CFTC Provides Additional Swap LIBOR-Replacement Relief | Practical Law

CFTC Provides Additional Swap LIBOR-Replacement Relief | Practical Law

The CFTC announced revised no-action letters providing additional relief to swap dealers (SDs) and other market participants related to the industry-wide transition from swaps that reference LIBOR and other interbank offered rates (IBORs) to swaps that reference alternative benchmark interest rates.

CFTC Provides Additional Swap LIBOR-Replacement Relief

Practical Law Legal Update w-027-2886 (Approx. 9 pages)

CFTC Provides Additional Swap LIBOR-Replacement Relief

by Practical Law Finance
Published on 03 Sep 2020 • USA (National/Federal)
The CFTC announced revised no-action letters providing additional relief to swap dealers (SDs) and other market participants related to the industry-wide transition from swaps that reference LIBOR and other interbank offered rates (IBORs) to swaps that reference alternative benchmark interest rates.
On August 31, 2020, the CFTC announced the following revised no-action letters providing additional relief to swap dealers (SDs) and other market participants related to the industry-wide transition from swaps that reference LIBOR and other interbank offered rates (IBORs) to swaps that reference alternative benchmark interest rates:
The relief is designed to:
  • Help smooth the transition away from IBORs, particularly with respect to older, legacy swaps sitting on the books of SDs and their clients, including end users worldwide.
  • Remove regulatory obstacles in the event that an IBOR ceases or becomes non-representative to the adoption of protocols, such as the anticipated ISDA® LIBOR replacement protocol (ISDA protocol) and updated fallback procedures.
  • Help market participants continue managing their swap portfolios as clearinghouses implement their planned transition of discount rates towards new reference rates.

No-Action 20-23

No-Action 20-23 is intended to permit parties to legacy swaps to amend these swaps for LIBOR/IBOR replacement without triggering a number of CFTC requirements applicable to SDs, which could otherwise apply to an amended swap.
Under No-Action 20-23, DSIO will not recommend that the CFTC take an enforcement action against:
  • De minimis swap dealer threshold relief. Any person if, for purposes of determining whether it is deemed to be an SD under the CFTC swap dealer definition, it does not include a swap in its de minimis swap dealer calculation (see Practice Note, US Derivatives Regulation: Swap Dealer and SBSD Registration Thresholds: De Minimis Exemption from Designation as Swap Dealer) solely to the extent such swap would be required to be included as a consequence of a qualifying amendment to such swap.
  • Margin relief. An SD for a failure to comply with the CFTC uncleared swap margin rules solely to the extent such compliance would be required as a consequence of a qualifying amendment to a legacy swap subject to the CFTC uncleared swap margin rules.
  • Basis swap relief. An SD for failure to comply with the CFTC uncleared swap margin rules with respect to a basis swap that meets the following conditions:
    • the basis swap references only one or more legacy swaps (referenced swaps) that are subject to the CFTC uncleared swap margin rules;
    • the basis swap is entered into solely to achieve substantially the same effect as would be obtained by an amendment to the referenced swap to accommodate the replacement of an impaired reference rate (IRR); and
    • the basis swap does not have the effect of (i) extending the maturity of the referenced swap beyond what is necessary to accommodate the differences between market conventions for an IRR and its replacement or (ii) increasing the total effective notional amount of the referenced swap or the aggregate total effective notional amount of a portfolio of referenced swaps beyond what is necessary to accommodate the differences between market conventions for an IRR and its replacement.
  • Business conduct relief. An SD for a failure to comply with counterparty business conduct standards (BCS) under subpart H to Part 23 of the CFTC regulations (excluding CFTC Regulation 23.431(a), but including the mid-market mark requirement of 23.431(a)(3)(i)) (see Practice Note, US Derivatives Regulation: External Business Conduct (EBC) Rules for Swap Dealers and MSPs), solely to the extent such compliance would be required as a consequence of a qualifying amendment to an uncleared swap.
  • Confirmation relief. Provided that the amendment is accomplished pursuant to a multilateral protocol or a bilateral agreement that amends multiple swaps, an SD for a failure to comply with the transaction confirmation requirement of CFTC Regulation 23.501 solely to the extent such compliance would be required as a consequence of a qualifying amendment to an uncleared swap.
  • STRD relief. An SD for a failure to comply with the swap trading relationship documentation (STRD) requirement of CFTC Regulation 23.504 solely to the extent such compliance would be required as a consequence of a qualifying amendment to an STRD legacy swap.
  • Resolution timing relief. An SD for a failure to comply with the discrepancy resolution timing requirements of CFTC Regulation 23.502(a)(4) and (b)(4) solely to the extent such compliance would be required as a consequence of a qualifying amendment to an uncleared swap.

Qualifying Amendment Under No-Action 20-23

Under No-Action 20-23, a qualifying amendment is any of the following:
  • A qualifying IRR amendment, which is amendment of an uncleared swap that references an IRR solely to:
    • include new fallbacks to alternative reference rates triggered only by permanent discontinuation of an IRR or determination that an IRR is non-representative by the benchmark administrator or the relevant authority in a jurisdiction; or
    • accommodate the replacement of an IRR.
  • A qualifying swaption amendment.
  • A qualifying credit support annex (CSA) amendment.
  • Any combination of the foregoing.
However, a qualifying amendment may not include any amendment that:
  • Extends the maximum maturity of a swap or a portfolio of swaps beyond what is necessary to accommodate the differences between market conventions for an impaired reference rate (IRR) or discount rate used by a central counterparty (CCP) and its replacement.
  • Increases 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 accommodate the differences between market conventions for an IRR or a discount rate used by a CCP and its replacement.

