CFTC issues grace period for Dodd-Frank variation margin compliance

The US Commodity Futures Trading Association (CFTC) has provided market participants with relief from compliance with upcoming variation margin (VM) rules. Edward Ivey, an associate in the New York office of Linklaters LLP, says the important point to remember is that the CFTC relief is not a blanket relief, it applies to swap dealers (SDs) only for not being in compliance with CFTC rules as of 1 March 2017 and they must act in good faith to progress with compliance.

Original news

The CFTC has issued relief delaying the upcoming 1 March 2017 deadline for compliance by SDs registered with the CFTC with its Dodd-Frank VM rules for uncleared swaps until 1 September 2017.

Why has the CFTC delayed implementation of the VM rules?

The CFTC, along with other global regulators, have received numerous requests from market participants who have asked for delays and/or relief from the 1 March 2017 compliance date. Leading up to the CFTC’s relief, the International Swaps and Derivatives Association (ISDA), the Global Financial Markets Association, including its Global FX Division (GFMA), the Investment Association (IA), Financial Services Roundtable (FSR), the ABA Securities Association (ABASA), and the American Council of Life Insurers (ACLI) co-signed a letter that went to many of the global regulators, including the CFTC, formally requesting on behalf of their members for a forbearance from the 1 March compliance date.

This letter was in addition to earlier letters from the Securities Industry and Financial Markets Association’s Asset Management Group (SIFMA AMG), the Investment Adviser Association (IAA), the Committee on Investment of Employee Benefit Assets Inc (CIEBA) and the ERISA Industry Committee (ERIC). All such letters similarly requested forbearance from the 1 March 2017 compliance date and some type of transitional relief. Data was presented to the CFTC and other regulators around the world that a small percentage of necessary CSAs were in place for compliance, despite the industry’s efforts to be prepared by 1 March 2017. Some reports provided that less than 10% of all outstanding CSAs needed by 1 March 2017 were finalised and executed.

What relief does this give?

The CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO) provided no-action relief, from 1 March 2017 to 1 September 2017. No-action relief is effectively a formal action by the DSIO stating that it will not recommend an enforcement action against an SD for failure to comply with the VM requirements for swaps that are subject to a 1 March 2017 compliance date.

In other words, the DSIO no-action letter does not postpone the 1 March 2017 compliance date for variation margin, rather it allows market participants a grace period to come into compliance. Specifically, an SD will not be at risk of an enforcement action for non-compliance with the 1 March 2017 compliance date for VM where:

  • the SD does not comply with the 1 March 2017 VM requirements with respect to a particular counterparty solely because it has not completed necessary credit support documentation (including custodial segregation documentation, if any) with such counterparty or, acting in good faith, requires additional time to implement operational processes to settle VM in accordance with the 1 March 2017 requirements with such counterparty
  • the SD uses its best efforts to comply with the 1 March 2017 VM requirements with each counterparty as soon as possible following 1 March 2017
  • to the extent the SD has existing VM arrangements with a counterparty, it must continue to post and collect VM with such counterparty in accordance with such arrangements until such time as the SD is able to comply with the 1 March 2017 VM requirements with respect to that counterparty
  • no later than 1 September 2017, the SD complies with the 1 March 2017 requirements with respect to all swaps to which the 1 March 2017 VM requirements are applicable entered on or after 1 March 2017

Which market participants will assist?

This is only going to help the small set of SDs who are subject to the CFTC’s margin requirements. For those SDs that are banks or otherwise are subject to the margin requirements of the US prudential regulators, this relief has no impact on their regulatory obligations come 1 March 2017. If similar relief is not provided by the prudential regulators, then SDs subject to the prudential regulators’ margin requirements will need to be in full compliance by 1 March 2017. Market participants should keep an eye out for any developments here. The prudential regulators have been reaching out to their regulated SDs to determine how ready they are for the 1 March 2017 compliance date.

To this end, the US prudential regulators have made clear in a formal statement that a SD’s compliance with counterparties that present 'significant credit and market risk' exposures is expected to be in place on 1 March 2017. However, for other counterparties that do not present such significant credit and market risks, the US prudential regulators expect SDs to make good faith efforts to comply with the final rule in a timely manner, but no later than 1 September 2017.

Is it likely that the UK will follow this stance?

It has been reported that the UK’s Financial Conduct Authority ‘will use judgment in our supervision of firms taking into account their position and the credibility of the plans they have made’. This sentiment appears consistent across Europe where there has been talk in the market that the European financial regulators are looking for ways to help their regulated market participants. Germany’s markets regulator, BaFin has mentioned that there may be some ‘wiggle room’ in applying the rules and noted that if firms have ‘technical problems’ that prevent them from meeting the 1 March 2017 deadline, BaFin plans to work towards finding a solution. Similar reports noted that the Autorite des Marches Financiers, France’s financial markets regulator, wants a coordinated approach across the EU.

How has this been received in the market?

Since the relief only impacts a small part of the global over-the-counter (OTC) derivatives market, the hope is that maybe this is either a sign of further relief coming elsewhere and/or it will push other regulators to consider similar relief/delays from the 1 March 2017 compliance date.

Are there any other points worth mentioning here?

The important point to remember is that the CFTC relief is not a blanket relief. It applies to SDs only for not being in compliance with CFTC rules as of 1 March 2017. SDs have to act in good faith to progress with compliance. The CFTC margin requirements will still apply (retrospectively) to all swap transactions entered into after the 1 March 2017 implementation date.

Edward Ivey regularly advises clients with respect to a variety of derivative and exchange traded transactions, with a particular focus on the regulation of OTC derivatives, swaps and related market participants. Edward was named a ‘Rising Star’ in derivatives from 2014–17 and capital markets in 2017 by IFLR1000 and spent time at a leading Wall Street bank working in its structured products group, focusing on emerging markets.

Interviewed by Kate Beaumont.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

First published on LexisPSL Banking & Finance. Click here for a free trial.

Filed Under: Derivatives

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