Jonas Robison, a Senior Associate
in Orrick’s New York office, is a member of the Structured Finance Group. His
practice focuses on derivatives – including negotiating documentation and
advising on the requirements under the Dodd-Frank Act – as well as
securitization, financial product taxation, private funds, and general corporate
Jonas was previously seconded to Luxottica Group and, before law school,
worked at the Federal Reserve Board.
The Board of Governors of the Federal Reserve System (Board), the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) adopted rules (together, the QFC Stay Rules) in 2017 requiring amendments to certain qualified financial contracts (QFCs). The compliance dates for these rules depend on the type of QFC counterparty facing a “covered entity” (as defined below), and are being phased in beginning on January 1, 2019 and ending on January 1, 2020. Notwithstanding this compliance phase-in, dealers subject to the QFC Stay Rules have been requesting that all of their counterparties, including end users, take action to facilitate compliance as though the initial compliance date, January 1, 2019, applied to all types of QFC counterparties. This article is intended to help buy-side participants navigate the compliance process, with emphasis on describing (i) the various types of contracts that constitute “covered” QFCs subject to the rules and (ii) the various alternative methods for compliance.
In recent years, the U.S. Commodity Futures Trading Commission (CFTC) has devoted significant resources to addressing how the requirements of the Commodity Exchange Act (CEA) and the regulations thereunder apply to transactions involving Bitcoin and other virtual currencies. The CFTC has not adopted any rules specific to virtual currencies, but rather has made clear that derivatives contracts based on a virtual currency are subject generally to the same CFTC regulations that apply to other types of derivatives contracts that have traditionally been within the CFTC’s jurisdiction. Additionally, the CFTC has noted that derivatives contracts are susceptible to automation through smart contracts and distributed ledger technology (DLT) and “[e]xisting law and regulation apply equally regardless what form a contract takes . . . [even to] contracts [or parts of contracts] that are written in code[.]”
An Orrick lawyer authored an article titled “Getting Smarter: CFTC Publishes Smart Contracts Primer,” addressing LabCFTC’s recently released “Primer on Smart Contracts.” The Primer provides (i) a high-level overview of smart contract technology and applications, (ii) a discussion of the potential role of the CFTC in smart contract regulation and (iii) a discussion of the unique risks and governance challenges posed by smart contracts. The article is available here.
On July 12, the International Swaps and Derivatives Association, Inc. (“ISDA”) initiated a market-wide consultation (the “Consultation”) on technical issues related to new benchmark fallbacks for derivatives referencing certain interbank offered rates, or IBORs, in response to the expected discontinuance of the publication of those IBORs at the end of 2021. The purpose of the Consultation is to ease the transition of the derivatives market from referencing existing IBOR rates to alternative risk-free-rates (“RFRs”) that have been identified as part of the global benchmark reforms. These RFRs are intended to be based on robust and highly liquid underlying markets that, unlike the relevant IBORs, do not require and are not based on submissions from panel banks or others.
On July 25, Commodity Futures Trading Commission (“CFTC”) Chairman Giancarlo testified before the House Committee on Agriculture to address the priorities and recent work of the agency. The testimony touched on a number of areas, but focused in significant part on the CFTC’s oversight of virtual currencies and financial technology (“FinTech”). Those portions of the testimony are summarized below.
On April 26, Commodity Futures Trading Commission (“CFTC”) Chairman Giancarlo and the CFTC Chief Economist published a white paper titled “Swaps Regulation Version 2.0: An Assessment of the Current Implementation of Reform and Proposals for Next Steps” (the “White Paper”). At the International Swaps and Derivatives Association, Inc. (“ISDA”) annual meeting where the White Paper was initially presented, Chairman Giancarlo described the White Paper as “economy-focused” and stated that regulatory role of the CFTC is focused on “what’s in the best interest of markets.”
On January 19 the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) issued a joint statement warning about potential enforcement actions involving the offering of digital instruments: “When market participants engage in fraud under the guise of offering digital instruments – whether characterized as virtual currencies, coins, tokens, or the like – the SEC and CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws.” In conjunction with this warning, the CFTC brought a number of virtual currency enforcement actions in January, three of which are discussed below. READ MORE
On August 28, amendments recently adopted by the Commodity Futures Trading Commission (“CFTC”) to recordkeeping obligations under CFTC Rule 1.31 are scheduled to become effective. The CFTC periodically updates this rule to take into account technological advances and modernize requirements for persons subject to recordkeeping obligations under the U.S. Commodity Exchange Act or the CFTC’s rules, known as “records entities.” In proposing these amendments earlier this year, the CFTC acknowledged that recordkeeping has “evolved significantly” since its last overhaul of Rule 1.31 in 1999. READ MORE
On July 27, the Chief Executive of the UK Financial Conduct Authority (“FCA”) announced that, after the end of 2021, the FCA would no longer use its power to persuade or compel panel banks to submit rate information used to determine the London Interbank Offered Rate, known as “LIBOR.” LIBOR serves as a benchmark rate for hundreds of trillions of dollars of securities, loans and transactions, including over-the-counter and exchange-traded derivatives. The total market of financial instruments based on LIBOR is approximately $350 trillion. READ MORE
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