On July 1, 2020, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the Federal Housing Finance Agency (together, the “agencies”) published a final rule adopting amendments to the agencies’ regulations imposing margin requirements on swap dealers and security-based swap dealers (“covered swap entities”). On the same date, the agencies also published an interim final rule prompted by the COVID-19 crisis, postponing certain initial margin implementation deadlines.
The amendments in the final rule include several clarifications of importance to market participants, including with respect to the treatment of legacy swaps in connection with IBOR transitions. Some of the more significant amendments include the following:
- Legacy Swap Status. The final rule permits swaps entered into before an applicable compliance date (“legacy swaps”) to retain their legacy status (and so, not trigger margin requirements) in certain circumstances:
- IBOR Transition. Legacy swaps retain their status if such swaps are amended to replace an IBOR or other discontinued benchmark rate. The final rule clarifies that benchmark amendments may be made to interest rates under any category of non-cleared swap, not just interest rate swaps (g., a rate used as a discounting interest rate for collateral or payment calculations in a commodity, foreign exchange, equity or credit swap).
- Other Amendments. Legacy swaps also retain their status if they are amended to reflect technical changes (g., administrative or operational provisions, such as payment instructions) that do not alter the fundamental economic terms of the non-cleared swap or to reduce operational or counterparty risk, such as notional reductions and portfolio compressions.
- Initial Margin Compliance Dates. The final rule introduces an additional compliance date for initial margin requirements. Prior to this amendment, the initial margin requirements were implemented in five phases, from September 1, 2016 through September 1, 2020, depending on the size of the covered swap entity’s portfolio of non-cleared swaps and the market participant’s portfolio of non-cleared swaps. (Variation margin requirements for all covered swap entities and in-scope market participants were completely phased in by March 1, 2017.)
The fifth phase was scheduled to take effect on September 1, 2020 and would have applied to covered swap entities and market participants with an average daily aggregate notional amount (AANA) of between $8 billion and $750 billion. This fifth phase was intended to cover the category with the lowest thresholds, with market participants having less than $8 billion in AANA exempt from the initial margin requirements. However, the amended compliance schedule has split the fifth stage into two, adding a sixth phase for certain entities. Specifically, the amendments require compliance by September 1, 2020, for market participants with an AANA ranging from $50 billion to $750 billion, while the compliance date for those with AANA ranging from $8 billion up to $50 billion has been extended until September 1, 2021.
At the same time, the COVID-19-related interim final rule extends for one year the phase five and phase six deadlines. Hence, the effective date for phase five is September 1, 2021, and for phase six is September 1, 2022.
- Inter-affiliate Swaps. The final rule modifies the initial margin (but not variation margin) requirements for non-cleared swaps between covered swap entities and their affiliates, subject to certain conditions. Specifically, a covered swap entity will calculate and monitor the amount of inter-affiliate initial margin that otherwise would be required to be collected, but must actually collect initial margin from its affiliates only if such aggregate initial margin calculation amount exceeds 15 percent of the covered swap entity’s Tier 1 capital (the “15 Percent Tier 1 Threshold”).
The requirement to collect initial margin will apply to inter-affiliate swaps executed on any business day that the 15 Percent Tier 1 Threshold is exceeded and will remain in place until the 15 Percent Tier 1 Threshold is no longer exceeded.
- Trading Documentation. The final rule clarifies that a covered swap entity is not required to execute initial margin trading documentation with a counterparty until it is actually required to collect or post initial margin.
The postponed phase five and phase six effective dates should allay industry concerns about the difficulties associated with the full implementation of the initial margin requirements. A large number of relatively small market participants fall under the postponed fifth and sixth phases, affording welcome additional time for compliance. Similarly, the final rule should provide clarity regarding the treatment of covered swap entity inter-affiliate swaps and relief regarding the treatment of qualifying amendments to legacy swaps, including in connection with expected IBOR transitions.
 The applicable compliance date for a covered swap entity is based on the AANA of non-cleared swaps, foreign exchange forwards and foreign exchange swaps of the covered swap entity and its counterparty (accounting for their respective affiliates) for each business day in March, April, and May of that year.