Tag: Swaps entities


U.S. Uncleared Swap Margin, Capital, and Segregation Rules

Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP, and a former commissioner at the U.S. Securities and Exchange Commission. The following post is based on a Davis Polk visual memorandum; the complete publication, including charts, is available here.

U.S. prudential regulators (the OCC, Federal Reserve, FDIC, FCA and FHFA) and the CFTC have finalized uncleared swap margin, capital and segregation requirements (the “PR rules,” and “CFTC rules,” respectively, and the “final rules,” collectively).* The PR rules apply to swap entities that are prudentially regulated by a U.S. prudential regulator (“PR CSEs”). The CFTC rules apply to swap entities that are regulated by the CFTC and that are not prudentially regulated (“CFTC CSEs”). In this memorandum, “covered swap entities” refers to PR CSEs and CFTC CSEs, together.

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CFTC’s Proposed Rules on Cybersecurity

Dan Ryan is Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Mr. Ryan, Sean Joyce, Joseph Nocera, Jeff Lavine, Didier Lavion, and Armen Meyer.

Last week, the Commodity Futures Trading Commission (CFTC) proposed cybersecurity regulations for electronic trading platforms, clearing organizations, and data repositories. Most importantly, the proposal calls for five types of systems testing, the most impactful of which is the requirement that organizations test key controls (e.g., access to sensitive data or procedures that control changes to critical systems).

Guidance from other regulators thus far has come in the form of examination guidelines or self-assessment tools rather than regulations. [1] The CFTC’s proposal would be the first cybersecurity regulation, and some other regulators are likely to follow suit. [2]

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Derivatives and Uncleared Margins

Dan Ryan is Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Mr. Ryan, Mike Alix, Adam Gilbert, Armen Meyer, and Christopher Scarpati.

Over the past two weeks, the US banking regulators released their much anticipated final margin requirements for the uncleared portion of the derivatives market. [1] This portion amounts to over $250 trillion of the global $630 trillion outstanding and has up to now been operating in “business as usual” mode, [2] while other derivatives have been pushed into clearing. The final rule’s release completes a long process since it was proposed in 2011 and re-proposed in 2014. [3]

The good news for the industry is that the final rule is generally aligned with international standards [4] and similar requirements proposed in major foreign jurisdictions. Most notably, the final rule increases the threshold of swap activity that would bring a financial end user (e.g., hedge fund) within the rule’s scope from $3 billion to $8 billion. This change, which aligns the rule with European and Japanese proposals, eases the compliance burden of smaller, less-risky market participants.

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Title VII and Security-Based Swaps

Robert W. Reeder III and Dennis C. Sullivan are partners at Sullivan & Cromwell LLP. This post is based on a Sullivan and Cromwell publication. The complete publication is available for download here.

In the first half of 2015, the Securities and Exchange Commission (the “SEC”) finalized or proposed a number of rules relating to security-based swaps (“SBSs”). These include final and proposed rules on the reporting and public dissemination of security-based swaps, proposed rules on security-based swap transactions arranged, negotiated or executed by U.S.-based personnel of a non-U.S. person and final rules on the registration of security-based swap data repositories (“SDRs”). This post provides an overview of these regulatory developments.

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New Rules for Mandatory Clearing in Europe

Arthur S. Long is a partner in the Financial Institutions and Securities Regulation practice groups at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn publication. The complete publication, including footnotes, is available here.

On August 6, 2015, the European Commission issued a Delegated Regulation (the “Delegated Regulation”) that requires all financial counterparties (“FCs”) and non-financial counterparties (“NFCs”) that exceed specified thresholds to clear certain interest rate swaps denominated in euro (“EUR”), pounds sterling (“GBP”), Japanese yen (“JPY”) or US dollars (“USD”) through central clearing counterparties (“CCPs”). Further, the Delegated Regulation addresses the so-called “frontloading” requirement that would require over-the-counter (“OTC”) derivatives contracts subject to the mandatory clearing obligation and executed between the first authorization of a CCP under European rules (which was March 18, 2014) and the date on which the clearing obligation takes place, to be cleared, unless the contracts have a remaining maturity shorter than certain minimums. These mandatory clearing obligations for certain interest rate derivatives contracts will become effective after review by the European Parliament and Council of the European Union (“EU”) and publication in the Official Journal of the European Union and will then be phased in over a three-year period, as specified in the Delegated Regulation, to allow smaller market participants additional time to comply.

