Industry Protocols, Publications and Actions

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. READ MORE

Industry Groups File Lawsuit Challenging Cross-Border Guidance


On December 4, 2013, the Securities Industry and Financial Markets Association, the International Swaps and Derivatives Association, Inc., and the Institute of International Bankers filed a lawsuit challenging the CFTC’s final cross-border guidance issued in July of 2013 (the “Guidance”).[1]  The amended complaint[2] primarily argues that, in issuing the Guidance, the CFTC issued “a sweeping, international compliance directive that it characterized as mere ‘guidance,’”[3] instead of promulgating an actual rule governing the extraterritorial reach of the rules under Title VII of the Dodd-Frank Act that complied with the requirements of the Administrative Procedure Act (“APA”) and the Commodity Exchange Act (“CEA”), such as cost-benefit analysis.[4]  Put simply, the plaintiffs argue that the CFTC “purposefully circumvented the congressionally-required procedures for CFTC rulemaking.”[5]  Despite its purported status as mere non-binding guidance, the amended complaint notes that the CFTC has repeatedly made clear that the Guidance is intended to bind the CFTC staff and the public in the manner of a rule.[6]  The amended complaint further argues that, in promulgating many Title VII rules (such as the clearing requirement rule and the swap data repository reporting rule), despite public comments, the CFTC failed to address how those rules would apply extraterritorially and failed to consider the costs and benefits of the application of the rules to foreign entities and entities engaged in cross-border transactions.[7]


ISDA Publishes Industry Provisions for Collateral Segregation of Uncleared Swaps


On December 6, 2011, the International Swaps and Derivatives Association, Inc. (“ISDA”) published sample tri-party provisions intended to assist market participants in the negotiation of provisions relating to the segregation of excess collateral, or “independent amounts.” The Dodd-Frank Act (the “Act”) imposes certain requirements for dealers to collect initial and variation margin from their counterparties. The sample provisions effectively provide market participants with suggested mechanics to implement Sections 724(c) (regarding “swaps”) and Section 763(d) (regarding “security-based swaps”) of Title VII of the Act, which generally require that dealers provide their end-user counterparties with the option of having independent amount collateral they deliver be segregated and held by a third-party custodian. READ MORE

ISDA to Create Form of Amendment to Address Suspension of Payments


The International Swaps and Derivatives Association, Inc. (“ISDA”) is preparing forms of amendment to its boilerplate master agreements in connection with market practice relating to the suspension of payments by a non-defaulting party. ISDA is also considering a protocol to implement the amendments into existing agreements on a multilateral basis.

Currently, Section 2(a)(iii) of the ISDA master agreements permits a non-defaulting party to indefinitely withhold scheduled payments it owes on transactions while at the same time not requiring that party to terminate its outstanding transactions. This contractual provision has been treated differently across jurisdictions in disputes. Most recently, cases relating to the Lehman bankruptcy, both in New York and in the United Kingdom, have brought additional attention to this provision. In one case, known as Metavante (2009), a New York bankruptcy court concluded that by failing to terminate its existing transactions with Lehman for more than 11 months after its bankruptcy filing, the non-defaulting party had waived its right to terminate pursuant to the “safe harbor” provisions of the U.S. Bankruptcy Code and, therefore, no longer had the right to suspend scheduled payments. In another case, known as Lomas (2010), the English High Court decided that the non-defaulting party could withhold scheduled payments indefinitely (i.e., the court refused to imply that the parties had intended to limit such a suspension only for a “reasonable period”), and that the non-defaulting party was not obligated to terminate its five outstanding swap transactions (in which case it would have owed Lehman some US$57.3 million). The Lomas court also concluded that any suspended payments would be extinguished on the last scheduled payment date of a transaction, provided that the condition precedent had not been satisfied (i.e., the default had not been cured) at such time.

The original intent of Section 2(a)(iii) was to protect a non-defaulting party from increasing its exposure to a defaulting party (or a party that was approaching default). However, the conflicting decisions present significant uncertainty and litigation risk for market participants and have, in some respects, upended market expectations. As a result, ISDA is considering certain amendments that would clarify and restrict a non-defaulting party’s rights under Section 2(a)(iii). Specifically, ISDA may consider proposing a time limit for suspension of payments (e.g., 90-180 days after a party withholds a scheduled payment), after which a non-defaulting party must perform or terminate. ISDA also may consider clarifying that a party’s obligation to pay suspended payments survives—and is not extinguished—upon the scheduled termination of the relevant transaction. Of course, even with these amendments, contractual provisions permitting a party to suspend payments to a bankrupt entity would be subject to applicable local bankruptcy law.

