Columbia Law School
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This alert discusses the U.S. Commodity Futures Trading Commission’s (“CFTC”) and European Commission’s (“EC”, together with the CFTC, the “Commissions”) announcements on October 13, 2017 regarding the international harmonization on two key derivatives regulatory requirements.[1] The Commissions first announced that they had separately adopted comparability and equivalence determinations related to their respective uncleared swap margin regulations (“Uncleared Margin Determinations”).[2] The Commissions then announced that they had reached a common plan to recognize each other’s authorized derivatives trading venues as comparable and equivalent (“Common Plan on Trading Venues”).[3] Ultimately, both of these actions will have positive impacts on cross-border swap trading for both U.S. and European market participants once fully implemented. The most significant of these impacts is the avoidance of potential market disruption and fragmentation resulting from the implementation of the European Union’s (“EU”) cornerstone financial markets legislation and regulation—the Markets in Financial Instruments Directive (“MiFID II”)[4] and the European Market Infrastructure Regulation (“EMIR”), respectively—which go into force on January 3, 2018.
To present these two important announcements, CFTC Chairman J. Christopher Giancarlo and EC Vice President for Financial Stability, Financial Services and Capital Markets Union, Valdis Dombrovskis, held a joint press conference and issued statements emphasizing their commitment to international coordination and cooperation on derivatives regulation. The unprecedented manner of these announcements demonstrates that the tone and approach under CFTC Chairman Giancarlo on matters relating to cross-border swap regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank” or “Dodd-Frank Act”)[5] will be quite different from that of his predecessors. Indeed, when commenting on the Commissions’ two actions, Giancarlo noted that, “Today marks a significant milestone in cross-border harmonization between the EC and the CFTC. These cross-border measures will provide certainty to market participants and also ensure that our global markets are not stifled by fragmentation, inefficiencies, and higher costs.”[6]
In the days and weeks following the Commissions’ adoption of these two actions, while U.S. and European swap market participants subject to the CFTC and EU’s uncleared swap margin rules can breathe a sigh of relief in terms of their compliance with requirements under those rules, U.S. and European market participants should not become too comfortable since the Commissions must take further actions in order to implement the Common Plan on Trading Venues before the MiFID II implementation deadline on January 3, 2018. While Giancarlo and Dombrovskis indicated that their respective staffs are working collaboratively and extensively to meet this deadline, the exact timing and details of the Commissions’ actions to effectuate their plan remain uncertain.
In the sections that follow, we first summarize the impact of the Uncleared Margin Determinations and then outline and discuss the known elements of the Commissions’ Common Plan on Trading Venues. Please feel free to contact Gibson Dunn’s Derivatives Team if you have any questions.
1. Uncleared Margin Determinations
Shortly before making their announcements on October 13, the Commissions adopted the Uncleared Margin Determinations for each other’s uncleared margin requirements. As a result, swap dealers subject to both CFTC and European uncleared margin rules now have more certainty that they will not have to establish duplicative compliance programs. In contrast, swap dealers that are subject to the U.S. prudential regulators’ uncleared margin rules are not covered by the Uncleared Margin Determinations and, as a result, are unable to rely on this substituted compliance relief. The U.S. prudential regulators have not yet issued a comparability determination relating to the EC’s uncleared derivatives margin rules.
Background and a discussion of the implications of the CFTC’s and the EC’s determinations are provided in more detail separately below.
