The Regulatory Margin Self-Disclosure Letter,
published on June 30, 2016, by the International Swaps and
Derivatives Association, Inc. ("ISDA") (the
"Letter"), represents one of the first major steps taken
by the derivatives industry towards facilitating compliance with
the rules of various regulatory regimes for the exchange of margin
for non-cleared derivatives. These rules have been proposed or adopted in the
U.S., Canada, the EU, Japan and Switzerland, and are based on the
framework jointly published by the Basel Committee on Banking
Supervision and the International Organization of Securities
Commissions. Other regulators around the globe, such as those in
Hong Kong and Australia, are expected to follow suit.
While these rules will not come into effect on the same timelines
(notably given the recent announcement of a delay to implementation
in the EU and Switzerland), compliance dates in the U.S. remain
imminent for the time being and market participants need to
prepare. Accordingly, with respect to each non-cleared swap (and
each non-cleared swap's trading relationship more generally),
each party to that non-cleared swap will need to determine if and
when that swap will become subject to margin requirements. This
determination will be based on which regime(s) will apply to that
particular trading relationship.
Whether a regime is applicable (and which particular rules or
exemptions are applicable under that regime) depends both on the
status of the party making the determination as well as the status
of its counterparty. Once these determinations are made, this will
dictate the particular margin and segregation documentation that
will need to be put in place to govern in scope non-cleared swaps.
It is possible that a particular swap is subject to more than one
margin regime, in which case the question of substituted compliance
or equivalence would be relevant. At this stage regulators have
made little progress, if any, on equivalence or substituted
compliance determinations. Pending progress on this front, parties
are considering applying the stricter version of the rules that
would satisfy the rules of all applicable margin regimes.
These determinations will often be difficult to make given the
complexity of OTC derivatives trading relationships that can arise
as a result of, among other factors, booking entities within a
group being organized in different jurisdictions (whether as a
branch or a subsidiary), intra-group guarantees and back-to-back
trades between group entities, consolidated groupings, and the
location of booking of particular trades within a group.
Accordingly, ISDA has been working with market participants to
create a tool to facilitate the exchange of information between
counterparties and, where necessary, the opening of a dialogue
between parties to enable the parties to make these
determinations.
To that end, ISDA has published the Letter as a standard form for
the sharing of information regarding an entity's status under
each applicable regime with that entity's non-cleared swaps
trading counterparties. While market participants are not obliged
to complete and deliver a Letter to any of its counterparties, the
information disclosed in the Letter is likely to be necessary for
determining if and when the rules under a particular margin regime
will apply. The Letter is designed to be completed by a party to a
non-cleared swap (as Principal) and delivered to each counterparty
(a Recipient). For example, with respect to a non-U.S. investment
fund trading non-cleared swaps with a CFTC-registered swap dealer,
the investment fund will complete and provide a Letter as Principal
to the CFTC-registered swap dealer as Recipient, and the
CFTC-registered swap dealer will complete and provide a Letter as
Principal to the investment fund as Recipient. In the first case,
the CFTC-registered swap dealer will likely need the fund to
complete the U.S. CFTC section of the Letter in order to determine
whether and how the CFTC rules will apply to that relationship. In
the second case, given that the regulatory requirements to collect
and post initial and variation margin in the U.S. fall on the
covered swap dealer, it is unlikely that the investment fund would
need the CFTC-registered swap dealer to complete any sections of
the Letter for the fund's purposes.
With respect to the structure of the Letter, the first section is
intended to be completed by all market participants delivering a
Letter as Principal, as it sets out general information for the
Principal including contact information and whether the Principal
is a multi-branch entity. The remaining sections set out
jurisdiction or regulator-specific information about the Principal
and are organized by jurisdiction. Separate sections are provided
for Canada, the EU, Japan, Switzerland and the U.S. (both CFTC and
U.S. prudential regulators). Each of these sections seeks to
collect information on (1) a group's average aggregate notional
amount (or "AANA") of OTC derivatives, which is necessary
to determine whether an entity and/or group will be subject to a
particular regime's margin requirements based on jurisdictional
thresholds and calculation methodology; (2) the cross-border status
of a party; and (3) the applicability of any available entity or
transaction-specific exemptions (such as the hedging exemption in
the U.S.). Definitions are included for each jurisdiction in order
to guide a Principal completing a form, but it is likely that a
party will have to perform additional commercial and legal analysis
to complete the Letter. For example, under the CFTC rules, the
Letter does not give guidance as to how the AANA calculation should
be undertaken. For a more detailed explanation of the calculation
of AANA in the U.S. and other related definitions and
considerations, see our previous client alert.
While the parties can exchange paper versions of the Letter, the
Letter will also be available on ISDA Amend. Both the Letter and
the ISDA Amend build-out are structured in a modular fashion so
that market participants can complete as much or as little of the
Letter as they wish. A market participant will also be able to
deliver a different version of the Letter to each of its
counterparties if only portions of the Letter apply to a particular
trading relationship. On ISDA Amend, it is expected that the
Recipient will be able to identify which sections of the Letter
should be completed by a Principal from which it expects to receive
a Letter, but the Principal should complete all applicable
sections. Returning to the previous example of a non-U.S.
investment fund and a CFTC-registered swap dealer, the
CFTC-registered swap dealer will be able to communicate to the
investment fund via ISDA Amend which jurisdictional information it
would like the fund to complete given the regimes which the dealer
expects will apply to the trading relationship, and the fund should
in any case consider whether any additional information should be
provided. We understand that the ISDA Amend service will be
available two to three months from publication of the Letter. This
may miss the initial compliance date of September 1, at least for
the U.S. regime, unless the timeline is postponed similar to the EU
postponement. That said, it is only the largest swap dealers and
their non-cleared swaps with other such dealers that will be
subject to the September 1 compliance date. If bilateral
communication is necessary between the parties outside of ISDA
Amend, the Principal to each Letter should provide contact
information in the general information section for such
purpose.
Completion of the Letter is going to be time-consuming and less
than straightforward for many market participants, particularly
where multiple jurisdictional sections are relevant and/or where
the organizational structures of the Principal and the Recipient
are complex. Investment managers acting on behalf of multiple funds
will, we think, be particularly challenged, as they will have to
reach out separately to each of their fund clients in order to
obtain the required information.
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.