Posts by: Jonas Robison

LIBOR Discontinuance and the Derivatives Market

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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.[1] The total market of financial instruments based on LIBOR is approximately $350 trillion. READ MORE →

CME and LCH Amend Rulebooks on Variation Margin

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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 →

Effective Date for FINRA Rule 4210 Margin Amendments Approaches

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Beginning on December 15, 2017, amendments approved by the Securities and Exchange Commission (“SEC”) last year to FINRA Rule 4210[1] 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.[2]

These new margin requirements apply to “Covered Agency Transactions,” which include: (i) “to-be-announced” (or “TBA”) transactions[3] on mortgage-backed securities (“MBS”) and specified pool transactions[4] 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.[5]  TBA transactions account for the vast majority of trading in the sizable agency MBS market.[6] READ MORE →

CFTC Extends No-Action Relief to Swap Dealers in Connection with Swaps Subject to EMIR Margin Requirements

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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.[1]  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 →

Regulation AT – An Update

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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 →

Recent Blockchain Regulatory Developments

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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.[1]  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.”[2]  Each of these recent developments is discussed in turn below. READ MORE →

CFTC Proposes Amendments to Recordkeeping Requirements

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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.[1]  The proposed amendments are largely intended to modernize and make technology-neutral the form and manner in which regulatory records are kept.[2]

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. [3]  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.[4] READ MORE →

CFTC Delays Reduction in Swap Dealer De Minimis Exception Threshold

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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.

The delay in the threshold decline follows the recent issuance by the CFTC of the Swap Dealer De Minimis Exception Final Staff Report (the “Final Report”).[2]  The Final Report supplemented a preliminary report (the “Preliminary Report”)[3] on the same matters and provided a summary of numerous comment letters the CFTC received in response to that report, as well as further data analysis.  These two reports together comprise the “report” contemplated by CFTC Regulation 1.3(ggg)(4)(ii)(B), which directed the CFTC to issue a report on topics relating to the definition of the term “swap dealer” and the de minimis threshold.

The Preliminary Report analyzed available swap data (primarily from the four swap data repositories (“SDRs”) registered with the CFTC) during the period from April 1, 2014, through March 31, 2015, for five asset classes: interest rate swaps (“IRS”), credit default swaps (“CDS”), non-financial commodities (“Non-Financial Commodities”), foreign exchange derivatives and equity swaps. However, the CFTC noted in the Final Report that it faced numerous challenges in data quality available from the SDRs, including a lack of information regarding whether a swap was entered into for dealing purposes and a lack of reliable notional data for all but IRS and CDS.[4]

The CFTC solicited comments on several topics in the Preliminary Report, including: (i) whether the current de minimis threshold should be maintained, raised or reduced; (ii) whether swaps that are executed on a swap execution facility (“SEF”) or designated contract market (“DCM”) and/or centrally cleared should be excluded from an entity’s de minimis calculation; (iii) whether the de minimis exception should be based on multiple factors (e.g., number of counterparties) instead of only gross notional swap dealing activity; (iv) whether a de minimis threshold should be established for each asset class; and (v) whether the current exclusion available to insured depositary institutions should be expanded.  The CFTC received 24 comment letters from banks, industry groups, legislators and other market participants and interested parties in response to the Preliminary Report.

The Final Report analyzed an additional one-year period of data for the IRS, CDS and Non-Financial Commodity asset classes to the period considered in the Preliminary Report.[5]  The primary conclusion of the Final Report was that “only a substantial increase or decrease in the de minimis threshold would have a significant impact on the amount of IRS and CDS covered by swap dealer regulation, as measured by notional amount, transactions, or unique counterparties.”[6]  The following chart from the Final Report summarized the results leading to this conclusion:[7]

Table 1 – IRS and CDS Potential Dealing Activity Covered by Notional Amount

dir-october-2016-table

Consistent with the Preliminary Report, the Final Report estimated that approximately 84 additional entities (from 145 to 229 entities) trading IRS and CDS might have to register as swap dealers if the de minimis threshold declined to $3 billion.  However, this 58% increase in the number of entities regulated would result in coverage of less than 1% of additional notional activity and swap transactions, and only 4% of additional unique counterparties.  Interestingly, as reflected in the table set forth above, an increase of the de minimis threshold to $15 billion would yield similar results: 34 fewer entities having to register, but reduced coverage of less than 1% of additional notional activity, swap activity and unique counterparties.

Moreover, the data analyzed indicated that a substantial majority of swaps (99% of IRS, 99% CDS and 89% Non-Financial Commodity swaps) involved a registered swap dealer during the final review period. In conclusion, the CFTC stated that it may want to consider whether to set the de minimis threshold to its current $8 billion threshold, allow the threshold to decline to $3 billion, as scheduled, or delay the reduction of the threshold while it continues its efforts to improve data quality.

Separately, the Final Report indicated that the comments received generally expressed support for excluding from an entity’s de minimis calculations swaps entered into on a SEF or DCM and/or centrally cleared, but that the CFTC had not had sufficient time to evaluate several factors that could impact the implementation of such an exclusion.[8]

In addition, the Final Report stated that the CFTC may want to consider: (i) maintaining a single de minimis threshold based on notional amount (instead of a threshold based on multiple factors); and (ii) maintaining the single gross notional de minimis exception (instead of adopting a class-specific approach) or consider adopting a class-specific approach in the future as data quality improves.[9]

Finally, the Final Report indicated that the CFTC may want to consider whether the conditions to the current exclusion to the swap dealer definition for insured depository institutions are overly-restrictive.

[1] Order Establishing De Minimis Threshold Phase – In Termination Date, 81 Fed. Reg. 71, 605 (October 18, 2016).

[2] Swap Dealer De Minimis Exception Final Report, August 15, 2016 (available at http://www.cftc.gov/idc/groups/public/@swaps/documents/file/dfreport_sddeminis081516.pdf).

[3] Swap Dealer De Minimis Exception Preliminary Report, November 18, 2015 (available at: http://www.cftc.gov/idc/groups/public/@swaps/documents/file/dfreport_sddeminis_1115.pdf).  For a summary of this report, click here.

[4] Final Report, at 5.

[5] The CFTC focused on IRS and CDS data because reliable notional data was not available for the other asset classes. Final Report, at 20.  The Final Report highlighted that many of the same limitations noted in the Preliminary Report for Non-Financial Commodity swaps persisted, but that the CFTC nevertheless performed an analysis using counterparty and transaction counts for this asset class. Id. at 19-20.

[6] Id. at 20.

[7] Id. at 21 (Table 1).

[8] Id. at 25.

[9] Id. at 26.

 

CFTC Expands Swap Clearing Requirement

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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 →