As 2015 is now underway, we wanted to highlight some of the potential regulatory developments from the CFTC that may arise in the new year.
Overall we expect 2015 to be a year of continued CFTC implementation of the Dodd-Frank rules and related “tweaks” to those rules to address the concerns of end-users and market participants.
At the end of last year, the Office of Management and Budget published the regulatory agenda for the CFTC. Although additional items will likely arise and the CFTC may not get to every entry, the agenda gives us a good view of the CFTC’s regulatory priorities for the next year. The agenda is available here, and we highlight a few items of note below.
Guarantees of Swaps: The CFTC agenda includes a provision that the CFTC staff is considering recommending that the CFTC “address certain regulatory matters arising from its interpretation that the term "swap" includes a guarantee of such swap.” In the joint SEC and CFTC release further defining the term “swap,” the CFTC stated that it interprets the term swap to include a guarantee of such swap, to the extent that a counterparty to a swap position would have recourse to the guarantor in connection with the swap, and noted that it would address in a separate release the practical implications of such interpretation. See 77 FR 48226 (Aug. 13, 2012). In CFTC Letter 12-17, the CFTC Office of General Counsel stated that it interprets section 2(e) to require each guarantor of a swap to be an eligible contract participant (“ECP”). (See our prior posts on CFTC Letter 12-17: A Swap Guarantor Must Be An ECP: CFTC OGC Letter No. 12-17 and A Practical Guide to the Eligible Contract Participant (ECP) Definition: A Q&A for Banks and Borrowers). One issue with swap guarantees is that swap obligations made in connection with a loan will be part of the defined term “Obligations” under most credit documents, and “Obligations” are in turn secured by pledged collateral and guaranteed by affiliates of the borrower. While the application of CFTC Letter 12-17 to guarantees is clear, its application to pledges of collateral is uncertain. The market response has been for lenders to exclude swap obligations from any pledges of collateral or guarantees from entities that are not ECPs at the time to swap is entered into. In addition, the classification of a guarantee of a swap as a swap implicates recordkeeping, reporting and business conduct requirements that may be addressed in this new rulemaking.
Block Trades: The CFTC agenda includes a provision that the CFTC staff is considering proposed rules would limit off-exchange block trading to a specified percentage of the Average Daily Volume of the listed futures and options on futures contracts.
NDF Clearing: The CFTC agenda includes an entry referencing a new swap clearing requirement. Although the entry does not specifically reference non deliverable FX forwards (“NDFs”), the CFTC has made statements in the past few months that it is considering whether to issue for comment a proposed clearing determination for certain NDFs in the near future.
Finalization of Existing Rules
Margin and Collateral for Uncleared Swaps: On October 13, 2014, the CFTC re-proposed its rules regarding Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants to bring the rule in line with the margin requirements proposed by the prudential regulators (see our prior post Bank Regulators Re-Propose Rule for Margin on Uncleared Swaps). Neither the prudential regulators nor the CFTC have finalized their margin rules, and the CFTC has also not finalized (or re-issued for comment) its related regulatory capital rules for non-bank Swap Dealers. The CFTC is expected to finalize its margin rules this year. On a related note, the recently enacted “Business Risk Mitigation and Price Stabilization Act of 2015,” signed into law by President Obama as part of the Terrorism Risk Insurance Act, exempts from the margin rules applicable to swap dealers swaps to which commercial end-users, certain cooperatives and certain affiliated entities are parties. Stay tuned to The Swap Report for an update on potential changes to the margin rules as a result of the Terrorism Risk Insurance Act.
Position Limits: The CFTC is expected to finalize the currently Proposed Aggregation Rules and Proposed Position Limits Rules. In addition, the CFTC just re-opened the comment periods on these proposals in light of certain issues identified at the CFTC’s Agricultural Advisory Committee, and the comment period closes on January 22, 2015.
In addition to the items identified on the CFTC’s regulatory agenda, we expect the CFTC under Chairman Massad to continue its recent history of focusing on cross-border harmonization efforts to build a strong and consistent global regulatory framework, emphasizing its continued focus on enforcement and compliance, and taking a pragmatic approach to “tweaking” CFTC rules that pose problems to end-users (for example, see Chairman Massad's December 10, 2014 Testimony to the Senate Committee on Agriculture, Nutrition & Forestry and our prior post CFTC Chairman Massad Announces Open Meeting on Three End-User Issues). These include finalizing the proposed interpretation regarding when forward contracts with volumetric optionality should be classified as "swaps," as well as codifying prior CFTC staff no-action relief regarding CFTC Rule 1.35 recordkeeping obligations. Chairman Massad has also noted that the Commission will turn its attention to addressing issues in the evolving SEF markets for swaps, such as execution methods and package transactions.