Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act and Commodity Futures Trading Commission (“CFTC”) Rules 23.702 and 23.703 thereunder (together, the “Rules”), swap dealers are required to notify their counterparties that they have the right to require segregation with a third-party custodian of any initial margin (also known as “independent amounts”) posted to the swap dealer in connection with uncleared swaps. As a result of these new rules, the International Swaps and Derivatives Association (“ISDA”) recently published a form of notification and a set of frequently asked questions regarding these rules. All buy-side entities that trade in uncleared swaps with swap dealers (including buy-side entities that already post their margin with a third-party custodian, such as registered investment companies, and buy-side entities that do not post initial margin) should receive a copy of the notification from their swap dealer counterparties in the coming weeks or months and should plan to respond promptly to the notification in order to avoid any trading disruptions.
Posts Tagged ‘Swaps’
On March 12, the SEC issued a 400-page rule proposal that, if adopted as proposed, would impose a multitude of new compliance requirements on The Options Clearing Corporation (“OCC”), The Depository Trust Company (“DTC”), National Securities Clearing Corporation (“NSCC”), Fixed Income Clearing Corporation (“FICC”) and ICE Clear Europe. Since these clearing agencies play a fundamental role in the options, stock, debt, U.S. Treasuries, mortgage-backed securities and credit default swaps markets, the proposed requirements have important implications for banks, broker-dealers and other U.S. securities market participants, as well as securities exchanges, alternative trading systems and other trading venues.
This post is a summary of certain recent developments under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) that impact corporate end-users of over-the-counter foreign exchange (FX) derivative transactions and should be read in conjunction with the four prior WSGR Alerts on Dodd-Frank FX issues from October 2011, September 2012, February 2013, and July 2013.
Title VII of Dodd-Frank amended the Commodity Exchange Act (CEA) and other federal securities laws to provide a comprehensive new regulatory framework for the treatment of over-the-counter derivatives, which are generally defined as “swaps” under Section 1a(47) of the CEA. Among other things, Dodd-Frank provides for:
Just one day in advance of the December 21, 2013 expiration of the CFTC’s exemptive order delaying the applicability of some CFTC swap regulations for non-U.S. swap dealers and foreign branches of U.S. swap dealers, the CFTC approved a series of comparability determinations. These comparability determinations will allow CFTC-registered non-U.S. swap dealers and foreign branches of U.S. swap dealers to comply with local requirements rather than the corresponding CFTC rules in cases where substituted compliance is available under the CFTC’s cross-border guidance.  The CFTC made comparability determinations for some swap dealer entity-level requirements for Australia, Canada, the European Union (the “EU”), Hong Kong, Japan and Switzerland and for a limited number of transaction-level requirements for the EU and Japan.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) amended section 4a of the Commodity Exchange Act (the “CEA”) to require the Commodity Futures Trading Commission (the “CFTC”) to establish position limits on an aggregate basis for (1) futures and options contracts on agricultural and exempt commodities traded on or subject to the rules of a designated contract market (“DCM”) and (2) contracts based on the same underlying commodity as such futures and option contracts, including (a) swaps listed for trading by a DCM or swap execution facility (“SEF”), (b) swaps that are not traded on a DCM, SEF or other registered entity but which are determined to perform or affect a “significant price discovery function” (“SPDF swaps”) and (c) foreign board of trade (“FBOT”) contracts that are price-linked to a DCM or SEF contract and made available for trading on the FBOT by direct access from within the United States.
Bankruptcy law in the United States, which serves as an important precedent for the treatment of derivatives under insolvency law worldwide, gives creditors in derivatives transactions special rights and immunities in the bankruptcy process, including virtually unlimited enforcement rights against the debtor (hereinafter, the “safe harbor”). The concern is that these special rights and immunities grew incrementally, primarily due to industry lobbying and without a systematic and rigorous vetting of their consequences.
This type of legislative accretion process is a form of path dependence—a process in which the outcome is shaped by its historical path. To understand path dependence, consider Professor Mark Roe’s example of an 18th century fur trader who cuts a winding path through the woods to avoid dangers. Later travelers follow this path, and in time it becomes a paved road and houses and industry are erected alongside. Although the dangers that affected the fur trader are long gone, few question the road’s inefficiently winding route.
On November 5, 2013, the Commodity Futures Trading Commission proposed rules to establish new position limits that would apply to 28 agricultural, energy and metals futures contracts, and swaps, futures and options that are economically equivalent to those contracts.  Once adopted, the proposal would reinstate, with certain changes, the position limit rules that were vacated by a U.S. federal court in 2012 (the “Vacated Rules”).  The CFTC also re-proposed aggregation standards that are similar to those initially proposed as amendments to the Vacated Rules, but with a few notable differences, to be used in applying position limits (the “Aggregation Proposal”). 
The proposals would:
On November 5, 2013, the Commodity Futures Trading Commission (the “CFTC” or “Commission”) held a public meeting during which it:
- Voted 3-1, with commissioner O’Malia dissenting, to propose for public comment a new set of rules on position limits (the “Proposed Rules”) applicable to options, futures, and swaps contracts (“derivatives”) related to 28 agricultural, metal, and energy commodities;
- Confirmed that it will voluntarily dismiss its appeal of the September 2012 decision from the United States District Court for the District of Columbia (the “Court”) vacating the Commission’s previous attempt at imposing position limits across derivatives (the “Original Position Limit Rules”); and
- Voted unanimously to propose separately for public comment rules that would expand the availability of aggregation exemptions, as compared to the Original Position Limit Rules, from the CFTC’s aggregation standards applicable to position limits for futures and swaps (the “Proposed Aggregation Rules”).
On September 30, 2013, the Division of Market Oversight of the US Commodity Futures Trading Commission (CFTC) released responses to Frequently Asked Questions regarding Commodity Options (FAQ). While intended to be provide non-binding guidance to affected market participants, the FAQ also serves to highlight the significant complexity of the current analysis required for commodity options.
Andrew K. Soto, Senior Managing Counsel for Regulatory Affairs of the American Gas Association (AGA), in written testimony before the US House of Representatives Committee on Agriculture Subcommittee on General Farm Commodities and Risk Management at a recent hearing regarding the Future of the CFTC: End-User Perspectives effectively summarized this complexity as follows:
The Basel Committee on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions (“IOSCO”) on September 2 released their final policy framework on margin requirements for uncleared derivatives (the “Framework”). The Framework, which follows two proposals on the topic from BCBS and IOSCO (the “Proposals”), is intended to establish minimum standards for uncleared derivatives margin rules in the jurisdictions of BCBS and IOSCO’s members, which includes the United States.
The Framework is designed to provide guidance to national regulators in implementing G-20 commitments for uncleared derivatives margin requirements. In the United States, the Dodd-Frank Act, reflecting the same G-20 commitments, requires the SEC, CFTC and banking regulators to adopt initial and variation margin requirements for swap dealers and major swap participants (“MSPs”) under their supervision.  The U.S. regulators have proposed rules to implement these requirements (the “U.S. Proposals”), but have not yet adopted final rules, in part due to the ongoing BCBS/IOSCO efforts. The Framework is similar in concept to the U.S. Proposals, but differs in a number of significant respects. Appendix A summarizes the Framework and the three U.S. Proposals, highlighting a number of the key differences.
With the Framework finalized, we expect that U.S. regulators will work to issue final rules implementing uncleared swap margin requirements in the coming months.