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A Reassessment of the Clearing Mandate

Ilya Beylin is a Postdoctoral Research Scholar at Columbia Law School and the Editor-at-Large of the CLS Blue Sky Blog. This post is based on an article authored by Mr. Beylin.

Following the financial crisis, the G-20 nations committed to a raft of reforms for swap markets. These reforms are intended to mitigate systemic risk, and with it, the damage that failing financial institutions inflict on the financial sector and the broader economy. A core component of the reforms is the introduction of the “clearing mandate” for standardized swaps.

Clearing refers to the interposition of a clearinghouse, or central counterparty, between the two parties to a financial transaction. When a swap is cleared, the initial swap is extinguished and two new swaps are created in its place. The first is an identical swap between the first counterparty and the clearinghouse, and the second is another identical swap between the clearinghouse and the second counterparty. In this manner, absent default, parties make payments as they would if they had transacted bilaterally and the clearinghouse simply passes the payments between counterparties. However, when one of the counterparties to a transaction defaults, the presence of the clearinghouse as an intermediate counterparty shields the non-defaulting party from losses; that is because although the defaulting party may not pay the clearinghouse, the clearinghouse is still liable for, and makes, the payment to the remaining counterparty.

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A Registration Framework for the Derivatives Market

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent public statement; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The financial crisis of 2008, and the ensuing turmoil, shook the global economy to its core and exposed the weaknesses of our regulatory regime. Years of lax attitudes, deregulation, and complacency allowed an unregulated derivatives marketplace to cause serious damage to the U.S. economy, resulting in significant losses to investors. As a result, Title VII of the Dodd-Frank Act tasked the SEC and the CFTC with establishing a regulatory framework for the over-the-counter swaps market. In particular, the SEC was tasked with regulating the security-based swap (SBS) market and the CFTC was given regulatory authority over the much larger swaps market, covering products such as energy and agricultural swaps.

Today [August 5, 2015], the global derivatives market is estimated to exceed $630 trillion worldwide—with approximately $14 trillion representing transactions in SBS regulated by the SEC. The regulatory regime for the SBS market, however, cannot go into effect until the SEC has put in place the necessary rules to implement Title VII.

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SEC and CFTC Turn to Swaps and Security-Based Swaps Enforcement

Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP, and a former commissioner at the U.S. Securities and Exchange Commission. This post is based on a Davis Polk client memorandum.

The week of June 15, 2015 saw two of the first publicly announced enforcement actions brought by the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) to enforce security-based swap and swap regulatory requirements under Title VII of the Dodd-Frank Act. The SEC accepted an offer of settlement from a web-based “exchange” for, among other things, offering security-based swaps to retail investors in violation of the Securities Act of 1933 and the Securities Exchange Act of 1934. In a separate action, the CFTC obtained a federal court order against a Kansas City man in a case alleging violations of the antifraud provisions of the swap dealer external business conduct rules in Part 23 of the CFTC regulations. [1] Swap dealers and security-based swap market participants may wish to consider these orders and the agencies’ approach to enforcement as firms further develop, review and update their compliance programs.

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SEC Re-Proposes Rules on Arranging, Negotiating or Executing Security-Based Swaps

Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP, and a former commissioner at the U.S. Securities and Exchange Commission. The following post is based on a Davis Polk client memorandum; the complete publication, including appendices, is available here.

On May 13, 2015, the SEC published proposed amendments and re-proposed rules on the application of certain Title VII requirements to cross-border security-based swap activities of non-U.S. persons based on U.S. conduct. The proposed rules would modify numerous prior SEC proposals and final rules, including the May 2013 proposed rules on the cross-border application of security-based swap regulations, the August 2014 final cross-border definitions and de minimis rules and the March 2015 reporting final rules. [1]

Notably, the proposed rules would:

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Proposed Rules for US and Non-US Person’s Security-Based Swaps Dealing

Kara M. Stein is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Stein’s recent public statement, available here. The views expressed in the post are those of Commissioner Stein and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

During the financial crisis, the world witnessed how financial contracts known as swaps played a key role in creating a global financial hurricane. These financial contracts tied together the destinies of seemingly unrelated financial firms. The threat of a daisy chain of failures drove bailouts to companies no one dreamed would ever be risky. What’s more, the crisis and bailouts flooded across international borders. Indeed, over half of the largest recipients of the AIG bailouts were foreign organizations. [1]

Following the crisis, policymakers around the world committed to stop this from happening again. The resulting reform legislation, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), directed the Securities and Exchange Commission (“Commission”) and its fellow regulators to bring the swaps marketplace into the light and to make it resilient enough to weather the next storm.

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