications of Blockchain for the Securities Industry.” Each of these recent developments is discussed in turn below. READ MORE
On January 12, the Commodity Futures Trading Commission (“CFTC”) unanimously approved the proposal of numerous amendments to CFTC Regulation 1.31, the regulation that sets forth the recordkeeping requirements for records required to be kept under the U.S. Commodity Exchange Act (the “Act”) and the CFTC’s regulations, including with respect to swaps. The proposed amendments are largely intended to modernize and make technology-neutral the form and manner in which regulatory records are kept.
The last major revision of Regulation 1.31 was made in 1999, when records were largely kept in paper form and before the prevalence of advanced electronic information systems.  Through the proposed amendments, the CFTC intends to update, reorganize and, effectively, re-write Regulation 1.31, while maintaining its ability to examine and inspect required records. READ MORE
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. 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
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”). 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. 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. READ MORE