Prudential Regulators and CFTC Re-Propose Rules for Uncleared Swap Margin

The “prudential regulators” (i.e., the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Farm Credit Administration, and the Federal Housing Finance Agency) re-proposed their April 2011 proposed rule imposing initial and variation margin requirements on banks and their counterparties in connection with uncleared swaps. The April 2011 proposed rule has been re-proposed rather than simply finalized in light of significant differences from the original proposal and the issuance of the 2013 final policy framework by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions.

The prudential regulators’ re-proposed rule imposes the following requirements, among others, on a bank or bank holding company that is a swap dealer or major swap participant (“covered swap entity”) entering into an uncleared swap:

Initial margin collection:

  • If its counterparty is either a “swap entity” (i.e., a swap dealer or major swap participant) or a “financial end user with material swaps exposure” (as described below), the covered swap entity must collect an “initial margin collection amount,” calculated either in accordance with the standardized margin schedule set forth in the re-proposed rule or through an internal margin model satisfying certain criteria and approved by the relevant prudential regulator.
  • For other counterparties, the covered swap entity must collect initial margin only at such times and in such forms as it determines appropriately address the credit risk of its counterparty and/or the risks associated with the relevant product being traded.[1]
  • Initial margin must be transferred at least on a daily basis, with no threshold of uncollateralized exposure, in response to changes in portfolio composition or any other factors that would change the required initial margin amounts.
  • Initial margin is required to be segregated at a third-party custodian and generally may not be reused or rehypothecated by the custodian.
  • The covered swap entity may establish and apply an initial margin threshold against a counterparty (on a consolidated basis) up to $65 million.

Initial margin posting:

  • If its counterparty is a financial end user with material swaps exposure, the covered swap entity must post an initial margin collection amount calculated as described above but applied to the counterparty of the covered swap entity.
  • However, the covered swap entity is not required to post initial margin below its established initial margin threshold amount of up to $65 million.
  • Also, the covered swap entity is not required to post initial margin unless and until the total amount to be posted exceeds a minimum transfer amount of $650,000.

Variation margin collection and posting:

  • The covered swap entity must collect from and post with a counterparty that is a swap entity or financial end user a “variation margin amount,” meaning the cumulative mark-to-mark change in value of the swap, adjusted for variation margin previously collected or posted.
  • The covered swap entity is not required to collect or post variation margin unless and until the total amount to be collected or posted exceeds a minimum transfer amount of $650,000.
  • Historical trades generally are excluded from variation margin requirements. However, if an internal margin model is used by the covered swap entity, then historical trades covered by a single master netting agreement with new trades need to be margined.[2]
  • Variation margin must be transferred at least once per business day, with no threshold of uncollateralized exposure.
  • Variation margin is not required to be segregated at a third-party custodian and may be reused or rehypothecated by the custodian.

The re-proposed rule lists various types of entities that constitute “financial end users,” including, for example, a bank holding company or an affiliate thereof, or a private fund or an entity that “raises money from investors primarily for the purpose of investing in loans, securities, swaps, funds or other assets for resale or other disposition or otherwise trading in loans, securities, swaps, funds or other assets.” Sovereign entities, the Bank for International Settlements and several others are specifically excluded from the definition of “financial end user.” An entity has “material swaps exposure” if it and its affiliates have a daily average aggregate notional amount of outstanding uncleared swaps, uncleared security-based swaps, foreign exchange forwards, and foreign exchange swaps with all counterparties for June, July, and August of the previous calendar year in excess of $3 billion.[3] (The re-proposed rule states that using June, July, and August of the previous year, instead of a single as-of date, “is appropriate to gather a more comprehensive assessment of the financial end user’s participation in the swaps market, and address the possibility that a market participant might ‘window dress’ its exposure on an as-of date.”)[4]

Eligible Collateral:                                 

Highly-liquid assets such as cash (in USD or the currency in which payment obligations are required to be settled), high-quality government securities, gold and publicly-traded debt securities and asset-backed securities fully guaranteed by a U.S. government sponsored enterprise may be delivered and posted to satisfy initial margin requirements. Eligible assets would be subject to haircuts specified in an exhibit attached to the re-proposed rule. However, only cash may be delivered to satisfy variation margin requirements.

Cross-border application:

None of the foregoing margin requirements are applicable to a swap between a “foreign” covered swap entity and a “foreign” counterparty (unless either counterparty’s obligations have a non-“foreign” guarantor). A party is “foreign” if it is other than: (i) a U.S.-organized entity, including a U.S. branch, agency, or subsidiary of a foreign bank; (ii) a branch or office of a U.S.-organized entity; or (iii) a covered swap entity that is directly or indirectly controlled by a U.S.-organized entity.

