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
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.
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
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.
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
Orrick attorneys authored an overview of Regulation Automated Trading (known as “Regulation AT”) proposed by the Commodity Futures Trading Commission (“CFTC”) in the May/June 2016 issue of the Journal of Taxation and Regulation of Financial Institutions. The “overarching goal” of proposed Regulation AT is to update the CFTC’s rules in response to the development and prevalence of electronic trading. The article is titled “Regulating Automated Trading in Derivatives: An Overview of the CFTC’s Proposed Regulation AT” and is available here.
The disruptive effects of blockchain technology on the financial system may take several years to materialize. Nevertheless, in preparation, regulators are increasingly focused on understanding potential uses of blockchain technology and considering related legal issues. Many regulators are already familiar with bitcoin, the popular virtual currency underpinned by blockchain technology.[1] As discussed below, the bitcoin blockchain, which records and makes publicly available every transaction ever made in that virtual currency, is a “distributed ledger” created by a “consensus algorithm” that ensures that each local copy of the distributed ledger is identical to every other local copy. It is widely expected that such distributed ledger technology (“DLT”) will be used in the future to track the ownership of financial, legal, physical, electronic, and other types of assets and, as discussed below, to automate the performance of certain contracts.
The CFTC has begun to consider the implications of DLT with respect to the derivatives markets. For example, a meeting of the CFTC Technology Advisory Committee (the “TAC”) on February 23, 2016 featured a panel presentation, titled “Blockchain and the Potential Application of Distributed Ledger Technology to the Derivatives Markets.”[2] In addition, CFTC Commissioner J. Christopher Giancarlo has recently given numerous speeches on the topic to various groups, including Markit Group and the Depository Trust & Clearing Corporation.[3] An overview of DLT is provided below, followed by a summary of certain points, including legal considerations, from the TAC meeting and Commissioner Giancarlo’s speeches. READ MORE
