ISDA Publishes IBOR Consultation Paper

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On July 12, the International Swaps and Derivatives Association, Inc. (“ISDA”) initiated a market-wide consultation (the “Consultation”)[1] 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.[2] 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.

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CFTC Chairman Giancarlo Testifies on Virtual Currency and FinTech

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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.[1] 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.

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Proposed Regulations Favorably Affect Foreign Currency Hedging Transactions

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Background

United States shareholders of controlled foreign corporations (“CFCs”) are required to include certain forms of passive income in their taxable income. This is referred to as “subpart F income” by reference to its position in the Internal Revenue Code. Subpart F income is includable as ordinary income. Until the enactment of recent tax reform legislation, if income of a CFC was not subpart F income, the U.S. shareholders did not have to include it when calculating their income for the current year and the tax was effectively deferred. This has changed with the adoption of the Global Intangible Low-Taxed Income (“GILTI”) regime, as part of the Tax Cuts and Jobs Act, which will require non-subpart F income to be taxed currently but at a lower rate than regular income. We will turn to that at the end of this note. Prior to the enactment of the Tax Cuts and Jobs Act, on December 19, 2017, the Treasury and the Internal Revenue Service proposed regulations under sections 446, 988 and 954 (the “Proposed Regulations”) that favorably impact the treatment of foreign currency hedges of the activities of a CFC, some of which we will describe below. READ MORE →

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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Orrick Hosts Panel Discussion on Use of Financial Instruments in Renewable Energy Transactions

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Independent power producers (IPPs) and incumbent electric utilities have traditionally entered into long-term arrangements for the physical sale and delivery of electric power. As alternatives to these arrangements, the renewable energy market is increasingly making use of financial trading instruments. On February 22, 2018, energy professionals from Microsoft, Citi Commodities and Lockton Companies met in Houston’s Orrick offices to discuss various products in the financial markets available to hedge renewable energy pricing and volumetric risk. This presentation is part of a series of events hosted by the Houston chapter of Women of Renewable Industries and Sustainable Energy (WRISE).

Cause for Caution: Virtual Currency-Related Enforcement Actions

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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.”[1] 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 →

English Supreme Court Brings an End to Dexia-Prato Swap Dispute

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On January 18 the English Supreme Court refused to grant Comune di Prato (“Prato”), an Italian local authority with responsibility for the municipality of Prato in Tuscany, permission to appeal a 2017 decision of the Court of Appeals in favor of Dexia Creditop SpA (“Dexia”), Prato’s swap counterparty.[1] This decision brings to an end a long-standing dispute that was one of many involving swaps entered into by Italian municipalities between 2001 and 2008, when the onset of the financial crisis triggered defaults and brought increased scrutiny to the derivatives market.[2]

The decision of the Court of Appeals, together with the determination by the Supreme Court not to allow further appeal, may provide greater certainty as to the narrow scope of Article 3(3) of the Rome Convention, particularly in respect of derivatives agreements documented under standard documentation that are governed by English law. READ MORE →

CFTC Amends Recordkeeping Rules

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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.[1] 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.”[2] 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.[3] READ MORE →

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 →