Compliance timeline:

The foregoing initial and variation margin requirements would be applicable as follows to swaps entered into after the following dates:

  • December 1, 2015: Variation margin.
  • December 1, 2015: Initial margin where both the covered swap entity combined with its affiliates and the counterparty combined with its affiliates have an average daily aggregate notional amount of covered swaps for June, July, and August of 2015 exceeding $4 trillion.
  • December 1, 2016: Initial margin where such amount for 2016 exceeds $3 trillion.
  • December 1, 2017: Initial margin where such amount for 2017 exceeds $2 trillion.
  • December 1, 2018: Initial margin where such amount for 2018 exceeds $1 trillion.
  • December 1, 2019: Initial margin for any other covered swap entity with respect to covered swaps with any other counterparty.

Following the release of the prudential regulators’ re-proposed rule, the Commodity Futures Trading Commission (“CFTC”) re-proposed its own April 2011 proposed rule imposing initial and variation margin requirements on non-bank swap dealers and major swap participants (“SD/MSPs”) and their counterparties in connection with uncleared swaps. The CFTC’s re-proposed margin rule is substantially similar to that of the prudential regulators summarized above, including with respect to the compliance timeline. However, the CFTC’s re-proposed margin rule contains three alternative options for its cross-border application, and it requests public comment as to which option should be adopted in the final rule.

The three options are as follows: (i) following the cross-border approach provided in the prudential regulators’ re-proposed margin rule, summarized above; (ii) following the CFTC Cross-Border Guidance, summarized below; or (iii) following an “Entity-Level Approach,” summarized below.

CFTC Cross-Border Guidance:

Under this approach, the CFTC’s margin requirements would be potentially applicable only if: (i) one or both counterparties constitute a U.S. person; or (ii) the non-U.S. counterparty of the non-U.S. SD/MSP is guaranteed by, or an “affiliate conduit” of, a U.S. person. However, in the case of (ii), substituted compliance may be available.

“Entity-Level Approach”:

Under this approach, the CFTC’s margin requirements (if otherwise applicable) generally would apply to a swap between any SD/MSP (regardless of whether located in the U.S.) and any counterparty (regardless of whether located in the U.S.). However, substituted compliance generally would be available for a swap between a non-U.S. SD/MSP not guaranteed by a U.S. person and any counterparty (regardless of whether located in the U.S.). Additionally, with respect to a swap between an SD/MSP (regardless of whether located in the U.S.) and a non-U.S. counterparty not guaranteed by a U.S. person, substituted compliance would be available with respect to the initial margin collected by the non-U.S. counterparty not guaranteed by a U.S. person.


[1] Margin and Capital Requirements for Covered Swap Entities, 79 Fed. Reg. 57,348, 57,391-92 (September 24, 2014) (“Re-Proposed Rule”).

[2] Id. at 57,392.

[3] Although foreign exchange swaps and forwards are relevant for determining whether “material swaps exposure” exists with respect to a party, foreign exchange swaps and forwards are not subject to the prudential regulators’ margin requirements. Id. at 57,391; Determination of Foreign Exchange Swaps and Foreign Exchange Forwards Under the Commodity Exchange Act, 77 Fed. Reg. 69,694 (November 20, 2012).

[4] Re-Proposed Rule at 57,363

Major Banks Agree to Protocol “Staying” Exercise of Termination Rights

On October 18, the International Swaps and Derivatives Association, Inc. (“ISDA”) announced that eighteen major global banks had agreed to sign a protocol (the “Protocol”) that imposes a stay on cross-default and termination rights under standard derivatives contracts governed by an ISDA master agreement. The terms of the Protocol, which was developed in close coordination with regulators to facilitate cross-border resolution efforts and to address risks associated with the disorderly unwind of derivatives portfolios, would apply where one of the Protocol signatories becomes subject to resolution action in its jurisdiction.

The push for a temporary suspension of termination rights was prompted, at least in part, by the rush of counterparties to unwind some 900,000 derivatives contracts against Lehman Brothers trading entities and seize collateral upon Lehman’s bankruptcy filing. This stampede to exercise termination rights further destabilized the markets and led to disorder that deepened the financial crisis. In response, certain countries developed statutory resolution regimes. For example, in the United States, Title II of the Dodd-Frank legislation provides a stay of termination rights against “covered financial companies” for which the Federal Deposit Insurance Corporation (“FDIC”) has been appointed receiver until 5:00 p.m., U.S. Eastern time, on the business day following the date on which the FDIC is appointed receiver.[1] However, absent the Protocol, statutory regimes such as that of Title II might only apply to trades between domestic parties under domestic law governed agreements, and not to cross-border trades.

