United States: CFTC Issues Final Cross-Border Margin Rule

Last Updated: June 3 2016
Article by Nihal S. Patel

Most Read Contributor in United States, August 2018

The CFTC voted 2-1 to adopt rules (the "Cross-Border Margin Rules")1 regarding the application of the CFTC margin requirements for uncleared swaps in the context of cross-border transactions. The Final Rules follow the CFTC adoption of margin requirements for uncleared swaps ("Final Margin Rules"), which were published in January 2016. See 81 Fed. Reg. 636 (Jan. 6, 2016). A Cadwalader memorandum summarizing the Margin Rules is available here. The CFTC margin requirements for uncleared swaps would apply only to those swap dealers that do not have a "prudential regulator," as that term is defined in Commodity Exchange Act § 1a(39) (i.e., the CFTC generally has jurisdiction in this regard over non-bank swap dealers).

The Cross-Border Margin Rules are largely similar to the proposed rules, with the exception of a few notable changes discussed below. In addition, the CFTC indicated its intention to align the Cross-Border Margin Rules with the approach taken by the prudential regulators in their final margin rules. See 80 Fed. Reg. 74840 (Nov. 30, 2015). A Cadwalader memorandum summarizing the prudential regulators' rules is available here.

Overview of the Cross-Border Margin Rules

Regulated Entities. When determining whether the CFTC margin requirements would apply to a swap, the Cross-Border Margin Rules divide regulated entities into four categories: (i) U.S. swap dealers; (ii) non-U.S. swap dealers guaranteed by U.S. persons ("U.S.-Guaranteed SDs"); (iii) non-U.S. swap dealers that are consolidated subsidiaries of a U.S. "ultimate parent entity" ("foreign consolidated subsidiaries" or "FCSs"); and (iv) non-U.S. swap dealers that are neither (ii) nor (iii) ("Fully Non-U.S. SDs").2 This is shown in the table that appears below.

Definitions versus Cross-Border Guidance. As it chose to do in the case of the proposal, the Cross-Border Margin Rules do not rely on the definitions of "U.S. person" and "guarantee" that were used in its cross-border guidance that applies to other swap regulations. See 78 Fed. Reg. 45292 (July 26, 2013). Those terms remained largely as proposed (see the discussion of the proposal that is available here). However, the CFTC included an anti-evasion provision to the guarantee analysis. Under the Cross-Border Margin Rules, the definition of "guarantee" includes an arrangement by which a guarantor has a right to receive or otherwise collect payments from another guarantor as to the relevant swap obligations. See pp. 27-29 of the adopting release (discussion of "guarantee" definition).

Substituted Compliance Process. The Cross-Border Margin Rules adopted the approach to comparability determinations as outlined in the proposal, but added more color added in the adopting release at pp. 68-73. (A summary of the proposed – now adopted – substituted compliance approach is available here.)

Type of Swap Dealer Margin Requirements

U.S. Swap Dealers and U.S.-Guaranteed SDs

Subject to all CFTC requirements, except where substituted compliance may apply with respect to the posting of initial margin to a non-U.S. person.

Fully Non-U.S. SDs

Requirements do not apply to transactions with non-U.S. persons (other than FCS's, U.S. branches of Non-U.S. swap dealers and entities guaranteed by U.S. persons) (the "Exclusion"). The Exclusion is not available if (i) there is no comparability determination for IM collection for the relevant swap and (ii) the Non-U.S. SD enters into a swap with an affiliate to transfer risk to a U.S. Swap Dealer or U.S.-Guaranteed SD.

Substituted compliance is generally available if the counterparty is not a U.S. swap dealer or a U.S.-Guaranteed SD (i.e., including with respect to U.S. persons generally).

With regard to transactions with U.S. swap dealers and U.S.-Guaranteed SDs, substituted compliance is available solely for initial margin collection if the counterparty is a U.S. swap dealer or a U.S.-Guaranteed SD.

FCS's and U.S. branches of Fully Non-U.S. SDs

Same as above, except that the Exclusion is not available (i.e., CFTC or sub. comp. margin requirements apply even when trading with fully non-U.S. counterparties).

Non-Segregation and Non-Netting Jurisdictions

The CFTC added two new sections to the final rules: one for transactions in jurisdictions where it would be legally or operationally impracticable to comply with the IM segregation requirement in the Final Margin Rules and another regarding transactions in jurisdictions where netting may not be available.

The segregation provision would, subject to a number of conditions, excuse FCSs and non-U.S. branches of U.S. swap dealers from compliance with the IM posting and segregation requirements addressing non-U.S. persons where it would be legally or operationally impracticable to do so. The provision is limited to a 5% notional test that applies separately to four risk categories of swaps.

The netting provision is substantially similar to a rule adopted by the prudential regulators. It would allow certain swap dealers to engage in transactions where relevant netting arrangements are unavailable, provided that the dealer collected margin on a gross basis (but still could post margin on a net basis).

Commissioners' Discussion

CFTC Chair Timothy Massad voted for the Cross-Border Margin Rules, and indicated that, "in light of the impending September 1 compliance date" the CFTC staff should work closely with other regulators and industry participants in order to ensure a "smooth transition."

Commissioner Sharon Bowen also voted in favor of the Cross-Border Margin Rules, but voiced reservations that echoed her objections she made when voting against the adoption of the Final Margin Rules. In her statement, Commissioner Bowen focused on what she would look for in the CFTC capital rules. Footnote 14 of the Cross-Border Margin Rules states that the CFTC indicates intends to repropose its capital rules later this year.

Commissioner J. Christopher Giancarlo dissented from the adoption of the Cross-Border Margin Rules, and chose to focus on the CFTC approach to substituted compliance, which he found to be "overly complex, unduly narrow and operationally impractical."

Commentary

The complexities of the substituted compliance process, and the fact that the first compliance date for the substantive rules will occur in little more than three months, create a situation that is far from ideal. CFTC Chair Massad and Commissioner Giancarlo acknowledged this problem implicitly, albeit in different ways: Commissioner Giancarlo criticized the complexity of the CFTC's approach – which is problematic because the substantive rules are based on a global framework that is being implemented in numerous jurisdictions – while Chair Massad acknowledged that the date of compliance is fast approaching, and indicated that, once again, CFTC staff members have lots of work to do and not much time in which to do it.

Commissioner Bowen's comments on capital requirements for CFTC registrants set the stage for what should be a lively debate. The CFTC capital proposal is now over five years old. Although today's rulemaking indicates that the CFTC will repropose the capital rules, the initial proposal and Commissioner Bowen's comments suggest a number of questions must be resolved before the rules can be adopted.

Footnotes

1. The pre-Federal Register version of the Cross-Border Margin Rules is available here.

2. The margin rules would apply equally to "major swap participants" but, for ease of reference, we refer to only swap dealers here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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