a. CFTC’s Comparability Determination
On the morning of the announcements, the CFTC unanimously voted to approve its comparability determination,[7] affirmatively finding that the EU’s uncleared derivatives margin rules are comparable in outcome to the CFTC’s uncleared swap margin rules under the Commodity Exchange Act (“CEA”)[8] and CFTC regulations.[9] The prelude to the CFTC’s vote on October 13 started on December 16, 2015, when the CFTC adopted its final uncleared swap margin rules. Those rules required non-prudentially-regulated swap dealers to post and collect initial and daily variation margin for their uncleared swaps entered into with other swap dealers and “financial end-users” (e.g., insurance companies, private funds and securitization vehicles) by March 1, 2017.[10] Those rules also required that non-prudentially-regulated swap dealers post and collect initial margin subject to a phased-in compliance schedule, with various compliance dates extending into the year 2020. Following its December 2015 vote, the CFTC adopted a final rule in May 2016, setting forth the manner in which its uncleared swap margin rules would apply to cross-border transactions. This subsequent rulemaking provided that certain foreign swap dealers subject to both the jurisdiction of the CFTC and the foreign regulator through substituted compliance could elect to comply with the applicable foreign jurisdiction’s uncleared margin rules (instead of the CFTC’s rules) once the CFTC issued a comparability determination for the foreign jurisdiction. To begin the CFTC’s comparability determination process, the EC filed a submission with the CFTC on November 22, 2016, requesting that the CFTC make such a determination for the EU’s uncleared derivatives margin rules.
The CFTC’s comparability determination for the EU’s uncleared derivatives margin rules analyzed several principles, including the scope and objectives of the EU’s uncleared swap margin requirements and whether the EU’s requirements achieve comparable outcomes to the CFTC’s corresponding requirements.[11] In short, the CFTC’s analysis primarily stressed the importance of the EU’s uncleared derivatives margin rules aligning with the Basel Committee on Banking Supervision’s (‘‘BCBS’’) and the International Organization of Securities Commissions’ (‘‘IOSCO’’) principles for uncleared derivatives margin rules.[12] Based on its analysis, the CFTC’s determination deemed any swap dealer that is subject to both CFTC jurisdiction and EU law and complies with the EU’s uncleared derivatives margin requirements to be in compliance with the CFTC’s uncleared swap margin rules, effective immediately. The CFTC’s comparability determination noted, however, that the swap dealer’s dually-regulated swap positions would remain subject to the CFTC’s examination and enforcement authority.
In effect, the CFTC’s adoption of its comparability determination should not result in any material change to impacted swap dealers’ existing compliance programs since CFTC staff took action earlier this year specifically to address any differences between the CFTC’s and EU’s requirements. In particular, the CFTC’s October 13 comparability determination effectively supersedes CFTC Staff No-Action Letter 17-22 (“Letter 17-22”), which the CFTC’s Division of Swap Dealer and Intermediary Oversight issued on April 18, 2017.[13] That letter—and a previously issued, but now expired staff letter—were intended to specifically address concerns related to the differences between the CFTC’s and EU’s variation margin requirements around the types of transactions and counterparties subject to margin requirements, the types of eligible collateral required, margin transfer timing and valuation methods. Letter 17-22 extended the previously-issued no-action relief to swap dealers subject to the CFTC’s uncleared swap margin rules from having to comply with certain provisions in the CFTC’s rules when those swap dealers entered into swaps with counterparties that are subject to the EU’s uncleared derivatives margin rules. Letter 17-22 was set to expire on November 7, 2017. Swap dealers subject to the CFTC’s uncleared swap margin rules now can rely on the more permanent relief provided by the CFTC’s comparability determination.
b. EC’s Equivalence Determination
As noted above, the EC similarly adopted a determination on October 13 before its formal announcement recognizing the CFTC’s uncleared swap margin regulations as equivalent to similar requirements under EMIR. EMIR sets forth requirements for the exchange of margin for uncleared, over-the-counter (“OTC”) derivatives contracts entered into by financial counterparties and non-financial counterparties above the EU’s clearing threshold.[14] The EU’s uncleared derivatives margin rules entered into force on January 4, 2017, and from March 1 2017, certain counterparties begun posting both variation margin and initial margin (with a phase-in of the initial margin requirements through the year 2020).