For some time, regulators, industry groups and banks have expressed a strong interest in amending derivatives documentation to recognize the suspension of early termination rights on bilateral uncleared swaps upon the commencement of insolvency or resolution proceedings against a systemically important financial institution. Indeed, in November 2013, four global regulators sent a letter to ISDA expressing their desire for the group to effect changes to its widely-used master agreement documenting derivatives. In this letter, the regulators noted that “[a] change in the underlying contracts for derivative instruments that is consistently adopted is a critical step to provide increased certainty to resolution authorities, counterparties, and other market participants, particularly in the cross-border resolution context.”[2]

Under the Protocol, adhering parties incorporate suspension terms into their derivatives contracts by “opting-into” certain qualifying overseas resolution regimes. In effect, by signing the Protocol, an adhering party recognizes stays under various statutory resolution regimes. The purpose of the suspension is to provide regulatory authorities with a brief period during which they could exercise certain powers, such as the transfer of derivatives contracts to a solvent third party or, possibly, conversion of financial institution obligations into equity. In short, the Protocol will facilitate regulators’ ability to deal with the swap positions of financial institutions that present systemic risk because they are perceived to be “too big to fail,” hence shielding taxpayers from bail-out costs.

The Protocol reportedly will cover more than 90% of the outstanding derivatives notionals of the adhering parties, a percentage that is expected to increase as additional firms agree to its terms, especially if global prudential regulators require its adoption by regulated entities. However, certain end-users have expressed reluctance in having their potential termination rights curtailed, especially during a time of distress and extreme market volatility. Asset managers, in particular, have argued that voluntarily limiting early termination rights could violate fiduciary duties owed to their clients.

The eighteen banks are expected to adhere to the terms of the Protocol by early November—before the next G-20 meeting in Australia—and the Protocol generally will become effective beginning January 1, 2015. Nevertheless, additional work remains to remove obstacles to cross-border resolution. On September 29, the Financial Stability Board launched a public consultation on a set of proposals to achieve the cross-border recognition of resolution actions and remove impediments to cross-border resolution.[3]

[1] Generally, “qualified financial contracts” (“QFCs”) (which are defined to include, inter alia, “swap agreements”), may not be terminated, liquidated and accelerated solely by reason of, or incidental to, the appointment of the FDIC as receiver for a “covered financial company” (i.e., a financial company for which, among other things, the Secretary of the Treasury has made a systemic risk determination) until the earlier of: (i) 5:00 pm on the business day following the date of the appointment of the FDIC as receiver; or (ii) receipt of notice of transfer of the QFC. Wall Street Financial Reform and Consumer Protection Act § 210(c)(10)(B)(i).

[2] Letter to ISDA from the Bank of England, Bundesanstalt für Finanzdiensteistungsaufsicht, Federal Deposit Insurance Corporation and Swiss Financial Market Supervisory Authority, available at

[3] See “Cross-border recognition of resolution action” (29 September 2014), available at

SIFMA v. CFTC Cross-Border Lawsuit Dismissed

The U.S. District Court for the District of Columbia dismissed, with certain exceptions, the lawsuit filed by the Securities Industry and Financial Markets Association and others challenging the CFTC’s final cross-border guidance (the “Guidance”) issued in July 2013 and the extraterritorial application of the various CFTC rulemakings under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Title VII Rules”).[1] The court held that the Guidance was not a legislative rule but rather was, in part, a policy statement and, in part, an interpretive rule and, therefore, generally not subject to judicial review under the Administrative Procedure Act.[2] This holding was based largely on the court’s finding that the Guidance “reads like a non-binding policy statement and has been neither characterized nor treated in practice as binding by the CFTC.”[3]

The court also concluded that the CFTC has discretion to define the extraterritorial reach of the Title VII Rules through case-by-case adjudication rather than by rulemaking, and therefore the CFTC was not required to address within each Title VII Rule the scope of that Rule’s extraterritorial application.[4] However, the court agreed with the plaintiffs that the CFTC was required but failed to consider adequately the costs and benefits of the extraterritorial applications of certain of the Title VII Rules.[5] Without vacating them, the court remanded those rules – specifically, the Real-Time Reporting,[6] Daily Trading Records,[7] Portfolio Reconciliation and Documentation,[8] Entity Definition,[9] Swap Entity Registration,[10] Risk Management,[11] Chief Compliance Officer,[12] SDR Reporting,[13] Historical SDR Reporting,[14] and SEF Registration Rules[15] – to the CFTC to conduct an adequate cost-benefit analysis under 7 U.S.C. § 19(a).[16]


[1] Sec. Indus. & Fin. Mkts. Ass’n., et al., v. CFTC, 13-CV-1916 slip op. (D.D.C. Sept. 14, 2014) (the “Opinion”).

[2] Id. at 71-72.

[3] Id. at 69.

[4] See id. at 76.

[5] See id. at 80.

[6] Real-Time Public Reporting of Swap Transaction Data, 77 Fed. Reg. 1,182 (January 9, 2012) (codified at 17 C.F.R. Part 43).

[7] Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 77 Fed. Reg. 20,128, 20,133 (April 3, 2012) (codified at 17 C.F.R. § 23.202).

