On September 1, 2016, the CFTC issued No-Action Letter 16-70 (No-Action 16-70), granting relief to swap dealers (SDs) that failed to meet the September 1, 2016 deadline (Phase-one date) for compliance with initial margin (IM) segregation rules for uncleared swaps between large dealer parties.

Specifically, the CFTC has granted relief from the requirement under CFTC Regulation 23.157 that IM posted to or collected from a counterparty by an SD be held by an unaffiliated third-party custodian. The CFTC will give SDs subject to IM regulations until October 3, 2016 before assessing penalties and initiating enforcement actions against parties for noncompliance.

This delay was requested by banking and finance industry groups ISDA and SIFMA. The request came after ISDA and SIFMA found that a majority of SDs would not have all the necessary documentation and supporting infrastructure in place by the Phase-one date.

Under the terms of No-Action 16-70, the CFTC will not recommend enforcement action against SDs that have not:

The CFTC no-action recommendation is subject to certain conditions. Namely, SDs subject to Phase-one date IM regulations are required to:

IM exchange was required beginning on September 1, 2016 for a covered swap entered into by a covered swap entity, or CSE (that is, an entity subject to the rules – in most cases, an SD), where both (i) the CSE combined with all its affiliates and (ii) its counterparty combined with all its affiliates have an average daily aggregate notional amount (AANA) of covered swaps outstanding for March, April, and May of 2016 that exceeds $3 trillion. The initial IM Phase-one date was therefore designed to capture only transactions between the largest SDs.

The compliance dates for IM exchange between various types of counterparties range from September 1, 2016, to September 1, 2020, depending on the AANA of uncleared swaps, foreign exchange (FX) forwards, and FX swaps of the CSE and its counterparty for each business day in March, April, and May of that year (see Practice Note, The Dodd-Frank Act: Margin Posting and Collection Rules for Uncleared Swaps Compliance Dates for Initial Margin Requirements).

However, IM requirements have been delayed by other regulators, including the EU, Singapore, Hong Kong and Australia (see Legal Update, EU Delays Margin Rules for Uncleared Swaps). It is important to note that similar relief was not granted by US prudential bank regulators for corollary US margin rules on margin for uncleared swaps (prudential margin rules).

This creates a discrepancy that could provide a pricing arbitrage opportunity for uncleared products over the next month between CFTC-regulated SDs and prudentially regulated SDs, as it is less costly to enter into a swap that is not subject to the segregation requirements under CFTC Regulation 23.157.

These delays have led to concerns by market participants over the market dislocations in regulatory requirements. Banks in Europe, Singapore, Hong Kong and Australia have temporarily ceased trading with registered SDs subject to IM regulations over concerns of posting collateral. This is in part because the CFTC has adopted a final rule on the cross-border application of the its margin rules. The final rule utilizes the concept of "Foreign Consolidated Subsidiary" (FCS) to delineate when the margin rules apply in the absence of a US guaranty.

FCS are non-US nonbank swap entities (referred to as CSEs in the rule) whose obligations under the relevant swap are not guaranteed by a US person, but whose financial statements are included in those of a US ultimate parent entity. FCS are not entitled to an exclusion from CFTC uncleared swaps margin rules (see Practice Note, the Dodd-Frank Act: Margin Posting and Collection Rules for Uncleared Swaps: Cross-Border Transactions Under the Prudential Rules).

Note that ISDA has developed several products to aid regulated parties with their margin compliance documentation, see Legal Update, ISDA and IHS Markit Launch ISDA Amend 2.0 to Assist with Margin Compliance and Resolution Stay.

For more information on US margin regulations for uncleared swaps, see Practice Note, The Dodd-Frank Act: Margin Posting and Collection Rules for Uncleared Swaps.

For information on calculating margin using the ISDA Standard Initial Margin Model (SIMM™) and updating credit support documentation, see Practice Note, The New ISDA® Credit Support Annexes and Global Margin Compliance for Uncleared Swaps: The ISDA Standard Initial Margin Model (SIMM™).