CFTC Proposes Closing Cross-Border Uncleared Swaps Margin De-Guaranty Loophole | Practical Law

CFTC Proposes Closing Cross-Border Uncleared Swaps Margin De-Guaranty Loophole | Practical Law

The CFTC proposed a rule on the cross-border application of CTFC uncleared swap margin requirements for swap dealers and MSPs. The rule would close part of a loophole that US entities have used to avoid the application of Dodd-Frank requirements to uncleared swaps entered into by their foreign subsidiaries.

CFTC Proposes Closing Cross-Border Uncleared Swaps Margin De-Guaranty Loophole

Practical Law Legal Update 9-616-9248 (Approx. 6 pages)

CFTC Proposes Closing Cross-Border Uncleared Swaps Margin De-Guaranty Loophole

by Practical Law Finance
Published on 02 Jul 2015 • USA (National/Federal)
The CFTC proposed a rule on the cross-border application of CTFC uncleared swap margin requirements for swap dealers and MSPs. The rule would close part of a loophole that US entities have used to avoid the application of Dodd-Frank requirements to uncleared swaps entered into by their foreign subsidiaries.
On June 29, 2015, the CFTC issued a proposed rule that would close part of a loophole that US entities have used to avoid the application of Dodd-Frank requirements to uncleared swaps entered into by their foreign subsidiaries. The proposed rule follows an announcement made by CFTC chairman Timothy Massad earlier this month that the CFTC would close the loophole (see Legal Update, CFTC to Close Dodd-Frank Swaps "De-guaranty" Loophole).
Section 731 of the Dodd-Frank Act directed the CFTC to adopt rules establishing minimum initial margin and variation margin requirements for uncleared swaps entered into by swap dealers (SDs) and major swap participants (MSPs) that are not covered by Title VII-mandated rules for SDs and MSPs issued by US prudential bank regulators. In September 2014, the CFTC proposed these margin requirements (see Legal Update, CFTC Re-proposes Corollary Dodd-Frank Margin Rules for Uncleared Swaps).
However, these rules would allow non-US subsidiaries of US parent entities to avoid the rules for their uncleared swaps, provided that the swaps are not guaranteed by a US entity. This provides incentive for US parent companies with foreign subsidiaries to "de-guaranty" the foreign subsidiary's swap transactions in order to avoid the margin rules scheduled to take effect in December of this year (see Legal Update, Is It Safe to "De-guaranty" Cross-border Swaps to Avoid Dodd-Frank?).
The new proposal would apply CFTC uncleared swaps margin rules to all swap entities registered with the CFTC that are not subject to any of the US prudential bank regulators, referred to in the rules as CSEs. (Note that many SDs and MSPs are covered by the bank rules (see Practice Note, The Dodd-Frank Act: Margin Posting and Collection Rules for Uncleared Swaps); the CFTC rules therefore cover nonbank broker-dealers and other nonbank SDs and MSPs.)
Under the CFTC's "de-guaranty" proposal:
  • All foreign controlled subsidiaries (FCS) would be subject to CFTC margin requirements for their uncleared swaps. FCS are:
    • non-US CSEs that have a US parent entity with a controlling financial interest; and
    • that report their financial statement on a consolidated basis with the US parent in accordance with US GAAP.
  • Substituted compliance with non-US uncleared swaps initial margin rules would be available for non-US CSEs that have their swaps guaranteed by a US entity for the requirement to post initial margin to non-US counterparties (in other words, these entities would be permitted to comply with foreign regulations in place of CFTC regulations, to the extent that the CFTC has made a comparability determination for initial margin rules in the jurisdiction in which the counterparty sits, discussed further in the final bullet point below), provided that:
    • the counterparty is not a US person or a foreign person that has their swaps guaranteed by a US person;
    • the initial margin posting complies with the requirements of the foreign jurisdiction to which the counterparty is subject; and
    • the CFTC has issued a comparability determination for that jurisdiction (see final bullet, below).
  • Non-US swaps that are not guaranteed by US persons would be eligible for an exclusion from CFTC margin regulations. Specifically, non-US CSEs would not be required to post margin under a swap in accordance with CFTC regulations (assuming substituted compliance is not available, as discussed below) if all of the following conditions are met:
    • the non-US CSE's obligations under the relevant swap are not guaranteed by a US person;
    • the non-US CSE is not a US branch of a non-US CSE;
    • the non-US CSE is not a FCS; and
    • the counterparty is a non-US person (excluding a FCS or the US branch of a non-US CSE) whose obligations under the relevant swap are not guaranteed by a US person.
    Otherwise the CFTC margin rules apply.
  • To the extent that the exclusion above is inapplicable, substituted compliance for CFTC margin requirements would be available for swaps of non-US CSEs without US guarantors under the following circumstances:
    • if the counterparty (party B) is not a US CSE and the swap is not guaranteed by a US person, the non-US CSE (party A) may comply with the margin requirements of a foreign jurisdiction to which it is subject, but only to the extent that the CFTC has issued a comparability determination (see final bullet, below); or
    • if the counterparty (party B) is a US CSE or a non-US CSE that is guaranteed by a US person, the non-US CSE (party A) may satisfy its requirement to collect initial margin under the rules of a foreign jurisdiction to which the non-US CSE (party A) is subject, if CFTC has issued a comparability determination for that jurisdiction.
    Otherwise the CFTC margin rules apply.
  • Comparability determinations for CFTC margin requirements would be made pursuant to a proposed request mechanism and would be made based on the similarity of the foreign regulation for uncleared swap margin to CFTC requirements. CSEs that comply with foreign uncleared swap margin rules in accordance with comparability determinations would be deemed to be compliant with CFTC rules. As the mechanism by which comparability determinations are is still in its proposal phase, no comparability determinations for margin requirements have yet been made.
Notably, US CSEs would be eligible for substituted compliance only for margin they post to non-US entities. Substituted compliance would not be available for margin that US CSEs collect.
For a user-friendly guide to application of the proposed rule, see the table below under Application of the Proposed Rule.
It is noteworthy that the CFTC decided to address the de-guaranty loophole in one of the few areas in which they have not yet finalized rulemaking. Most swap de-guarantying is likely the result of parties trying to avoid the application of cumbersome business conduct, governance and other swap dealer requirements under Title VII (see The Dodd-Frank Act: Requirements for Swap Dealers and MSPs Checklist). It is also noteworthy that the CFTC chose to address the loophole in one of the few areas in which its rulemaking is of somewhat limited application, as many swap dealers will be subject to the bank uncleared swaps margin rules.
Because margin compliance requires certain infrastructure and documentational frameworking, the CFTC may have decided to address this issue in this area at a time when the market is in the planning stages for these rules to take effect later this year, which will occur December 1, 2015 for variation margin and which will be phased in starting on that date for initial margin, including initiatives like the ISDA® SIMM™ uncleared swaps margin project (see Legal Update, ISDA Releases SIMM Swap Margin Model Draft Discussion Paper and Methodologies).
Public comment on the proposal is due on or before September 14, 2015. Comments may be sent via mail or courier to Christopher Kirkpatrick, Secretary of the Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581. Comments may also be submitted on the CFTC's website (http://comments.cftc.gov) or on the federal eRulemaking portal (http://www.regulations.gov). All comments must be identified by RIN 3038-AC97.