[8] Confirmation, Portfolio Reconciliation, Portfolio Compression, and Swap Trading Relationship Documentation Requirements for Swap Dealers and Major Swap Participants, 77 Fed. Reg. 55,904 (September 11, 2012) (codified at 17 C.F.R. §§ 23.500-506).

[9] Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant”, 77 Fed. Reg. 30,596 (May 23, 2012) (codified in various sections of 17 C.F.R.).

[10] Registration of Swap Dealers and Major Swap Participants, 77 Fed. Reg. 2,613 (January 19, 2012) (codified at 17 C.F.R. §§ 23.21-22).

[11] Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 77 Fed. Reg. 20,128, 20,205-11 (April 3, 2012) (codified at 17 C.F.R. §§ 23.600-606).

[12] Id. at 20,200-01 (codified at 17 C.F.R. §§ 3.3).

[13] Swap Data Recordkeeping and Reporting Requirements, 77 Fed. Reg. 2,136 (January 13, 2012) (codified at 17 C.F.R. Part 45).

[14] Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps, 77 Fed. Reg. 35,200 (June 12, 2012) (codified at 17 C.F.R. Part 46).

[15] Core Principles and Other Requirements for Swap Execution Facilities, 78 Fed. Reg. 33,476 (June 4, 2013) (codified at 17 C.F.R. Part 37).

[16] See the Opinion at 91-92.

SEC Adopts Cross-Border Rules

On June 25, the Securities and Exchange Commission (“SEC”) adopted a final rule and interpretive guidance[1] (the “Final Rule”) to address the application of certain provisions of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) to cross-border security-based swap activities. Generally, the Final Rule does not, itself, impose obligations on market participants, but, rather, is definitional and may determine the cross-border scope of the SEC’s eventual implementation of certain security-based swaps requirements under Dodd-Frank. Certain significant provisions of the Final Rule are discussed below.

First, the Final Rule includes a definition of “U.S. person” that will be critical to identifying when security-based swaps requirements will apply to cross-border transactions. This definition includes the following:

  • any natural person resident in the United States;
  • any partnership, corporation, trust, investment vehicle, or other legal person organized, incorporated, or established under the laws of the United States or having its principal place of business in the United States;
  • any account (whether discretionary or non-discretionary) of a U.S. person; or
  • any estate of a decedent who was a resident of the United States at the time of death.

A person’s “principal place of business” is defined to mean “the location from which the officers, partners, or managers of the legal person primarily direct, control, and coordinate the activities of the legal person.”[2] The Final Rule also provides that, with respect to an externally managed investment vehicle, this location “is the office from which the manager of the vehicle primarily directs, controls, and coordinates the investment activities of the vehicle.”[3] Additionally, a non-U.S. branch of a U.S. bank generally is considered a U.S. person, while a U.S. branch of a non-U.S. bank is considered a non-U.S. person. Foreign central banks and certain supranational organizations and their agencies are excluded from the U.S. person definition.

The Final Rule’s “U.S. person” definition is generally similar to that set forth under the CFTC’s cross-border guidance,[4] but with certain differences. For example, the SEC definition does not include, as a separate test, U.S. person status of a collective investment vehicle solely by virtue of being majority-owned by one more U.S. persons.

The Final Rule also addresses the de minimis exemption from registration as a “security-based swap dealer.” Pursuant to the de minimis exemption, an entity generally need not register as a security-based swap dealer if its dealing activities over the preceding 12 months do not exceed any of the following thresholds: (i) $3 billion in notional of credit default security-based swaps (subject to a phase-in level of $8 billion); (ii) $150 million in notional of other types of security-based swaps (subject to a phase-in level of $400 million in notional); and (iii) $25 million in notional in any type of security-based swap entered into with “special entities.”[5] Pursuant to the Final Rule, a non-U.S. person (the “calculating counterparty”) that is not a conduit affiliate[6] generally must count security-based swap transactions entered into with the following persons towards the de minimis threshold from registration as a security-based swap dealer:

  • U.S. persons (other than foreign branches of a U.S. registered swap dealers); and
  • non-U.S. persons if such non-U.S. persons have rights of recourse in connection with security-based swaps against U.S. persons that are affiliates of the calculating counterparty.

However, a U.S. person must count all security-based swaps entered into with both U.S. and non-U.S. persons, including those conducted through a foreign branch of a U.S. person. The SEC intends to determine at a later date whether a non-U.S. person must count toward the de minimis threshold security-based swaps entered into with another non-U.S. person solely because transactions are “conducted” within the United States.

In addition, the Final Rule provides a process by which market participants and foreign regulators may apply to the SEC for a “substituted compliance” determination. Similar to “substituted compliance” determinations in the CFTC context,[7] eventually market participants may be able to comply with the requirements of a relevant foreign jurisdiction, such as the European Market Infrastructure Regulation (EMIR), in lieu of the comparable security-based swaps requirements under Dodd-Frank if a “substituted compliance” determination is made by the SEC.