Industry Groups Send Comments to Regulators on Collateral Segregation


On October 8th, ISDA sent pre-proposal comments (the “ISDA Comments”) to the CFTC regarding the segregation of collateral for uncleared swaps in light of the rulemaking the CFTC will undertake to implement Section 724(c) of the Act.[1]  The ISDA Comments note that ISDA had published in March, along with SIFMA and the Managed Funds Association (“MFA”), a white paper (the “White Paper”) describing various approaches that may be used to segregate collateral other than variation margin (most commonly, “Independent Amounts” under an ISDA Credit Support Annex) for the benefit of a dealer in respect of uncleared derivatives transactions.[2]  The White Paper discussed three approaches that could be used for these purposes, two of which contemplated bilateral custodial relationships (i.e., between the dealer and custodian) and one of which contemplated a tri-party custodial arrangement (i.e., among the dealer, counterparty and custodian).  As the ISDA Comments note, each approach has its advantages and disadvantages.  For example, the tri-party approach may provide more robust protections for counterparties, but a bilateral approach would be less costly and complex to administer and would present fewer technical legal issues.  The ISDA Comments recommend that the CFTC collateral segregation rules should allow dealers (and “major swap participants,” as defined in the Act) to make available to counterparties both bilateral and tri-party collateral arrangements, effectively allowing counterparties to choose an arrangement based on the cost-benefit considerations that they deem important.

The ISDA Comments further propose that the CFTC rules permit swap dealers (and major swap participants) to agree with their counterparties, based on the facts and circumstances that are relevant to their relationship, how certain issues related to collateral segregation should be resolved, including (i) the custodian to be used; (ii) the fees to be paid by the counterparty; (iii) which party will bear the risk of loss upon a custodian insolvency or performance failure (note that this risk is allocated to a secured party under the boilerplate ISDA Credit Support Annex); (iv) the form in which collateral may be posted; and (v) if cash is posted, how and where it will be invested and held and how gains and losses on such investments will be allocated and distributed.  Finally, the ISDA Comments note that Section 763 of the Act contains collateral segregation provisions for security-based swaps that are virtually identical to those set forth for swaps under Section 742, but that the Act does not specifically require the CFTC to conduct a joint rulemaking with the SEC on collateral segregation.  The ISDA Comments urge the Commissions to consult closely in their respective rulemakings to avoid inconsistent requirements that could introduce unnecessary costs, inefficiencies and the potential for unintended risks.

On October 27th, SIFMA also sent a comment letter (the “SIFMA Comments”) to both Commissions on several topics, including the segregation of collateral for uncleared swaps.  The SIFMA Comments note that there is currently no industry-wide standard for third-party custody of margin and that such custodial arrangements raise additional risks for swap dealers.  As a result, the SIFMA Comments recommend that the Commissions provide industry members with their views regarding the treatment of collateral supporting uncleared swaps “at an early date” to facilitate firms’ efforts to establish the necessary infrastructure to comply with contemplated rules.  The SIFMA Comments further recommend that the suggestions set forth in the ISDA Comments be considered, including that the Commissions engage in close collaboration to avoid inconsistent requirements.

[1] The relevant segregation provisions, which are found in Section 724(c) of the Act, begin on page 309. In relevant part, this subsection provides as follows:



”(A) NOTIFICATION.—A swap dealer or major swap participant shall be required to notify the counterparty of the swap dealer or major swap participant at the beginning of a swap transaction that the counterparty has the right to require segregation of the funds or other property supplied to margin, guarantee, or secure the obligations of the counterparty.

”(B) SEGREGATION AND MAINTENANCE OF FUNDS.—At the request of a counterparty to a swap that provides funds or other property to a swap dealer or major swap participant to margin, guarantee, or secure the obligations of the counterparty, the swap dealer or major swap participant shall—

”(i) segregate the funds or other property for the benefit of the counterparty; and

”(ii) in accordance with such rules and regulations as the Commission may promulgate, maintain the funds or other property in a segregated account separate from the assets and other interests of the swap dealer or major swap participant.

”(2) APPLICABILITY.—The requirements described in paragraph (1) shall—

”(A) apply only to a swap between a counterparty and a swap dealer or major swap participant that is not submitted for clearing to a derivatives clearing organization; and

”(B)(i) not apply to variation margin payments; or

”(ii) not preclude any commercial arrangement regarding—

”(I) the investment of segregated funds or other property that may only be invested in such investments as the Commission may permit by rule or regulation; and

”(II) the related allocation of gains and losses resulting from any investment of the segregated funds or other property.

”(3) USE OF INDEPENDENT THIRD-PARTY CUSTODIANS.—The segregated account described in paragraph (1) shall be—

”(A) carried by an independent third-party custodian; and

”(B) designated as a segregated account for and on behalf of the counterparty.

[2] For a summary of the White Paper, see DMIR March 2010.