Application of the Proposed Rule

APPLICATION OF THE PROPOSED RULE
CSE
Counterparty
Proposed Approach
US CSE or Non-US CSE (including US branch of a non-US CSE and a foreign consolidated subsidiary (FCS)) whose obligations under the relevant swap are guaranteed by a US person.
  • US person (including US CSE).
  • Non-US person (including non-US CSE, FCS, and US branch of a non-US CSE) whose obligations under the relevant swap are guaranteed by a US person.
US (all).
  • Non-US person (including non-US CSE, FCS and US branch of a non-US CSE) whose obligations under the relevant swap are not guaranteed by a US person.
US (initial margin collected by CSE in column 1).
Substituted Compliance (initial margin posted by CSE in column 1).
US (variation margin).
FCS whose obligations under the relevant swap are not guaranteed by a US person or US branch of a non-US CSE whose obligations under the relevant swap are not guaranteed by a US person.
  • US CSE. 
US (initial margin posted by CSE in column 1).
  • Non-US CSE (including US branch of a non-US CSE and FCS) whose obligations under the relevant swap are guaranteed by a US person.
Substituted compliance (initial margin collected by CSE in column 1). US (variation margin).
  • US person (except as noted above for a CSE).
  • Non-US person whose obligations under the swap are guaranteed by a US person (except a non-US CSE, US branch of a non-US CSE, and FCS whose obligations are guaranteed, as noted above). 
  • Non-US person (including non-US CSE, US branch of a non-US CSE, and a FCS) whose obligations under the relevant swap are not guaranteed by a US person.
Substituted compliance (all).
Non-US CSE (that is not a FCS or a US branch of a non-US CSE) whose obligations under the relevant swap are not guaranteed by a US person.
  • US CSE.
US (initial margin posted by CSE in column 1).
  • Non-US CSE (including US branch of a non-US CSE and FCS) whose obligations under the swap are guaranteed by a US person.
Substituted compliance (initial margin collected by CSE in column 1).
US (variation margin).
  • US person (except as noted above for a CSE).
  • Non-US person whose obligations under the swap are guaranteed by a US person (except a non-US CSE whose obligations are guaranteed, as noted above).
  • US branch of a Non-US CSE or FCS, in each case whose obligations under the relevant swap are not guaranteed by a US person.
Substituted compliance (all).
  • Non-US person (including a non-US CSE, but not a FCS or a US branch of a non-US CSE) whose obligations under the relevant swap are not guaranteed by a US person.
Excluded.