[1] Application of ‘‘Security-Based Swap Dealer’’ and ‘‘Major Security-Based Swap Participant’’ Definitions to Cross-Border Security-Based Swap Activities, 79 Fed. Reg. 47,278 (August 12, 2014) (“Final Rule”).

[2] Id. at 47,371.

[3] Id.

[4] Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 45,292 (July 26, 2013). See “U.S. Person” Definitions Under the Final Exemptive Order and the Final Guidance, Application to Certain Foreign Branches, and Determination for Collective Investment Vehicles.

[5] 17 C.F.R. § 240.3a71–2. “Special entities” are defined to include employee benefit plans subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), endowments and state and local governmental entities. See 15 U.S.C. 78o–10(h)(2)(C).

[6] Conduit affiliate means “a person, other than a U.S. person, that: (A) [i]s directly or indirectly majority-owned by one or more U.S. persons; and (B) [i]n the regular course of business enters into security-based swaps with one or more other non-U.S. persons, or with foreign branches of U.S. banks that are registered as security-based swap dealers, for the purpose of hedging or mitigating risks faced by, or otherwise taking positions on behalf of, one or more U.S. persons (other than U.S. persons that are registered as security-based swap dealers or major security-based swap participants) who are controlling, controlled by, or under common control with the person, and enters into offsetting security-based swaps or other arrangements with such U.S. persons to transfer risks and benefits of those security-based swaps.” Final Rule at 47,370.

[7] See, e.g., Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 45,292, 45,340-46 (July 26, 2013). See also CFTC Substituted Compliance Determinations and No-Action Letters.

Extension of Certain Dodd-Frank No-Action Relief

On May 1, 2014, the Commodity Futures Trading Commission (“CFTC”) established a phased compliance timeline for the implementation of the trade execution requirement[1] currently applicable to certain interest rate swaps and credit default swaps executed as part of a “package transaction.”[2]  Earlier this year, the CFTC had provided no-action relief that would have required all swaps that are part of a package transaction to be traded either on a designated contract market or on a swap execution facility after May 15, 2014.[3]

Based on the recent no-action relief, the phased compliance timeline for the execution requirement for package transactions is, generally, as follows:

  • if (i) at least one swap component has been made available to trade and is subject to the trade execution requirement, and (ii) each of the other swap components is subject to the clearing requirement, then the deadline was June 1, 2014;
  • if (i) the swap components have each been made available to trade and are subject to the trade execution requirement, and (ii) all other components are U.S. Treasury securities, then the deadline was June 15, 2014;
  • if both (i) at least one swap component has been made available to trade and is subject to the trade execution requirement and (ii):

o   at least one swap component is under the CFTC’s exclusive jurisdiction and not subject to the clearing requirement;

o   at least one component is not a swap; or

o   at least one swap component is a swap over which the CFTC does not have exclusive jurisdiction (e.g., a “mixed swap”),

then the deadline is November 15, 2014.

Also, on June 4, 2014, the CFTC issued a no-action letter further delaying until December 31, 2014 the effectiveness of a November 14, 2013 advisory (the “Advisory”) regarding the applicability of certain Dodd-Frank requirements in connection with activities that occur in the United States.[4]  The Advisory generally provided that a non-U.S. swap dealer registered with the CFTC must comply with the “transaction-level” requirements[5] of Dodd-Frank when entering into a swap with a non-U.S. person if the swap is “arranged, negotiated, or executed by personnel or agents” of the non-U.S. swap dealer located in the United States.[6]

Two previous no-action letters, issued on November 26, 2013 and January 3, 2014, had delayed the effectiveness of the Advisory until January 14, 2014 and September 15, 2014, respectively.[7]  The CFTC noted that it made the most recent extension based on public comments as well as concerns raised by non-U.S. swap dealers.[8]

[1]A swap subject to the trade execution requirement may not be traded bilaterally over-the-counter but, rather, must be executed on a swap execution facility or designated contract market, unless an exemption or exception applies.  See Dodd-Frank Trade Execution Developments.”

[2] CFTC Letter No. 14-62 (May 1, 2014).  A “package transaction” is a transaction involving two or more instruments: (1) that is executed between two counterparties; (2) that is priced or quoted as one economic transaction with simultaneous execution of all components; (3) that has at least one component that is a swap that is made available to trade and therefore is subject to the trade execution requirement; and (4) where the execution of each component is contingent upon the execution of all other components.  Some common types of interest rate swap package transactions include (but are not limited to) swap curves (package of two swaps of differing tenors), swap butterflies (package of three swaps of differing tenors), swap spreads (government securities vs. swaps typically within similar tenors), invoice spreads (Treasury-note or Treasury-bond futures vs. swaps), cash/futures basis (Eurodollar futures bundles vs. swaps), offsets/unwinds, delta neutral option packages (caps, floors, or swaptions vs. swaps), and mortgage-backed security basis (to-be-announced swaps (agency MBS) vs. swap spreads).  Common credit default swap package transactions include (but are not limited to) transactions commonly known as index options vs. index, tranches vs. index, and index vs. single name CDS.