In the cross-border context, the EU’s margin requirements also apply to OTC derivative contracts entered into with third-country entities that would be subject to the EU’s uncleared margin requirements if they were established in the EU where the contract has a direct, substantial and foreseeable effect within the EU or such obligation is necessary or appropriate to prevent the evasion of any provision of EMIR. The EC has authority under EMIR, however, to allow substituted compliance to third-country entities if the EC determines that a third country has a legal supervisory and enforcement regime that is equivalent to EMIR. Under this authority, the EC concluded that the CFTC’s uncleared swap margin rules were equivalent in substance to the EU’s uncleared derivatives margin rules and in terms of the CFTC’s legal supervision and enforcement regime.
2. Common Plan on Trading Venues
During the same press conference, the Commissions also announced their Common Plan on Trading Venues, which lays out the Commissions’ agreement regarding the recognition of each other’s authorized trading venues.[15] The Common Plan on Trading Venues was modeled after the Commissions’ common approach adopted in 2016 to address cross-border recognition issues dealing with derivatives clearinghouses.[16] In effect, the Common Plan on Trading Venues importantly aims to allow European firms operating in the United States to trade derivatives on authorized U.S. trading venues while still complying with the EU’s Markets in Financial Instruments Regulation (“MiFIR”)[17] trading obligation in advance of MiFID II’s expected implementation date on January 3, 2018. By that date, any market participant that is subject to the EU’s trading obligation will be required to execute certain swap transactions on regulated markets, multilateral trading facilities (“MTFs”), organized trading facilities (“OTFs”) or certain third-country trading venues.[18]
Once the Commissions’ finalize and issue comparability and equivalence determinations for each other’s authorized derivatives trading venues, U.S. firms will be able to comply with the CFTC’s trade execution mandate under the CEA and CFTC regulations[19] by executing swaps on EU-authorized MTFs and OTFs that are exempted from registration as a swap execution facility (“SEF”).[20] Conversely, European firms will be able to comply with the EU’s trading obligation by executing swaps on authorized CFTC-authorized SEFs and DCMs.
Notably, the Commissions’ announcement of the Common Plan on Trading Venues only sets forth the Commissions’ intentions to take further action and the key elements of the Commissions’ approaches. Thus, both regulators must take further steps in order to effectuate recognition of each other’s authorized trading venues.
The Common Plan on Trading Venues outlines some of the actions that the Commissions must undertake. In particular, it provides that Vice President Dombrovskis intends to propose an equivalence decision covering CFTC-authorized SEFs and DCMs operating the United States, which comply with relevant requirements under MiFID II, MiFIR and the Market Abuse Regulation (“MAR”).[21] The Common Plan on Trading Venues also noted that CFTC staff in the Division of Market Oversight—with the support of Chairman Giancarlo—intend to propose a single order exempting trading venues from the SEF registration requirement. The CFTC would adopt the order through its exemption authority under CEA Section 5h(g), which allows the CFTC to grant an exemption where it determines that a foreign trading venue is subject to comparable, comprehensive supervision and regulation on a consolidated basis by its relevant home country regulator.[22] In order to qualify for the CFTC’s exemption, a foreign trading venue would be required to (i) satisfy requirements under MiFIR and MiFID II, (ii) be identified to the CFTC by the EC, and (iii) in essence, meet such additional standards as the CFTC may determine under the CEA.
In terms of the timing of their proposed actions, the Commissions have indicated that they are working as expeditiously as practicable to ensure that all necessary actions to achieve recognition are completed in a coordinated manner. The CFTC is now preparing a list of eligible SEFs and DCMs that it will share with the EC. The EC is similarly preparing a list of eligible MiFID II/MiFIR and MAR compliant trading venues to share with the CFTC. In addition, the Commissions further noted that CFTC staff and the staffs of relevant national competent authorities (through coordination with the EC) will work towards concluding cooperation arrangements in order to ensure the effective exchange of information and coordination of supervisory activities.
