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11 March 2020
The Commodity Futures Trading Commission (CFTC) has issued three no-action letters providing relief for swap transactions (and amendments to swap transactions) in connection with the expected market transition from using the London Interbank Offered Rate (LIBOR) and other interbank offered rates (collectively with LIBOR, IBORs). Letter 19-26 from the CFTC Division of Swap Dealers and Intermediary Oversight (DSIO) provides relief to swap dealers (SDs) from certain requirements under the de minimis registration exemption, uncleared swap margin rules, business conduct requirements, confirmation and documentation and reconciliation requirements. Letter 19-27 from the Division of Market Oversight (DMO) provides time-limited relief from the trade execution requirement. Letter 19-28 from the Division of Clearing and Risk (DCR) provides time-limited relief from the swap clearing requirement.
DSIO Letter 19-26(1) was drafted in response to a request from the Alternative Reference Rates Committee (ARRC) requesting no-action relief for non-compliance with certain CFTC regulations in connection with amending uncleared swaps referencing:
To address the possibility of IRRs, market participants are expected to amend existing IRR-linked uncleared swaps to include new fallbacks to alternative reference rates (including so-called 'risk-free rates' ('RFRs')) that will be triggered when an IRR is discontinued or determined to be non-representative (fallback amendments). Some market participants may also choose to voluntarily make such conversion prior to a permanent cessation of the applicable IRR or determination that it is non-representative (replacement rate amendments). Market participants have been concerned that such amendments, without relief, could cause a loss of legacy status resulting in a swap becoming subject to regulatory requirements to which it was previously not subject. As a result, the ARRC requested, the DSIO was willing to provide relief to facilitate an orderly market-wide transition without causing amended swaps to become subject to additional requirements.
For the purposes of the DSIO no-action positions described below, a 'qualifying amendment' is an uncleared swap that references an IRR solely to:
This includes no amendment extending the maximum maturity of a swap or a portfolio of swaps or increasing the total effective notional amount of a swap or the aggregate total effective notional amount of a portfolio of swaps beyond what is necessary to address the differences in conventions relating to an IRR and its replacement.
De minimis exception to 'swap dealer' definition
To address the ARRC's concerns that entities that rely on the de minimis exemption from swap dealer registration may be reluctant to transition from IRRs, the DSIO provided relief from the requirement to count towards the de minimis threshold a swap that references an IRR solely to the extent that such swap would be required to be counted as a consequence of a qualifying amendment to such swap.
Uncleared swaps margin requirements
Because SDs and their counterparties will be amending uncleared swaps that were entered into prior to the CFTC Margin Rule(3) compliance date (CFTC Margin Rule Legacy Swaps), concerns have been raised that such legacy swaps would become subject to the margin rule. In response, the DSIO stated in the no-action relief that it will not recommend that the commission take enforcement action against an SD for non-compliance with the CFTC Margin Rule to the extent that such non-compliance is due to a qualifying amendment to a CFTC Margin Rule Legacy Swap.
Basis swap method relief
Some market participants may wish to transition swap portfolio reference rates to alternative reference rates through one or more new basis swaps that would swap the IRR basis of a portfolio with an alternative reference rate basis without amendments to any of the swap referencing IRRs (the basis swap method). The DSIO was willing to provide a no-action position under such circumstances. Accordingly, the DSIO will not recommend that the commission take enforcement action against an SD for failure to comply with the CFTC Margin Rule with respect to a basis swap that meets the following conditions:
SD business conduct requirements
The ARRC requested no-action relief with respect to SD non-compliance with the CFTC business conduct requirements(4) (the Counterparty BCS) when entering into a fallback amendment or replacement rate amendment to a legacy swap executed before the effective date of the Counterparty BCS final rules.
The DSIO accepted that such no-action relief is warranted and will not recommend that the commission take an enforcement action against an SD for a failure to comply with the Counterparty BCS (other than CFTC Regulation 23.431(a)) solely to the extent that such compliance would be required as a consequence of a qualifying amendment to an uncleared swap. However, relief from CFTC Regulation 23.431(a), which requires disclosure of material information concerning a swap, was viewed as inappropriate because pursuant to the IR transaction, counterparties will be transitioning from familiar reference rates to new rates, and the DSIO believes it appropriate that SDs provide material information about such new rate to facilitate counterparty understanding of the new rates.
CFTC documentation and swap processing requirements – confirmations, swap trading relationship documentation and reconciliation
The DSIO granted no-action relief with respect to the requirement to provide a confirmation in compliance with CFTC Regulation 23.501 to the extent that compliance with such requirement would be required as a consequence of a qualifying amendment to an uncleared swap, provided that such amendment is accomplished pursuant to a multilateral protocol.
For the same reason, and relating to the same circumstances, the DSIO granted further no-action relief with respect to compliance with CFTC Regulation 23.504(a)(2) requiring SDs to enter into swap trading relationship documentation for swaps solely as a result of a qualifying amendment.
The DSIO will also not recommend that the CFTC take an enforcement action against an SD for a failure to comply with the discrepancy resolution timing requirements of CFTC Regulations 23.502(a)(4) and (b)(4) relating to portfolio reconciliation solely to the extent that such compliance would be required as a consequence of a qualifying amendment to a legacy uncleared swap.
