On May 19, 2020, the CFTC's Global Markets Advisory Committee (GMAC) adopted a margin subcommittee report on CFTC margin requirements for non‐cleared swaps (CFTC margin rules), which includes several recommendations for action by the CFTC with respect to the final two phases (Phase Five and Phase Six) of implementation of its initial margin (IM) rules for uncleared swaps. The recommendations are focused on challenges faced by small end users of swaps and entities that engage in swap activity through separate managed accounts (SMAs).

The report included several:

The margin subcommittee was established by the GMAC to examine the implementation of the CC margin rules, to identify challenges associated with forthcoming implementation phases, and to recommend actions the CFTC may take to mitigate the challenges identified.

Note the report applies only to the CFTC margin rules, and not to the corollary prudential margin rules.

For details on the CFTC margin rules, see Practice Note, US Derivatives Regulation: Margin Collection and Exchange Requirements for Uncleared Swaps: Final CFTC Margin Rules.

Immediate-term recommendations are anticipated to have substantial beneficial impact if adopted by the CFTC prior to, or as of, the Phase Five compliance date. The immediate-term IM issues addressed by the report are as follows:

Challenge: Unique compliance issues arise where a CSE's counterparty, such as a pension fund, hires multiple asset managers to diversify its investments and investment expertise (a separately managed account client, or an SMA client). For SMA clients, each asset manager will establish on behalf of the SMA client one or more SMAs to execute different investment mandates for risk diversification and other purposes (each such account, an SMA). While the regulatory IM threshold amount of $50M (the IM threshold) will need to be calculated and monitored by the CSE for the SMA client in the aggregate, each SMA asset manager will only know the regulatory IM associated with the transactions that it independently executes for the SMAs that it manages on behalf of the SMA client.

Should the activities of another asset manager or managers unexpectedly put the SMA client’s uncollateralized regulatory IM exposure in the aggregate over the regulatory IM threshold with a given CSE, the CSE may feel it needs to cease trading activity with all of the SMA asset managers (even those acting under regulatory IM-compliant documentation or within agreed allocations of the regulatory IM Threshold) unless it has a regulatory interpretation on how to apply IM requirements to SMAs. The halting of trading, in turn, could impair investment activities and harm the underlying SMA client.

Recommendation: So long as the CSE and SMA client allocate no more than a total of $50M regulatory IM threshold across the SMAs, the margin subcommittee recommends permitting a CSE to treat each SMA separately for compliance purposes. As such, if the CSE were to inadvertently exceed $50M in uncollateralized regulatory IM exposure with an SMA client in the aggregate, an SMA could continue to trade with the CSE, if:

Removal of certain collateral eligibility restrictions on money market funds.

Challenge: The ability to use redeemable securities in a pooled investment fund, more typically referred to as a money market fund (MMF), as eligible collateral in the US has been severely restricted by the condition that assets of the MMF may not be transferred through securities lending, securities borrowing, repurchase agreements, and reverse repurchase agreements.

Recommendation: Eliminate undue restrictions on the activity of eligible MMFs to transfer assets through securities lending, securities borrowing, repurchase agreements, and reverse repurchase agreements.

Challenge: Certain investment funds are temporarily seeded by a parent, sponsor, or affiliate that does not guarantee the obligations of the fund or participate in or control the management of such fund. The fund is launched and seeded in order to establish a performance record before external investors will invest in it. When these seeded funds are seeded by a parent with material swaps exposure (MSE), such seeded funds have to post IM, while other seeded funds sponsored by entities without MSE or not otherwise affiliated with a group that has MSE do not have to post IM. This disparate treatment puts these seeded funds at a disadvantage domestically and globally as most global competitors have adopted the BCBS‐IOSCO framework recommendation that all investment funds be exempt from consolidation with their parent, sponsor, or affiliate for purposes of the application of CFTC IM requirements, provided that the seeding entity does not guarantee the fund’s obligations.

Recommendation: In accordance with the BCBS‐IOSCO framework and other global jurisdictions, provide an exemption from the consolidation of seeded funds with their sponsors (provided such sponsors do not guarantee the seeded funds' obligations) for purposes of calculating AANA and MSE during the limited seeding period in order to provide a level playing field domestically and globally for these seeded funds.

Relief relating to IM calculations for small CSEs.

Challenge: The smaller CSEs coming into scope in Phases Five and Six may not be approved to calculate IM amounts using a quantitative IM model like the ISDA® Standard Initial Margin Model (SIMM^TM). As a result, they may be required to post and collect higher IM amounts under the CFTC regulatory schedule included in the CFTC margin rules, and may more readily breach the IM threshold, reducing their preparation time.

Recommendation: Provide no‐action relief to small CSEs allowing them to rely on the IM amounts calculated by their CSE counterparties for purposes of IM monitoring and IM exchange.

