On June 6, 2019, the Commodity Futures Trading Commission’s (CFTC) Division of Swap Dealer and Intermediary Oversight (DSIO) announced it will provide no-action relief to permit certain amendments to legacy swaps without losing their status as legacy swaps. The CFTC Letter No. 19-13 No-Action dated as of June 06, 2019 (the “Letter”) was in response to a request from ISDA on behalf of its members for a position of no-action for failure of a swap dealer to comply with the CFTC’s uncleared swap margin requirements with respect to certain amendments to legacy swaps.
As defined in the Letter, legacy swap means a swap executed prior to the applicable compliance date prescribed in the CFTC’s uncleared swap margin rule (CFTC regulation 23.161). Where a swap is executed after the compliance date for variation margin (i.e., March 1, 2017) but before the applicable compliance date for initial margin, the swap is a legacy swap for the initial margin requirements only. Generally, pursuant to the CFTC Margin Rule, amendments to legacy swaps following the compliance date applicable to a swap dealer and its counterparty would cause such swaps to be brought into scope and require compliance with such rule.
The no-action relief provided by the Letter would permit swap dealers to continue to treat as legacy swaps (i) legacy swaps that are amended in an immaterial manner, (ii) a swap resulting from the exercise of swaption that is itself a legacy swap, (iii) the remaining portion of a swap following a partial termination of such legacy swap, (iv) the remaining portion of a swap following a partial novation of such legacy swap and (v) new swaps resulting from a multilateral compression exercise consisting solely of legacy swaps.
Summary of Request for No-Action Position
(i) Immaterial Amendments to Legacy Swaps: ISDA argues that immaterial amendments to legacy swaps should not require such swaps to be deemed “new” swaps subject to the CFTC Margin Rule. DSIO has previously recognized that certain amendments, such as administrative changes, are not often a choice of swap counterparties and do not believe swap dealers should be concerned that such changes will bring legacy swaps into scope of the CFTC Margin Rule..
(ii) Swaps Resulting from Exercise of Swaptions that are Legacy Swaps: A “swaption” is an option to enter into a specified swap upon exercise of an option. Although the swap resulting from the exercise of a swaption is processed in the same way as a new swap, the economic effect of the exercise is determined by the terms of the swaption transaction, which are agreed upon at the time both parties entered into the swaption, not when the swaption is exercised. Furthermore, ISDA argues, because the terms of the swap that results from the exercise of a swaption that is a legacy swap were set prior to the compliance date, such terms would not have “priced in” the requirements of the CFTC Margin Rule and thus such swap should be treated as a legacy swap.
(iii) Partial Terminations and Partial Novations of Legacy Swaps: When original counterparties to a swap wish to novate or terminate an original swap in part, they may agree to an amendment that reduces the notional amount of the swap by termination of a portion of a swap or novating a portion of the swap to another counterparty. The remaining portion of the swap between the original counterparties is referred to as the stub. ISDA represents that the terms of an original swap continue to govern the stub, apart from the reduction in the notional amount. ISDA requests that DSIO take a similar no-action position that the CFTC’s Division of Clearing and Risk has taken where such commission provides relief from the clearing requirement under section 2(h)(1)(A) of the CEA for partial termination and partial novations of swaps entered into prior to implementation of the CFTC clearing requirements. Thus, the legacy swaps should not lose their legacy status solely due to a reduction of notional amount by way of partial termination or partial novation of such swaps.
(iv) Multilateral Compression of Legacy Swaps: Multilateral portfolio compression allows swap market participants to decrease the number of outstanding swaps or the aggregate notional value of such swaps, thereby reducing operational risk and, in some cases, counterparty credit risk. Multilateral portfolio compression exercise, as defined in the CFTC’s regulation 23.500(h), means an exercise in which multiple swap counterparties wholly terminate or change the notional value of some or all of the swaps submitted by the counterparties for inclusion in the portfolio compression exercise and replace the terminated swaps with other swaps whose combined notional amount is less than the combined notional value of the terminated swaps in the compression exercise. ISDA requests that the DSIO take a similar no-action position as the CFTC’s Division of Clearing and Risk under section 2(h)(1)(A) of relief from the clearing requirement for amended and replacement swaps resulting from multilateral compression exercises consisting only of swaps entered into prior to implementation of the CFTC’s clearing requirement. Thus, when the original swap was a legacy swap at the time of execution, but that is subsequently amended or replaced in connection with a multilateral portfolio compression exercise after the applicable compliance date, such amended and replacement swaps of swap dealers do not lose their status as legacy swaps solely by virtue of being amended or replaced through a multilateral portfolio compression exercise.
DSIO No-Action Position
(i) Immaterial Amendments, Partial terminations and Partial Novations of Legacy Swaps: DSIO will not recommend that the CFTC take an enforcement action against a swap dealer for a failure to comply with the CFTC Margin Rule with respect to a legacy swap that is:
- Amended, provided that no term is amended that would affect the economic obligations of the parties or the valuation of the legacy swap; or
- Partially terminated or partially novated by such swap dealer, subject to the following conditions:
- The records of the legacy swap that exist in the trading and/or recordkeeping systems of the swap dealers are amended solely to reflect the reduced notional amount of the legacy swap;
- The stated portion of the legacy swap that is terminated or novated by such swap dealer is fully terminated between the swap dealer and its original counterparty apart from the stub; and
- All other material terms (as defined in CFTC’s regulation 23.600(g)) of the stub remain the same as the terms of the legacy swap.
(ii) Swaps Resulting from Exercise of Swaptions that are Legacy Swaps: DSIO will not recommend that the CFTC take an enforcement action against a swap dealer for a failure to comply with the CFTC Margin Rule with respect to swaps resulting from the exercise of swaptions, provided that the swaption is a legacy swap defined in the Letter and all terms of the swap were established upon execution of the swaption.
(iii) Swap Resulting from Multilateral Portfolio Compression Exercises: DSIO will not recommend that the CFTC take an enforcement action against a swap dealer for a failure to comply with the CFTC Margin Rule with respect to an amended swap or replacement swap that is generated as a part of multilateral portfolio compression exercise, subject to:
- The multilateral portfolio compression exercise generating the amended and replacement swaps must meet the definition set forth in CFTC regulation 23.500(g) and must involve more than two market participants;
- All swaps submitted by market participants as part of the multilateral portfolio compression exercise must be legacy swaps as defined in the Letter;
- The amended or replacement swaps generated by the multilateral portfolio compression exercise must:
- Be generated in accordance with a multilateral portfolio compression service provider’s established rules and parameters for multilateral portfolio compression exercises;
- Be entered into between the same counterparties as the legacy swaps that are amended or replaced;
- With the exception of reducing the notional amount, have the same material terms as the legacy swap that are amended or replaced; and
- Be entered into for the sole purpose of reducing operational or counterparty credit risk; and
- Once the legacy swaps have been selected and submitted by market participants as part of the multilateral portfolio compression exercise, the multilateral portfolio compression methodology does not permit participants to specify which swaps may be amended or replaced.