Industry Protocols, Publications and Actions

ISDA Publishes Additional IBOR Consultations

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On May 16, the International Swaps and Derivatives Association, Inc. (“ISDA”) published two consultations in connection with the potential discontinuation of certain interbank offered rates (“IBORs”), seeking input on (i) the replacement of USD LIBOR, CDOR and HIBOR (the “Second Benchmark Consultation”)[1] and (ii) the preferred approach for addressing pre-cessation issues in derivatives that reference certain IBORs (the “Pre-Cessation Consultation”). [2] These Consultations follow an earlier consultation published by ISDA in July 2018 (the “First Benchmark Consultation”[3] and, together with the Second Benchmark Consultation and the Pre-Cessation Consultation, the “Consultations”) relating to the potential discontinuation of numerous IBOR benchmark rates. READ MORE →

ACIC Releases Model Provision for Swap Breakage

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On April 18, the American College of Investment Counsel (the “ACIC”) released a final version of its Model Form Make-Whole and Swap Breakage Indemnity Language (the “Model Provision”),[1] as well as a substantially similar Swap Indemnity Letter Form (the “Letter Form”).[2] These final versions of the Model Provision and the Letter Form revise the initial drafts, released for comment on May 20, 2018, which were prepared to replace the existing 2007 versions. The purpose of both the Model Provision and the Letter Form is to place noteholders purchasing non-U.S. dollar denominated notes and entering into a cash-flow hedge with a swap counterparty in a similar economic position as if they had purchased a U.S. dollar denominated note.[3] READ MORE →

An End User’s Practical Guide to the QFC Stay Rules

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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.[1] 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.

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CFTC Releases White Paper Assessing Its Dodd-Frank Implementation

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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.”

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CFTC Indicates Willingness to Help Incubate Fintech

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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.

ISDA Publishes 2016 Variation Margin Credit Support Annex (NY Law)

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On April 14, 2016, the International Swaps and Derivatives Association, Inc. (“ISDA”) published the 2016 Variation Margin Credit Support Annex (New York Law) (the “2016 VM Annex (NY)”). The purpose of this document is to facilitate compliance with margin requirements for non-cleared derivatives scheduled to be phased in shortly in the United States.[1]

In the United States, by the end of 2015, both the prudential regulators[2] and the Commodity Futures Trading Commission (“CFTC”) had approved final rules generally imposing initial margin and variation margin requirements on certain regulated entities and their counterparties in connection with non-cleared derivatives.[3]  These rules incorporate compliance dates that depend on the type of margin (initial or variation),[4] the types of counterparties and, generally, the volume of transactions entered into by the counterparties.  The first of these compliance dates, which applies to trades between the largest derivatives users, is September 1, 2016.  Specifically, beginning on this date, the final rules impose initial margin and variation margin requirements where both the registered swap dealer or other entity subject to regulation (combined with its affiliates) and the counterparty (combined with its affiliates) have an average daily aggregate notional amount of non-cleared swaps, non-cleared security-based swaps, foreign exchange forwards, and foreign exchange swaps (“covered swaps”) for March, April, and May of 2016 exceeding $3 trillion.

The collateral calculation and transfer mechanics of the 2016 VM Annex (NY) are fairly similar to those in existing credit support annexes published by ISDA, including the standard 1994 ISDA Credit Support Annex (New York law) (the “Existing NY Annex”).  However, under the 2016 VM Annex (NY), the only transactions under an ISDA Master Agreement that are relevant for purpose of determining “Exposure” (generally, the mid-market estimate of what would be paid or received for replacement transactions to outstanding transactions) are to be specified by the parties as “Covered Transactions” in the Paragraph 13 to the 2016 VM Annex (NY).  Moreover, initial margin (known as “Independent Amount” in the Existing NY Annex) is not relevant for purposes of the 2016 VM Annex (NY), although such margin may be calculated and collected pursuant to another credit support annex or similar document (defined in the 2016 VM Annex (NY) as an “Other CSA”).  Similarly, the concept of a threshold of uncollateralized exposure (known as “Threshold” in the Existing NY Annex) is not relevant for purposes of the 2016 VM Annex (NY).

The 2016 VM Annex (NY) also tightens the timing for collateral transfers by one business day.  For example, if a collateral call is made by the “Notification Time” specified by the parties, then transfer of any delivery amount by the pledgor must be made by the close of business on the same business day (as opposed to by the close of business on the next business day under the Existing NY Annex).

Moreover, the 2016 VM Annex (NY) allows parties to address negative interest rate environments by agreeing to make “Negative Interest” applicable.  If the parties do not agree to make “Negative Interest” applicable and a negative interest amount is calculated on collateral posted in the form of cash for an interest period, then there is no interest payable by either party on the posted cash.

The 2016 VM Annex (NY) also allows parties to offset transfers of credit support due under the 2016 VM Annex (NY) against transfers of credit support due on the same date under any Other CSA, provided that the credit support items are fully fungible and are not segregated in an account maintained by a third party custodian or for which offsets are prohibited, by specifying that “Credit Support Offsets” is applicable.

Among other changes, the 2016 VM Annex (NY) also includes a mechanism by which posted collateral is deemed to have a value of zero if the secured party provides written notice to the pledgor in which, inter alia, the secured party represents that it has determined that one or more items of eligible credit support under the agreement has ceased to satisfy (or will cease to satisfy) collateral eligibility requirements under law applicable to the secured party requiring the collection of variation margin.

[1] This Client Alert focuses exclusively on U.S. regulatory requirements and compliance dates.

[2] The prudential regulators are the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Farm Credit Administration, and the Federal Housing Finance Agency.

[3] See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Participants, 81 Fed. Reg. 636 (January 2, 2016); Margin and Capital Requirements for Covered Swap Entities, 80 Fed. Reg. 74,840 (November 30, 2015).  For a summary of these final rules, please click here. European Union and Japanese regulators published their final rules in March 2016.

[4] Note that ISDA has been developing a “standard initial margin model” (“SIMM”), which is a standardized method for calculating initial margin on uncleared swaps.  Using a standard framework to calculate initial margin is expected to reduce the potential for disputes. The SIMM was discussed in a previous Derivatives in Review posting (available here).

ISDA Webinar Addresses Development of a “Standard Initial Margin Model”

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In February 2015, the International Swaps and Derivatives Association, Inc. (“ISDA”) released a webinar on various issues related to the margin requirements for uncleared swaps.[1]  Specifically, the webinar: (i) covered the organizational structure of ISDA’s Working Group on Margin Requirements Implementation Initiative and each of the Initiative’s “workstreams” responsible for tasks associated with the margin rules (i.e., the Portfolio Integrity Workstream, the Margin & Collateral Workstream, the Risk Classification & Methodology Workstream, the Data Sources Workstream, the Dispute Resolution Workstream, and the Legal & Documentation Workstream); (ii) provided an update on ISDA’s efforts to develop, and obtain regulatory approval for, its “standard initial margin model” (“SIMM”), which is a standardized method for calculating  initial margin on uncleared swaps; and (iii) discussed significant legal and operational issues related to the implementation of the recently re-proposed uncleared swap margin regulations.[2] READ MORE →

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

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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. READ MORE →

SIFMA v. CFTC Cross-Border Lawsuit Dismissed

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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.

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

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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.