On February 13, 2017, the Commodity Futures Trading Commission’s (“CFTC”) Division of Swap Dealer and Intermediary Oversight (“DSIO”) issued two no-action letters with respect to the March 1, 2017 implementation of variation margin (“VM”) requirements on uncleared swaps. The first letter provides a limited six-month extension of the deadline to put into place variation margin arrangements for swap dealers (“SDs”) and major swap participants (“MSPs”) that have been unable to complete the necessary documentation or operational implementation. The second letter clarifies the application of the minimum transfer amount (“MTA”) requirements for separately managed accounts (“SMAs”).
Significantly, the letters only apply to SDs and MSPs that are subject to the CFTC’s margin requirements. SDs and MSPs that are subject to the margin requirements of the US “prudential regulators”—such as banks and bank holding companies—are not covered by the CFTC’s relief. Absent parallel relief from the prudential regulators, SDs and MSPs, subject to their margin rules, will still have to meet the original March 1 deadline. In addition, it is not clear that regulators in other jurisdictions that have not already provided for a similar extension will do so. As a result, there remains a risk of market confusion and fragmentation—similar to what was experienced after the European Commission delayed implementation of the EMIR margin rules in June of 2016—as different deadlines may apply within the US to different types of SDs and MSPs, as well as between the US and other jurisdictions.
Time-Limited No-Action Relief for Failure to Collect and/or Post VM
The first no-action letter concerns SDs and MSPs (together, “Covered Swap Entities” or “CSEs”) registered with the CFTC and subject to the CFTC’s margin requirements for uncleared swaps. Under the staggered compliance schedule set forth in the final margin requirements, CSEs must post and collect variation margin for uncleared swaps with financial end-user counterparties commencing March 1, 2017 (the “March 1 VM Requirements”). As a result, CSEs generally have been required to put in place new or amended credit support documentation with such counterparties by that date, as well as put in place new operational processes to calculate and settle the required variation margin. According to ISDA, approximately 160,000 Credit Support Annexes (“CSAs”) require updating, of which only 4.43% had been completed as of February 14, 2017. Given the volume of CSAs that have yet to be executed or amended, market participants had expressed concerns that CSEs could be required to cease trading with a significant number of counterparties on March 1.
Under the no-action letter, in order to avoid disruptions to the uncleared swaps market as a result of such cessation of trading activity, DSIO will not recommend enforcement action with respect to CSEs that are not in compliance with the March 1 VM Requirements, subject to the following conditions:
- Failure to comply with the March 1 VM Requirements with respect to a particular counterparty is solely because the CSE has not, despite good faith efforts, completed necessary credit support documentation or, acting in good faith, requires additional time to implement the necessary VM-related operational processes;
- The CSE uses best efforts to continue to implement compliance with the March 1 VM Requirements without delay;
- The CSE must continue to post and collect VM with such counterparty in accordance with any existing VM arrangements; and
- The CSE complies with the March 1 VM Requirements with respect to all in-scope swaps entered into on or after March 1, 2017, no later than September 1, 2017.
The letter further states that DSIO will be monitoring progress, with respect to compliance with the March 1 VM Requirements by September 1, 2017, and expects CSEs to make continual, consistent and quantifiable progress on a rolling basis during the no-action period.
No-Action Relief Concerning MTAs with Respect to SMAs
The second no-action letter allows CSEs entering into swaps with SMAs to treat each such account as a separate counterparty for purposes of the MTA requirement under the CFTC margin rules, even though such accounts may be owned by the same legal entity. SMAs are defined to include those accounts managed by asset managers for institutional clients, such as pension plans and endowments, and governed by investment management agreements that grant each asset manager authority, with respect to a specified amount of assets under management.
To take advantage of the relief, the following conditions must be satisfied:
- Any swaps entered into with a CSE by an asset manager on behalf of an SMA are pursuant to authority granted under an investment management agreement;
- The swaps of such SMA are subject to a master netting agreement that does not permit netting of margin obligations across different SMAs of the legal entity that have swaps outstanding with the CSE; and
- The CSE applies an MTA no greater than $50,000 to the margin collection and posting obligations required pursuant to CFTC regulations of such SMA.
Although the relief will reduce the risk that some market participants that have not completed their margin documentation will no longer be able to trade after March 1, it does not extend to large parts of the market—particularly, CSEs subject to the margin rules of prudential regulations or other jurisdictions. Non-CSE market participants will need to determine whether their particular swap relationships may benefit from the relief, or whether they will need to comply with the March 1 deadline. It is also not clear how strictly the CFTC staff will evaluate the efforts of CSEs covered by the relief to bring themselves into compliance over the next six months, and CSEs may well seek to bring themselves into compliance before September 1. We will continue to monitor this topic for further regulatory developments.