With the upcoming March 1st effective date for the global variation margin rules for uncleared swaps quickly approaching, US and EU regulators issued guidance on February 23, 2017 that may have the effect of easing requirements for certain market participants in complying with the March 1st deadline. The move by the agencies is in response to concerns raised by many market participants that they could not meet the March 1st deadline and follows action taken by a division of the U.S. Commodity Futures Trading Commission on February 13, 2017 (which we discussed in a prior client alert that can be found here Swap Margin Requirements: CFTC Provides Limited Grace Period to September 1, 2017. The CFTC relief effectively delays its overall enforcement of the variation margin requirements for CFTC registered swap dealers for six months until September 1st subject to a number conditions. Given that the CFTC action only applied to CFTC registered dealers (i.e., non-bank swap dealers), without action from the U.S. banking regulators and EU authorities, there was significant uncertainty in the market over the compliance timeframe of the global rules.
In the US, the US banking regulators (including the Federal Reserve and the Office of the Comptroller of the Currency (OCC)) are responsible for implementing the variation margin rules for registered bank swap dealers. With the February 23rd guidance, the Federal Reserve and the OCC indicated that they would allow counterparties without what the agencies called “significant credit and market risk” to gradually comply with the variation margin requirement by September 1. However, those counterparties that do present such risk will still be required to meet the March 1st deadline. The Federal Reserve and OCC did not specify any threshold for market or credit risk, effectively leaving it up to the individual swap dealers to make risk based determinations as to whether a particular relationship falls within the relief provided by the guidance. The remaining US prudential regulators that have regulatory oversight over certain market participants, including the Farm Credit Administration, Federal Deposit Insurance Corp. and Federal Housing Finance Agency, indicated in a statement from the FDIC, that they would follow the Federal Reserve and OCC in their guidance.
In the EU, ESMA’s guidance to member state regulators indicated that they may exercise flexibility in enforcing the rules for smaller entities in Europe that might be facing difficulties in complying with the new margin requirements by March 1st. Similar to the CFTC, the ESMA approach appears to be taking the form of a delay in the enforcement of the rules, particularly focused at smaller entities. The member state regulators have been instructed to take into account the size of the exposure to the counterparty plus its default risk, and that participants must document the steps taken toward full compliance and put in place alternative arrangements to ensure that the risk of non-compliance is contained. Unlike US regulators, ESMA did not set a specific date for extending the March 1 deadline but indicated that it would expect the difficulties will be solved in the coming few months. Following the issuance of the ESMA guidance, the UK Financial Conduct Authority, which oversees dealers in the UK, issued guidance to UK dealers that it will take a risk-based approach in assessing compliance and indicated that firms that are not able to comply by March 1st should be able to demonstrate that they have made best efforts to achieve full compliance and be able to explain how they will achieve full compliance as soon as possible.
In addition to the US, EU, and UK guidance, the Board of the International Organization of Securities Commissions (IOSCO) also issued a statement relating to the March 1st deadline. The statement provided, among other things, that parties should strive to meet the deadline, but regulators should “consider taking appropriate measures available to them to ensure fair and orderly markets during the introduction and application of such variation margin requirements.”
While the guidance provides some flexibility in both the US and EU, it does not entirely put an end to the uncertainty in the market as to whether a particular trading relationship would be covered by the extended timeline, particularly given the risk-based approach that the regulators appear to be taking. As a result, fund clients should continue to coordinate with their swap dealer counterparties on negotiating regulatory compliant documentation in a timely manner. Clients also should have a discussion with counterparties to ascertain how the dealer intends to apply the risk-based guidance to their particular trading relationship and to determine whether they would be subject to the extended timeline. We will continue to monitor these evolving issues and will keep clients updated on any developments.