On May 23, 2018, the Commodity Futures Trading Commission (CFTC) published proposed amendments1 to its Margin Rule, which sets the margin requirements for uncleared swaps for swap dealers and major swap participants ("covered swap entities") not subject to a prudential regulator2

The purpose of the proposed amendments is to reconcile requirements known as the QFC Rules with protections afforded legacy swaps (i.e., those entered into before the compliance date for a particular type of counterparty) under the CFTC Margin Rule. Certain prudential regulators—the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC)—adopted the QFC Rules with respect to certain systemically important banking institutions3. In establishing requirements for certain uncleared financial contracts ("covered QFCs")4, the QFC Rules are designed to mitigate potentially destabilizing effects on the financial system that could arise if a large financial institution were to fail.

In the first place, the QFC Rules require covered QFC entities (i.e., US global systemically important banking institutions and their subsidiaries, the US operations of foreign global systemically important banking institutions and certain other large OCC-supervised national banks and federal savings associations) to include in a QFC contractual provisions to the effect that any default rights or restrictions on the transfer of the covered QFC are limited to the same extent as they would be under the Federal Deposit Insurance Act (FDIA)5 and Title II of the Dodd-Frank Act (Title II)6.

As a general matter, these limitations are designed to minimize the risk of a disorderly resolution of a failed covered QFC entity by limiting its counterparties' contemporaneous exercise of termination and other rights under a potentially large number of covered QFCs, which could have a negative systemic effect on the banking system generally. Additionally, according to the proposed amendments, adding such a contractual provision would reduce the risk that the orderly resolution regimes of the FDIA and Title II would be challenged by a court in a non-US jurisdiction.

Secondly, the QFC Rules prohibit covered QFC entities from allowing the counterparties of covered QFC entities to exercise default rights related directly or indirectly to the entry into resolution of an affiliate of the covered QFC entity. This limitation on the cross-default rights of a counterparty to a solvent entity is designed to prohibit the counterparty to terminate its contracts with such entity based solely on its affiliate's entry into resolution. Consequently, covered QFC entities are required to provide for the limitation on cross-default rights, as well as the limitations described in the preceding paragraph, in all covered QFCs entered into after the applicable compliance date for the QFC Rules. More importantly for purposes of this article, covered QFC entities must also amend pre-existing covered QFCs in order to add such provisions.

Among other provisions, the CFTC Margin Rule permits swap counterparties to calculate initial and variation margin on an aggregate net basis across uncleared swaps that are executed under an "eligible master netting agreement" (EMNA)7. In addition, the CFTC Margin Rule permits swap counterparties to identify distinct groups of uncleared swaps under an EMNA as to which initial and variation margin obligations will be netted only among the swaps of that group. Since legacy swaps are not generally subject to the initial and variation margin requirements under the CFTC Margin Rule, a netting portfolio consisting only of legacy swaps would likewise not be subject to the CFTC Margin Rule. However, the CFTC Margin Rule provides that if a legacy swap is amended in any manner after its compliance date, it loses its legacy treatment and will thereby be treated as subject to the initial and variation margin requirements under the CFTC Margin Rule.

Because the current EMNA definition does not recognize the restrictions on cross-default rights required under the QFC Rules, amending an EMNA in order to make it compliant with the QFC Rules could result in the ineligibility of such master agreement as an EMNA. Accordingly, a covered QFC entity could then be required to measure its swap exposures on a gross basis, as opposed to an aggregate net basis, for purposes of determining the required margin amounts. The proposed amendments seek to provide legal certainty for legacy swaps that are amended in order to comply with the QFC Rules by modifying the definition of "eligible master netting agreement" (1) to add the limitations contained in the QFC Rules regarding acceleration, termination, closeout and other rights upon an event of default of a counterparty (i.e., a covered QFC entity) and (2) to provide that a master netting agreement may still be an EMNA notwithstanding such limitations.

More specifically, the proposed addition to CFTC Regulation 23.161 provides that, "[f]or purposes of determining whether an uncleared swap was entered into prior to the applicable compliance date under this section, a covered swap entity may disregard amendments to the uncleared swap that were entered into solely to comply with" the QFC Rules8. Accordingly, legacy swaps that are amended solely to comply with the QFC Rules will not lose their legacy status because of such amendments. However, the proposed amendments note that if a legacy swap is amended for any other or additional reasons, the amended legacy swaps would be covered under the CFTC Margin Rule9.

The proposed amendments are available on the CFTC's website here. The comment period ends on July 23, 2018.


1 83 F.R. 23842-23847.

2 The term "prudential regulator" is defined in 7 U.S.C. 1a(39) and includes the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Farm Credit Administration and the Federal Housing Finance Agency. The proposed amendments are designed to harmonize with the proposed amendments to the margin rule that the prudential regulators jointly published on February 21, 2018, in 83 F.R. 7413.

3 12 C.F.R. §217.402.

4 Defined in 12 U.S.C. §5390(c)(8)(D) to mean a securities contract, commodity contract, forward contract, repurchase agreement, swap agreement, and any similar agreement that the FDIC determines by regulation, resolution, or order to be a qualified financial contract.

5 12 U.S.C. 1811 et seq.

6 Pub. L. 111-203, §§201-217.

7 The term "eligible master netting agreement" is defined in CFTC Regulation 23.151 (17 C.F.R. §23.151) as an agreement that "creates a single legal obligation for all individual transactions covered by the agreement upon an event of default following any stay permitted by paragraph (2) of this definition, including upon an event of receivership, conservatorship, insolvency, liquidation, or similar proceeding, of the counterparty." This definition would cover a 1992 or 2002 International Swaps and Derivatives Association Master Agreement as well as other master agreements that provide a netting mechanism.

8 83 F.R. at 23847.

9 83 F.R. at 23845.

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