Relief requested related to end users – CFTC Margin Rule, eligible contract participants and end-user documentation
With respect to fallback amendments and replacement rate amendments, the DSIO recognises that a temporary mismatch in the interest rates referenced in commercial arrangements and the swaps used to hedge the risk of such arrangements may lead certain counterparties to question whether one or more swaps still qualify as instruments used to hedge or mitigate commercial risk. To address this concern, the DSIO will not recommend the commission commence an enforcement action against an SD for failure to comply with the CFTC Margin Rule with respect to a swap entered into with an entity electing an exception or exemption pursuant to the requirements of CFTC Regulations 50.50(c) or 50.51(b)(2) (relating to commercial end-users and cooperatives) if:
The DSIO will also not recommend that the commission commence an enforcement action against any person for failure to qualify as an eligible contract participant pursuant to Section 1a(18)(A)(xi) of the Commodity Exchange Act (CEA) solely to the extent that such status would otherwise become relevant as a consequence of a qualifying amendment to an uncleared swap.
The DSIO will also not recommend enforcement against an SD for failure to obtain documentation meeting the requirements of CFTC Regulation 23.505(a)(4) (as to the counterparty's reliance on exemption based on hedging or mitigating commercial risk) from a counterparty for which it has previously obtained such documentation solely to the extent that such documentation would be required to be obtained as a consequence of a qualifying amendment to an uncleared swap.
The ARRC requested that the DMO(5) provide clarity regarding the application of the trade execution requirement under Section 2(h)(8) of the Commodity Exchange Act when market participants use certain mechanisms to transition swaps and swap portfolios from IBORs to RFRs. As this transition may take different forms, "depending on the needs of counterparties, the nature of the particular swap or swap portfolio being transitioned, and the liquidity and availability of products referencing new RFRs",(6) the ARRC asked commission staff to consider the need for flexibility to implement transition mechanisms that take into account individual facts and circumstances.
In order to promote regulatory certainty and support a smooth and orderly IBOR transition, until 31 December 2021, the DMO will not recommend enforcement against any person for failure to comply with the trade execution requirement under Section 2(h)(8) of the Commodity Exchange Act, with respect to an IBOR-linked swap that is amended or created by the execution of a new swap, a fallback amendment or a replacement rate amendment, for the sole purpose of accommodating the replacement of the applicable IBOR with an RFR.
No action position for uncleared legacy IRS
The ARRC requested that the DCR(7) confirm that an amendment of fallback provisions (or addition of contractual terms) regarding selection of the new floating rate because the rate is unavailable, permanently discontinued or determined non-representative (an IRS fallback amendment) with respect to a swap that was executed prior to the compliance date on which swap counterparties were required to begin centrally clearing interest rate swaps (Uncleared Legacy IRS) would not result in a requirement to clear such swap pursuant to Section 2(h)(1) of the Commodity Exchange Act, as implemented in Part 50 of the commission's regulations.
To help facilitate an orderly market-wide transition away from the use of IBOR floating rates to alternatives RFRs, until 31 December 2021, the DCR will not recommend that the CFTC commence an enforcement action for a failure to comply with the swap clearing requirement with respect to an Uncleared Legacy IRS that references US dollar LIBOR, Japanese yen LIBOR, UK pound LIBOR, Swiss franc LIBOR or Singapore dollar SOR that is amended by adding a fallback amendment for the sole purpose of changing the existing floating rate to an applicable RFR in the event that the existing floating rate is unavailable, permanently discontinued or has been determined non-representative by the benchmark administrator or the relevant authority in a jurisdiction, provided that the following conditions are met:
This relief does not apply to the commission's trade execution requirement, although separate time-limited relief has been granted relating to the trade execution requirement, as noted above.
No-action relief for end users
The DCR also provided no-action relief similar to that described above for end-users under the CFTC margin rules for uncleared swaps. As in that case, commercial end-users have noted that they may need to amend swaps referencing IBORs that are subject to the clearing requirements, but may not yet be made corresponding amendments to the related IBOR-linked credit agreements or vice versa, and raised concerns as to whether the resulting rate mismatch could create uncertainty as to whether a swap still qualifies for the clearing exception or exemption for instruments used to hedge or mitigate commercial risk pursuant to CFTC Regulations 50.50(c) and 50.51(b)(2). In response, the DCR has provided time-limited no-action relief that until 31 December 2021, it will not recommend the CFTC commence an enforcement action against an eligible entity electing such exception or exemption for failure to submit a swap that is required to be cleared to a derivatives clearing organisation for clearing pursuant to CFTC Regulation 50.2 if:
Overall, the no-action letters remove a number of potential hurdles and legal uncertainties that had been identified as market participants continue to prepare for the broader task of converting their existing derivative contracts from referencing IBORs to alternative rates over the coming year. The approach is consistent with an increasing focus at the CFTC and other regulators on facilitating an orderly transition to alternative rates.
For further information on this topic please contact Donna M Parisi, Geoffrey B Goldman, Azam H Aziz or Jennifer Oosterbaan at Shearman & Sterling LLP by telephone (+1 212 848 4000) or email (firstname.lastname@example.org, email@example.com, firstname.lastname@example.org or email@example.com). The Shearman & Sterling LLP website can be accessed at www.shearman.com.
(1) DSIO Letter 19-26.
(2) Including, but not limited to, LIBOR, the Tokyo Interbank Offered Rate, the Bank Bill Swap Rate, the Singapore Interbank Offered Rate, the Canadian Dollar Offered Rate, the Euro Interbank Offered Rate and the Hong Kong Interbank Offered Rate.
(3) Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR 636 (6 Jan 2016). The CFTC Margin Rule, which became effective 1 April 2016, is codified in Part 23 of the commission's regulations. See §§23.150-159, 161.
(5) DMO Letter 19-27.
(7) DCR Letter 19-28.
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