Securities Regulation Daily CFTC proposes to extend deadline on uncleared swaps margin for smaller swaps entities
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Wednesday, October 16, 2019

CFTC proposes to extend deadline on uncleared swaps margin for smaller swaps entities

By Lene Powell, J.D.

The CFTC proposed rule amendments to give small swaps entities another year to implement uncleared swaps margin systems as well as exclude a European crisis resolution agency from CFTC margin rules.

At an open meeting, the CFTC proposed to extend by one year the compliance date for the final phase of the CFTC’s margin rule for uncleared swaps, which is currently scheduled to impose initial margin (IM) documentation, custodial, and operational requirements on hundreds of small swaps entities for the first time as of September 1, 2020. The proposal would give entities an extra year to prepare and help avoid market strain from so many newly in-scope counterparties engaging the same limited number of IM service providers.

The CFTC also proposed to exclude the European Stability Mechanism (ESM) from the margin rule. The ESM is an intergovernmental agency that provides financial assistance to Eurozone member states experiencing or threatened by severe financing problems. The proposal would codify existing no-action relief, permanently excluding the ESM from CFTC margin requirements.

Both proposals will be open to comment following publication in the Federal Register.

Deadline extension. CFTC Regulation 23.161 establishes compliance dates for IM requirements on a phased basis, with earlier compliance deadlines for larger swaps entities and later deadlines for smaller entities. The final group, Phase 5, consists of the smallest swaps entities, which engage in between $8 and $50 billion of swaps activity per year.

According to a 2018 report by the CFTC Office of the Chief Economist, while Phases 1 through 4 capture just over 40 entities, Phase 5 could bring 700 entities in scope and require implementing nearly 7,000 IM relationships.

The Phase 5 group is currently slated to begin IM compliance as of September 1, 2020. Following similar moves by the FDIC, OCC, and the Basel Committee on Banking Supervision-International Organization of Securities Commissions (BCBS-IOSCO), the proposal would extend the deadline by one year to September 1, 2021.

All five CFTC commissioners supported extending the deadline. Chairman Heath Tarbert noted that counterparties unable to implement adequate IM arrangements by the deadline would be prohibited from entering into uncleared swaps, which would harm their ability to hedge risk. Shutting out so many market participants could also harm price discovery and liquidity. In addition, the influx of so many entities requiring IM services could cause market strain and disruption.

According to Commissioner Dan Berkowitz, the effect on systemic risk of extending the deadline for should be quite limited. The commissioner observed that the estimated average aggregate notional amount (AANA) for phase 5 entities is just $54 billion, compared to an average $12.71 trillion AANA for entities in phases 1, 2 and 3, and $1 trillion for entities in phase 4. In addition, the total estimated AANA for Phase 5 entities is only about three percent of the total AANA of all entities subject to the margin rules.

Commissioner Rostin Behnam supported the extension as appropriately harmonizing requirements with the prudential regulators and BCBS/IOSCO. However, Commissioner Brian Quintenz, while supporting the extension, believes that more needs to be done to align and rationalize uncleared margin frameworks globally.

ESM exclusion. The proposal would amend Regulation 23.151 to add the ESM to the list of governmental entities excluded from the definition of financial end user in CFTC margin rules. This would codify no-action relief provided in CFTC No-Action Letter 17-34 (July 24, 2017).

According to Tarbert, the ESM is similar to other intergovernmental agencies that perform similar functions and have been granted relief from CFTC margin rules, including sovereign entities, multilateral development banks, and the Bank for International Settlements.

Tarbert also announced that the CFTC will reissue no-action relief for the ESM from the swap clearing requirements of Section 2(h)(1) of the Act. Tarbert said he intends to take up a proposed rulemaking in the coming months to codify this relief.

Quintenz dissented from the proposal. In his view, the relief provides special accommodations to an E.U. institution at a time when the CFTC’s trust in EU counterparts is misplaced. According to Quintenz, European counterparts have refused to stand by or re-affirm their 2016 commitments in the CFTC’s and European Commission’s common approach to the regulation of cross-border central counterparties (CCPs). As a result, it is unclear if any of the five U.S. CCPs currently authorized to access the E.U. will ultimately be treated as domestic E.U. firms and forced to follow E.U. rules.

Berkowitz, however, said the ESM likely reduces systemic risk and thereby benefits the rest of the world, including the U.S.

Commissioner Dawn Stump acknowledged this tension and said she would not rule out retributive jurisdictional assertions should the CFTC’s authority be disrespected. However, Stump holds "a great deal of hope for a structure of mutual respect," especially among jurisdictions that agreed to work toward a common objective 10 years ago at the G20 summit in Pittsburgh.

"During the unfortunate events of the financial crisis, we learned that coordination among global regulators is critical and trust among us is essential," said Stump. "Today, those lessons remain true, and we are reminded that disregarding this reality has the potential to weaken, rather than strengthen, the resilience of our global derivatives markets."

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