[3] CFTC Letter No. 14-12, Re: No-Action Relief from the Commodity Exchange Act Sections 2(h)(8) and 5(d)(9) and from Commission Regulation § 37.9 for Swaps Executed as Part of a Package Transaction (February 10, 2014).  Ultimately, the original May 15, 2014 relief deadline applied only to package transactions in which all components were swaps that had been made “available to trade” and were subject to the trade execution requirement.  A swap is made “available to trade” if a swap execution facility or designated contract market has demonstrated, as approved by the CFTC, that it lists or offers that swap for trading on its trading system or platform and has considered various factors such as “whether there are ready and willing buyers and sellers.”

[4] CFTC Letter No. 14-74: Re: Extension of No-Action Relief: Transaction-Level Requirements for Non-U.S. Swap Dealers (June 4, 2014); CFTC Staff Advisory No. 13-69, Applicability of Transaction-Level Requirements to Activity in the United States (November 14, 2013).

[5] The “transaction-level” requirements include: (i) required clearing and swap processing; (ii) margining (and segregation) for uncleared swaps; (iii) mandatory trade execution; (iv) swap trading relationship documentation; (v) portfolio reconciliation and compression; (vi) real-time public reporting; (vii) trade confirmation; (viii) daily trading records; and (ix) external business conduct standards.  These requirements are separated into “Category A” and “Category B” requirements, the latter of which includes solely external business conduct standards.

[6] See CFTC Staff Advisory No. 13-69, Applicability of Transaction-Level Requirements to Activity in the United States (November 14, 2013).

[7] CFTC Letter No. 13-71, Re: No-Action Relief: Certain Transaction-Level Requirements for Non-U.S. Swap Dealers (November 26, 2013); CFTC Letter No. 14-01, Re: Extension of No-Action Relief: Transaction-Level Requirements for Non-U.S. Swap Dealers (January 3, 2014).

[8] See CFTC Press Release, CFTC Staff Issues Extension to Time-Limited No-Action Letter on the Applicability of Transaction-Level Requirements in Certain Cross-Border Situations, June 4, 2014 (available at:  Specifically, in conjunction with the issuance of the January 3, 2014 no-action letter, the CFTC had issued a notice of request for public comment on all aspects of the Advisory.  See Request for Comment on Application of Commission Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S. Counterparties Involving Personnel or Agents of the Non-U.S. Swap Dealers Located in the United States (available at:

CFTC Establishes Expedited Process for Relief for Certain Delegating CPOs

On May 12, 2014, the Commodity Futures Trading Commission (“CFTC”) issued guidance[1] (the “CPO Guidance”) establishing the circumstances under which it intends to provide registration no-action relief through a streamlined process where a commodity pool operator (“CPO”) has delegated investment management authority with respect to a commodity pool to another person registered as a CPO.  The CFTC had historically received requests for, and in some cases issued, such no-action relief, but without the benefit of a streamlined approach.

A CPO is generally defined under the U.S. Commodity Exchange Act to include a person engaged in a business that is of the nature of a commodity pool or similar form of enterprise and who markets interests in a commodity pool and solicits, accepts or receives customer funds for investment in the pool for the purpose of trading in “commodity interests.”  Pursuant to modifications made in connection with Dodd-Frank, “commodity interests” are now defined to include swaps.[2]

In the CPO Guidance, the CFTC included a form of request for no-action relief, which provides for certifications and acknowledgements to be made by both the delegating and designated CPOs.  Significantly, the delegating CPO is to represent that the applicable “criteria” for relief, as set forth in the CPO Guidance, are met.  Similarly, the designated CPO is to acknowledge that it meets all the applicable “criteria.”  These criteria include, inter alia, that: (i) the delegation of investment management authority has been made (from the delegating CPO to the designated CPO) with respect to the commodity pool pursuant to a “legally binding document”; (ii) the designated CPO is registered as a CPO; (iii) there is a business reason for the designated CPO being a separate entity from the delegating CPO that is not solely to avoid registration by the delegating CPO; and (iv) the books and records of the delegating CPO with respect to the commodity pool are maintained by the designated CPO in accordance with CFTC Regulation 1.31.

[1] CFTC Staff Letter No. 14-69, Requesting Registration No-Action Relief on an Expedited Basis for Commodity Pool Operators who Delegate Certain Activities to a Registered Commodity Pool Operator under Certain Circumstances (May 12, 2014).

[2] See 7 U.S.C. 1a(11)(A)(i)(I).  The corresponding definition of “commodity pool” was amended to read, in relevant part, “any investment trust, syndicate, or similar form of enterprise operated for the purpose of trading in commodity interests, including any . . . swap.”  7 U.S.C. § 1a(10) (emphasis added).