ISDA Publishes 2010 Preliminary Margin Survey Results


On April 23rd, ISDA released preliminary results from its 2010 ISDA Margin Survey (the “Margin Survey”).  Eighty-nine (89) firms responded to the Margin Survey, seventy (70) of which were banks or broker-dealers.  The results of the Margin Survey demonstrated that the use of collateralization as a mitigant for counterparty credit risk continued to expand.

According to the Margin Survey, seventy-eight percent (78%) of all OTC derivatives transactions now entered into among large dealers are subject to collateral agreements.  Such arrangements are especially common for credit derivatives, with ninety-seven percent (97%) of such transactions being subject to collateral agreements.

The Margin Survey reported that there are now almost 172,000 collateral agreements in place, eighty-three percent (83%) of which are bilateral arrangements under which either party may be required to deliver collateral; last year’s margin survey reported that only seventy-five percent (75%) of collateral agreements provided for bilateral arrangements.

ISDA pointed out in connection with the publication of these preliminary results that the association and the industry in general had made significant improvements in the area of collateralization.  In particular, it noted that approximately ninety percent (90%) of Margin Survey respondents indicated that they periodically perform “portfolio reconciliations”[1] (the major dealers were doing so on a daily basis) and that extensive progress had been made, in cooperation with global regulators, to strengthen the operational infrastructure of market participants.

[1] For an additional discussion of portfolio reconciliation efforts, see the January 2010 Derivatives Month in Review.

ISDA Publishes Whitepaper and Market Review on Collateral


On March 1st, the International Swaps and Derivatives Association, Inc. (“ISDA”), the Managed Funds Association and the Securities Industry and Financial Markets Association jointly published a Whitepaper (the “Whitepaper”) on Independent Amount.  On the same date, ISDA also published a market review of over-the-counter (“OTC”) bilateral collateralization practices (the “Market Review”).  The Whitepaper and Market Review were developed for the purpose of better understanding current derivative market practices surrounding collateralization, a key method of mitigating counterparty risk in exchange-traded and, especially, OTC derivatives.  The documents make specific recommendations (including for legislative and regulatory changes in certain jurisdictions) for market participants to improve or enhance their collateral management practices. READ MORE

ISDA and Market Participants Send Commitment Letter to Supervisors


On March 1st, ISDA and twenty-five (25) market participants submitted to the Federal Reserve Bank of New York, as well as to other global supervisors, a letter (the “Industry Letter”) detailing the steps the industry has taken to improve the framework for OTC derivatives transactions and making additional commitments.  The Industry Letter is the sixth in a series of letters addressing how the industry will work to, among other things, strengthen the robustness of OTC derivatives markets infrastructure and improve transparency. READ MORE

Industry Meeting on OTC Derivatives Held at Federal Reserve Bank of New York


On January 14, 2010, the Federal Reserve Bank of New York (the “Federal Reserve”) hosted a meeting of major market participants, including both major dealers and buy-side participants, industry groups (including the International Swaps and Derivatives Association, Inc. (“ISDA”), the Securities Industry and Financial Markets Association and the Managed Funds Association) and domestic and international supervisors.  The purpose of the meeting, the sixth such meeting with industry participants held at the Federal Reserve, was to discuss efforts to improve the infrastructure supporting the over-the-counter (“OTC”) derivatives market.

At the meeting, William C. Dudley, president of the Federal Reserve, noted that the industry needed to continue its efforts to bring greater transparency to the derivatives markets and reduce systemic risk.  Market participants updated the Federal Reserve on developments in the derivatives market and agreed to effect additional changes to reduce risk and increase transparency.  In particular, the market participants agreed to: (i) expand central clearing for interest rate swaps and credit derivatives (including expanding the range of products eligible for central clearing), (ii) expand reporting on OTC derivatives transactions to regulators and (iii) improve risk management for derivatives transactions that are not centrally cleared by formalizing “best practices” for managing the risks inherent in these transactions, including through collateralization.  These commitments are in addition to the commitments market participants have made to regulators to report non-cleared trades to central repositories and to work with central clearing parties to broaden the range of cleared products.  The market participants agreed to provide a letter to the regulators by March 1, 2010 detailing their progress on these new commitments.

ISDA Publishes Portfolio Reconciliation Feasibility Study


On December 18, 2009, the ISDA Collateral Committee published a study (the “Study”) on the feasibility of extending collateral portfolio reconciliations (the complete Study may be found at this link).  Since July 2008, ISDA and derivatives markets participants have made a series of commitments to regulators regarding collateral management.  These commitments have included enhancing portfolio integrity between pairs of derivatives counterparties, known as portfolio reconciliation.  In particular, industry groups and market participants have recognized the need to (i) agree to the existence and general economic terms of the transactions between them and (ii) agree to the mark-to-market value of those transactions (within some reasonable tolerance of difference). READ MORE