CFTC Approves Substituted Compliance for US-EU Derivatives Clearinghouses and Provides No-Action Relief | Practical Law

CFTC Approves Substituted Compliance for US-EU Derivatives Clearinghouses and Provides No-Action Relief | Practical Law

The CFTC issued a substituted compliance framework for derivatives clearinghouses (CCPs) located in the European Union that are also CFTC-registered derivatives clearing organizations (DCOs). The CFTC also issued a determination that certain EU CCP requirements are comparable to certain CFTC regulatory obligations applicable to DCOs, as well as related no-action relief.

CFTC Approves Substituted Compliance for US-EU Derivatives Clearinghouses and Provides No-Action Relief

by Practical Law Finance
Published on 17 Mar 2016 • USA (National/Federal)
The CFTC issued a substituted compliance framework for derivatives clearinghouses (CCPs) located in the European Union that are also CFTC-registered derivatives clearing organizations (DCOs). The CFTC also issued a determination that certain EU CCP requirements are comparable to certain CFTC regulatory obligations applicable to DCOs, as well as related no-action relief.
On March 16, 2016, the CFTC issued a substituted compliance framework for dually-registered central clearing counterparties (CCPs), or derivatives clearinghouses, located in the European Union (EU) that are also CFTC-registered derivatives clearing organizations (DCOs).
Under the CFTC's substituted compliance regime, if the CFTC deems certain non-US swaps rules comparable to its own, it may permit certain parties subject to its jurisdiction and to those rules to comply with those rules in place of its own. These rules were implemented under Title II of the Dodd-Frank Act. For details on CFTC substituted compliance under the Dodd-Frank Act, see Practice Note, The Dodd-Frank Act: Cross-Border Application of Swaps Rules: CFTC Substituted Compliance: Entity-Level Requirements and Transaction-Level Requirements.
The CFTC also issued a related comparability determination that certain EU CCP requirements are comparable to certain regulatory obligations applicable to CFTC-registered DCOs that are also authorized to operate as CCPs in the EU. The comparability determination will be effective upon publication in the Federal Register.
The comparability determination will permit EU CCPs that are also registered with the CFTC as DCOs (DCO/CCPs) and those seeking registration to provide services to US clearing members and clients while complying with certain corresponding EU requirements.
As described in the determination, the Commodity Exchange Act (CEA) and CFTC regulations require that foreign-based CCPs register with the CFTC in certain circumstances. If registered, they must comply with the relevant US requirements, including CFTC regulations applicable to registered DCOs. Under the determination, DCO/CCPs may comply with certain CFTC requirements for financial resources, risk management, settlement procedures, and default rules and procedures (as set forth in the determination) by complying with corresponding requirements under EMIR.
The releases follow the agreement reached last month between the CFTC and the European Commission (EC) regarding dually-registered DCOs/CCPs (see Legal Update, CFTC-EU Reach Agreement on Derivatives Clearing Equivalence). By issuing this determination, the CFTC hopes to further harmonize the CFTC and EMIR regimes without risking regulatory arbitrage, while enhancing customer protection.
The EC has also issued an equivalence determination for US CCPs (see Legal Update, European Commission Adopts Equivalence Decision for US CCP Regulatory Regime). However, issues remain before US CCPs can clear trades for EU clients, as the European Securities and Markets Authority (ESMA) must still approve US CCPs.
Simultaneously, the CFTC's Division of Clearing and Risk (DCR) also issued No-Action Letter 16-26, which provides limited relief for EU-based CCPs that are registered with the CFTC as DCOs (DCO/CCPs) from the application of the following CFTC regulations, most of which reflect differences in the clearing models between the US and the EU:
  • The requirement under CFTC Regulation 39.12(b)(6) that upon a DCO's acceptance of a swap for clearing the original swap is extinguished and is replaced by an equal and opposite swap between the DCO and each clearing member (acting as a principal for a house trade or an agent for a customer trade) will not apply in the context of a DCO/CCP where neither party is a US clearing member or futures commission merchant (FCM) clearing member.
  • Under CFTC Regulations Part 22, the "legally segregated but operationally commingled" (LSOC) account model for cleared swaps customer accounts will not apply in the context of a DCO/CCP to clearing members that are not FCMs (see Practice Note, The Dodd-Frank Act: Derivatives Margin Collateral Rules: Segregation of Cleared Swaps Customer Collateral by FCMs and DCOs).
  • The requirement under CFTC Regulation 39.13(g)(8)(i) that a DCO calculate and collect initial margin for customer accounts cleared by an FCM on a gross basis will not apply in the context of a DCO/CCP to non-FCM clearing member intermediaries.
  • The requirement under CFTC Regulation 39.13(g)(8)(ii) that a DCO collect initial margin at a level that is greater than 100% of the DCO's initial margin requirements for the non-hedge positions of FCM customers will not apply in the context of a DCO/CCP to such positions of the customers of non-FCM clearing member intermediaries.
  • The prohibition under CFTC Regulation 39.12(a)(2)(iii) that a DCO not set a minimum capital requirement of more than $50 million for any person that seeks to become a clearing member to clear swaps will not apply in the context of a DCO/CCP to non-US clearing members or non-FCM clearing members.
  • The requirement under CFTC Regulation 39.12(b)(7) that DCOs utilize "straight-through-processing" of swaps submitted for clearing will not apply to trades that are not executed on or subject to the rules of a designated contract market (DCM) or a swap execution facility (SEF) and for which neither clearing member is an FCM, a swap dealer (SD), or a major swap participant (MSP).
  • The requirement under Regulation 39.13(h)(5) that DCOs must require their clearing members to maintain written risk management policies and procedures and that DCOs must have the authority to obtain information and documents from clearing members regarding their risk will still apply. However, DCO/CCPs may implement different oversight programs for US/FCM clearing members and non-US clearing members.
  • The implicit requirements under CFTC Regulation 39.11(f) and Regulation 39.19(c)(3)(ii) that DCOs submit to the CFTC quarterly financial resource reports and an audited year-end financial statement that are prepared in accordance with US GAAP will not apply in the context of a DCO/CCP; rather, DCO/CCPs may submit financial statements prepared in accordance with International Financial Reporting Standards (IFRS), with periodic reconciliation to assist staff in reviewing the financial statements.
For details on differences between US and EU clearing models, see Practice Note, Mechanics of Derivatives Clearing.