Collateral Segregation Notices for Uncleared Swaps

Consistent with a final rule issued by the Commodity Future Trading Commission last year (the “IM Segregation Rule”),[1] registered swap dealers have begun to notify counterparties prior to the execution of uncleared swaps that counterparties may require that any initial margin be “segregated,” that is, held at an independent custodian in an individual account separate from margin posted by other swap dealer counterparties.

Generally, pursuant to the IM Segregation Rule, a swap dealer must notify a counterparty[2] that the counterparty may require segregation of initial margin for an uncleared swap either: (i) prior to the execution of each swap; or (ii) once per calendar year.  This notice also must identify one or more custodians[3] as an acceptable depository for segregated initial margin and provide information (if available) regarding the pricing of segregation with each such custodian.[4]  The swap dealer may not confirm the terms of any uncleared swap until obtaining the counterparty’s election as to whether segregation is required.[5]  If a counterparty receives a segregation rights notice for a specific calendar year, it may, after making its election, notify the swap dealer that it wishes to change its election, and such changed election will be applicable to swaps entered into thereafter.[6]

Swap dealers have been required to provide segregation rights notices for initial margin to each “new counterparty” (i.e., a counterparty with which no agreement concerning uncleared swaps — such as an ISDA Master Agreement — existed between the swap dealer and that counterparty as of January 6, 2014) since May 5, 2014.  However, such notices must be provided to each “existing counterparty” (i.e., a counterparty with which an agreement concerning uncleared swaps — such as an ISDA Master Agreement — existed between the swap dealer and that counterparty as of January 6, 2014) beginning November 3, 2014.

Requiring segregation of initial margin generally provides a counterparty with a stronger claim to that margin upon an insolvency or other bankruptcy event affecting the swap dealer.  This is because the posted collateral is held separately and is identifiable and, also, the swap dealer is unable to reuse posted cash or re-hypothecate posted securities.  However, segregation may require custodial fees for which the counterparty is responsible and, possibly, higher transaction fees charged by the swap dealer.  Hence, when electing whether to require the segregation of initial margin for uncleared swaps, an end-user should balance the risk of the swap dealer’s bankruptcy against possible increased fees.

[1] Protection of Collateral of Counterparties to Uncleared Swaps; Treatment of Securities in a Portfolio Margining Account in a Commodity Bankruptcy, 78 Fed. Reg. 66,621 (November 6, 2013).  Note that the rules pursuant to which swap dealers must collect initial margin in connection with uncleared swaps are expected to be finalized later this year.

[2] The notice must be provided to the counterparty’s officer who is responsible for the management of collateral, or, if none, to the counterparty’s Chief Risk Officer, or, if none, to the counterparty’s Chief Executive Officer, or, if none, to the highest-level decision-maker of the counterparty.

[3] The custodian must be independent of both the swap dealer and the counterparty, and segregated initial margin must be designated and held in an account segregated for and on behalf of the counterparty.  If the swap dealer and the counterparty agree, then the same account also may hold variation margin. 17 C.F.R. § 23.702(b).

[4] 17 C.F.R. § 23.701(a).

[5] 17 C.F.R. § 23.701(d).

[6] 17 C.F.R. § 23.701(f).

NYS Bar Association Tax Session Issues Report on Section 871(m) Regulations

On May 20, 2014, the New York State Bar Association Tax Session issued a Report on Proposed Regulations under Section 871(m) of the Internal Revenue Code of 1986.  The report addresses proposed regulations that the Internal Revenue Service issued in December 2013 concerning withholding on equity-linked financial instruments that reference U.S. stocks.[1]  The report, available here, was co-authored by Orrick partner Peter J. Connors.

[1] A past issue of Derivatives in Review (available here) also reported on those proposed regulations.


ISDA Publishes Section 2(a)(iii) Form of Amendment

In June 2014, the International Swaps and Derivatives Association, Inc. (“ISDA”) published a form of amendment relating to Section 2(a)(iii) of the preprinted form of ISDA Master Agreement.  Section 2(a)(iii) generally permits a contracting party to withhold performance indefinitely if an event of default or potential event of default has occurred and is continuing (or an early termination date has been designated) with respect to its counterparty.  ISDA initially announced an initiative to evaluate and address issues arising under Section 2(a)(iii) in 2011.

As previously discussed in Derivatives in Review, Section 2(a)(iii) has been treated inconsistently by courts across various jurisdictions in recent years, leading to market uncertainty regarding the ability of a non-defaulting party to indefinitely withhold performance.  The form of amendment effectively allows a defaulting party to impose a limit on the non-defaulting party’s right to suspend performance by designating a “condition end date” to that suspension of performance (the form of amendment suggests 90 days after notice by the defaulting party for this period), after which a non-defaulting party either must perform (together with payment of interest[1] on withheld amounts or other compensation in respect of withheld delivery), or terminate.

