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
In September 2016, the International Swaps and Derivatives Association, Inc. (“ISDA”) published a wide-ranging white paper entitled “The Future of Derivatives Processing and Market Infrastructure.” The white paper proposes a “path forward” from the new regulatory ecosystem created in response to the financial crisis and the resulting compliance burden on market participants.
As described in the white paper, tight time frames for complying with regulatory requirements prevented market participants in various jurisdictions from making necessary changes to compliance, operational risk management, and other processes in an optimal manner. The resulting complex workflows have created challenges. The white paper’s proposals are intended to foster a “standardized, efficient, robust and compliant ecosystem that supports the needs of an array of market participants.” In particular, the white paper identifies three key areas for improvement: (i) standardization; (ii) collaboration; and (iii) technology. READ MORE
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. 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.” 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. 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