Provide a grace period to reduce congestion and facilitate compliance.

Challenge: Even with the actions taken by the CFTC to date and the recommended extension of the Phase Five and Phase Six compliance dates due to the COVID‐19 crisis, many Phase Five and Phase Six firms will not be ready to exchange regulatory IM as of the phase‐in dates, notwithstanding best efforts due to existing industry resource constraints.

Recommendation: Grant a six‐month grace period commencing for Phase Five and Phase Six from the day the regulatory IM for a relationship exceeds the IM Threshold. During this grace period, the parties must complete the IM documentation and operational set‐ups and begin exchanging IM.

Later-term recommendations are anticipated to have substantial beneficial impact if adopted by the CFTC prior to, or as of, the Phase Six compliance date. The later-term IM issues addressed by the report are as follows:

Challenge: As indicated above, given the unique and separate counterparty relationship between an SMA client, acting through its SMA asset managers, and a CSE with which it trades, each individual SMA asset manager does not have visibility to, nor control over, the total regulatory IM amount of the SMA client in order to independently manage the timeline for IM preparation. The SMA client establishes each SMA independently (limited recourse arrangements, separate documentation, margining and netting arrangements, etc.) in order to achieve diversification. Each SMA asset manager is thus forced to make a cost‐benefit decision as to whether to put in place documentation and custodial arrangements based solely on the transactions that it independently executes for the SMA it manages. If the SMA client facing a particular CSE were to suddenly and unexpectedly exceed the $50M IM threshold in the aggregate, then SMA asset managers would encounter various cliff‐edge scenarios, including potentially being cut off from trading or having to terminate existing positions.

Recommendation: Given the lack of transparency and control among SMA asset managers and the independent operation of their SMAs, allow each SMA to be treated as a distinct entity to which a separate regulatory IM threshold will apply, thereby giving each manager control over when an SMA is at or near the IM Threshold.

Although the report states that this recommendation is the simplest and most efficient solution, the margin subcommittee acknowledges in the report that, absent broader support for it by other US and global regulators, an alternative recommendation would be to allow the option for each CSE and SMA asset manager to agree to apply a flat IM threshold of $10M per SMA in light of the operational and practical difficulties of sharing the $50 million IM threshold at the SMA client level. Although this recommendation to allow a $10 million IM threshold per SMA would not be subject to an overall cap of $50M, there are safeguards to mitigate the risks of an uncapped option, explained in the report.

Challenge: The CFTC margin rules (as well as the prudential margin rules) diverge from the global BCBS‐IOSCO uncleared margin framework in timing and method of conducting MSE calculations, as well as compliance dates following September 1, 2021. The differences create significant cross‐border complexity which leads to additional operational burdens, costs, and compliance challenges for market participants subject to margin requirements in multiple global jurisdictions.

Recommendation: Align the timing and methodology for MSE calculations and the post-phase‐in compliance periods with the BCBS-ISOCO framework and other global regulations.

Challenge: The MTA requirements under the CFTC margin rules do not account for certain practical operational processes and circumstances which limit the ability of CSEs and their covered counterparties to use the MTA, including issues with the application of an MTA for each SMA client and the ability to split the maximum allowable MTA between distinct IM and variation margin (VM) flows.

Recommendation: These challenges were effectively addressed by CFTC staff letters 17‐12 and 19‐25 (see Legal Updates, CFTC Issues No-Action Relief Regarding Uncleared Swap Margin Minimum Transfer Amounts (MTAs) for Swap Dealers and Major Swap Participants and CFTC Issues Relief to Swap Dealers From Compliance with Minimum Transfer Amount (MTA) Requirements for Uncleared Swap Margin Under Certain Conditions). As staff letters may expire or be revoked, it is recommended that the CFTC provide certainty to CSEs and their counterparties by amending the CFTC margin rules to codify the provisions of CFTC staff letters 17‐12 and 19‐25. For details on MTA under the CFTC rules, see Practice Note, US Derivatives Regulation: Margin Collection and Exchange Requirements for Uncleared Swaps: Minimum Transfer Amount (MTA) Under CFTC Margin Rules.

Removal of deliverable FX from MSE calculation.

Challenge: Small financial end users are unnecessarily burdened by monitoring and other requirements due to the inclusion of deliverable foreign exchange (FX) swaps and forwards (collectively, deliverable FX) in the MSE calculation.

Recommendation: While the margin subcommittee recognizes that inclusion of deliverable FX has been considered previously by international regulatory bodies without changes recommended, the margin subcommittee strongly requests reassessment of the market impact, particularly upon small financial end users, and amendment of the CFTC margin rules to exclude deliverable FX from the MSE calculation. Since deliverable FX itself does not have IM requirements, its inclusion in MSE calculations and resulting burdens on small financial end users is not warranted.