[1] Such interest would be payable at the “Non-default Rate,” which is defined: (i) under the 1992 ISDA Master Agreement, as a rate equal to the cost (without proof or evidence of any actual cost) to the non-defaulting party if it were to fund the relevant amount, as certified by it; and (ii) under the 2002 ISDA Master Agreement, as a rate offered to the non-defaulting party, as certified by it, by a major bank in a relevant interbank market for overnight deposits in the applicable currency, such banks selected in good faith by the non-defaulting party for the purpose of obtaining a representative rate that will reasonably reflect conditions prevailing at the time in that relevant market.

Publication of 2014 ISDA Credit Derivatives Definitions

On February 21, the International Swaps and Derivatives Association, Inc. (“ISDA”) announced the publication of the 2014 ISDA Credit Derivatives Definitions (the “2014 CD Definitions”), which amend several terms that existed in the 2003 version of the definitions, and introduce several new terms based on “lessons learned.”

The most important new terms in the 2014 CD Definitions are in response to events affecting financial institutions and sovereign entities that have occurred since the introduction of the 2003 version of definitions, including governmental interventions in bank debt.  These new terms include an entirely new credit event known as “Governmental Intervention,”[1] which is intended to be triggered upon a government-initiated “bail-in”[2] or debt restructuring, as well as a provision for delivery of instruments resulting from a government-initiated debt exchange.

In recent years, concerns have been expressed that the credit event for “Restructuring” may not cover certain measures actually taken by governments to support struggling entities, especially banks.  For example, there was uncertainty as to whether a Restructuring had been triggered by the February 2013 nationalization of SNS Bank NV, the fourth largest bank in the Netherlands, by the Dutch government and the expropriation of all of its subordinated bonds.[3]  This uncertainty was caused primarily because “expropriation” was not expressly included as a triggering event in the 2003 definition of Restructuring.

The Governmental Intervention credit event is intended to fill this gap in protection.  Governmental Intervention is 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 the Governmental Intervention credit event.

In addition to the new credit event, the 2014 CD Definitions also introduce the ability to settle certain credit events by delivery of assets into which debt is converted.  This change was prompted, at least in part, by Greece’s 2012 debt restructuring, in which the Greek government used a “collective action clause” under domestic law to exchange certain debt before an auction to settle credit default swaps could be held.  A final settlement price for contracts is typically determined by holding an auction for the defaulted bonds.  The result of the debt exchange was that there were fewer bonds constituting “deliverable obligations” for purposes of the auction.  As we have previously highlighted, credit protection buyers were spared serious losses in connection with the credit event caused by the Greek debt restructuring because the price for the new bonds delivered at the auction closely approximated the level of loss sustained by private investors on the old bonds.[5]  Nevertheless, the Greek debt exchange highlighted the need to address a potential disconnect in prices under similar circumstances in the future.

In response, the 2014 CD Definitions provide for new “Asset Package Delivery” provisions.  These provisions generally apply upon the occurrence of an “Asset Package Delivery Event,” which is defined to include events such as a Restructuring with respect to a sovereign entity.  Under the new provisions if, for example, a sovereign Restructuring credit event occurs, the assets that will be deliverable into an auction will be based on “Package Deliverable Bonds,” which are obligations that qualified as deliverable obligations at the time the Asset Package Delivery Event became effective and that are selected by ISDA based on certain specified criteria and published on its (or a third party designee’s) website.

ISDA has stated that it expects market participants to begin confirming transactions using the 2014 CD Definitions starting in September 2014.  A protocol will also be established to allow parties to utilize the 2014 CD Definitions for existing transactions.

[1] This new credit event, is defined 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).”

[2] A “bail-in” is when a borrower’s creditors are forced to partially bear some of the burden of assistance through a write-off (in contrast, a “bail-out” is when a government or external investors rescue a borrower, whether by infusing cash or assisting in the servicing of debt).  See What is a bail-in?, The Economist (April 7, 2013).

[3] See generally Letter of Minister of Finance Dijsselbloem to Parliament (English translation), dated February 1, 2013 (stating that “[i]t has been decided to expropriate the securities and other assets not only of SNS Bank but also SNS REAAL (the holding company). . . . the expropriation extends to both shares and subordinated creditors.”).  After deferring a decision on two separate occasions, the relevant ISDA determinations committee ultimately decided by a vote of 14 to 1 that a Restructuring had occurred.

[4] “Governmental Authority” is defined in Section 4.9(b) of the 2014 CD Definitions to include the following:

“(i) any de facto or de jure government (or any agency, instrumentality, ministry or department thereof);

(ii) any court, tribunal, administrative or other governmental, inter-governmental or supranational body;

(iii) any authority or any other entity (public or private) either designated as a resolution authority or charged with the regulation or supervision of the financial markets (including a central bank) of the Reference entity or some or all of its obligations; or

(iv) any other authority which is analogous to any of the entities specified in Sections 4.9(b)(i) to (iii).”

[5] See [DIR May 7, 2012].