We are closely monitoring the Commissions’ implementation of the Common Plan on Trading Venues and will provide updates once the Commissions’ take final action.
ENDNOTES
[1] See CFTC Press Release (PR 7629-17), CFTC Comparability Determination on EU Margin Requirements and a Common Approach on Trading Venues (Oct. 13, 2017). See also EC Press Release, European Comm’n, Vice-President Valdis Dombrovkis’ Press Statement With the U.S. Commodity Futures Trading Comm’n (Oct. 13, 2017).
[2] See CFTC, Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 Fed. 636 (Jan. 6, 2016); Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants – Cross-Border Application of the Margin Requirements, 81 Fed. Reg. 34818 (May 31, 2016). See also EC, Council Regulation 648/2012, 2012 O.J. (L 201) 1(EU); Comm’n Delegated Regulation 2016/2251, 2016 O.J. (L 340) 9 (EU).
[3] See CFTC, A Common Approach on Certain Derivatives Trading Venues (Oct. 13, 2017), available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/dmo_cacdtv101317.pdf.
[5] See Dodd-Frank Wall Street Reform and Consumer Protection Act, 124 Stat. 1376, Pub. Law 111-203 (July 21, 2010).
[6] CFTC Chairman J. Christopher Giancarlo, Prepared Remarks at Press Conference to Announce comparability Determination on EU Margin Requirements and a Common Approach on Trading Venues (Oct. 13, 2017), available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-30.
[7] See CFTC, Notification of Determination, Comparability Determination for the European Union: Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 82 Fed. Reg. 48394 (Oct. 18, 2017).
[8] See 7 U.S.C. 1 et seq. (2017).
[9] See 17 C.F.R. pt. 23, subpt. E.
[10] In light of widespread concern that the industry would be unable to meet the March 1, 2017 deadline, the CFTC, U.S. prudential regulators and some foreign regulators provide flexibility to swap dealers, which were unable achieve full compliance.
[11] The CFTC’s comparability determination analysis also examined the ability of the EC to supervise and enforce compliance with the EU’s uncleared derivatives margin requirements.
[12] See BCBS/IOSCO, Margin requirements for non-centrally cleared derivatives (updated March 2015), available at http://www.bis.org/bcbs/publ/d317.pdf.
[13] CFTC Staff No-Action Letter No. 17-22 (Apr. 18, 2017), which extends CFTC Staff No-Action Letter No. 17-05 (Feb. 1, 2017).
[14] The EU’s uncleared derivatives margin rules apply to a broader scope of financial instruments than the CFTC’s uncleared swaps margin rules. The EU’s rules apply to all “OTC derivatives” as that term is defined in Annex I to the Markets in Financial Instruments Directive (“MiFID”). In contrast, the CFTC’s rules do not apply to foreign exchange spot, foreign exchange forward and foreign exchange swap transactions.
[15] See Common Plan on Trading Venues, supra note 3.
[16] See CFTC Press Release, Common Approach for Transatlantic CCPs (Feb. 10, 2016), available at http://www.cftc.gov/PressRoom/PressReleases/cftc_euapproach021016.
[17] See Regulation (EU) No. 600/2014.
[18] See Council Regulation 600/2014, 2014 O.J. (L 173), 84, 122 Art. 28.
[19] The CFTC’s trading mandate under the CEA and CFTC regulations requires counterparties to execute certain swap transactions that are “made available to trade” on a SEF, a SEF that is exempt from registration, or a designated contract market (“DCM”). See CEA Section 2(h)(8) and 17 C.F.R. Parts 37 and 38.
[20] Note that the EC has not authorized any entities as OTFs to date.
[21] See Regulation (EU) No 596/2014.
This post comes to us from Gibson, Dunn & Crutcher LLP. It is based on the firm’s memorandum, “Ready? Set? Harmonize. The CFTC and EC Announce Two Actions to Harmonize Their Derivatives Regulations,” dated October 27, 2017, and available here.