End-User Relief Under No-Action 20-23

Also under No-Action 20-23, DSIO will not recommend the CFTC commence an enforcement action against:
  • An SD for failure to comply with the CFTC uncleared swap margin rules with respect to a covered IRS entered into with an eligible end user if compliance with the CFTC uncleared swap margin rules would be required solely as a consequence of a qualifying amendment to such covered IRS, or, with respect to the related commercial arrangement upon which an eligible end user is relying for purposes of electing an exception or exemption from the clearing requirement, solely as a consequence of an amendment to such commercial arrangement solely for the purpose of accommodating the replacement of an IRR or including new fallbacks to alternative reference rates triggered only by permanent discontinuation of an IRR or determination that an IRR is non-representative by the benchmark administrator or the relevant authority in a jurisdiction. Covered IRS include any interest rate swap (IRS) that:
    • qualified as a swap used to hedge or mitigate commercial risk pursuant to CFTC Regulation 50.50(c) at the time of execution;
    • qualified as a swap for which an eligible end user (a) elected an exception or exemption from the IRS clearing requirement pursuant to CFTC Regulations 50.50, 50.51, or any prior no-action position taken by DCR; and (b) notified its swap counterparty of such an election; and
    • was reported to a swap data repository (SDR) at the time an applicable exception or exemption was elected, pursuant to CFTC Regulation 50.50(a)(1)(iii), 50.51, or applicable condition in a prior DCR staff letter.
  • Any person for failure to comply with section 2(e) of the CEA or to qualify as an eligible contract participant (ECP) pursuant to section 1a(18) of the CEA solely to the extent such status is relevant as a consequence of a qualifying amendment to an uncleared swap.
  • An SD for failure to obtain documentation meeting the requirements of CFTC Regulation 23.505(a)(4) from an eligible end user for which it has previously obtained such documentation solely to the extent such would be required as a consequence of a qualifying amendment to an uncleared swap.

No-Action 20-24

Under No-Action 20-24, until December 31, 2021, DMO will not recommend the CFTC take enforcement action for failure to comply with the CFTC's trade-execution requirement under Section 2(h)(8) of the CEA for IBOR-linked swaps that are amended or created by an IBOR transition mechanism for the sole purpose of accommodating the replacement of the applicable IBOR with an alternative benchmark.
Under Section 2(h)(8) of the CEA, swap transactions that are subject to the clearing requirement must be executed either on a designated contract market (DCM), swap execution facility (SEF) that is registered with the CFTC, or a SEF that is exempt from registration unless no DCM or SEF makes that swap available to trade or the relevant swap transaction is subject to the clearing exception under CEA Section 2(h)(7).
Under the relief, a swap that is modified or created by an IBOR transition mechanism will not be subject to the trade execution requirement under Section 2(h)(8). IBOR transition mechanisms are:
  • The execution of a new risk-free rate swap (RFR swap) for the purpose of effecting benchmark replacement.
  • Fallback amendments.
  • Replacement rate amendments.

No-Action 20-25

Under No-Action 20-25, until December 31, 2021, certain amendments to a legacy IRS or legacy swaption made solely for LIBOR/benchmark-replacement purposes will not cause such legacy IRS or legacy swaption to lose its legacy status and become subject to the CFTC swap clearing requirement.
During this time, DCR will not recommend that the CFTC take an enforcement action against any person for a failure to comply with the IRS clearing requirement under Section 2(h)(1)(A) of the CEA and CFTC Regulations 50.2 and 50.4(a) when such person makes a qualifying amendment to an uncleared legacy IRS or uncleared legacy swaption, provided that such an amendment is made for the sole purpose of transitioning from an IRR to an alternative reference rate.

Qualifying Amendment Under No-Action 20-25

The following are qualifying amendments under No-Action 20-25:
  • Adding a fallback amendment, including by the ISDA protocol.
  • A replacement rate amendment, if the alternative reference rate selected as the replacement rate would otherwise subject the swap to the IRS clearing requirement. These include follow-on amendments necessary for successful completion of a replacement rate amendment.
  • A qualifying CSA amendment, solely to:
    • align the interest rate paid on posted collateral for uncleared swaps under a CSA with the discount rate used by a CCP; or
    • replace an IRR that is an interest rate paid on posted collateral for uncleared swaps.
  • A qualifying swaption amendment if, solely as a result of a public announcement by a derivatives clearing organization (DCO) of an impending change to the discount rate used for purposes of valuing cleared swaps and the rate applied to collateral or settlement amounts relating to certain cleared swaps, the counterparties to a swaption either:
    • voluntarily exchange compensation for a swaption; or
    • amend a swaption's terms solely to reflect an agreement regarding the discount rate used by a CCP.
  • Any combination of these.
Qualifying amendments may include ancillary changes to existing trade terms to conform to different market conventions, resulting, for example, in different reset dates, fixed/floating leg payment dates, business day conventions, and day count fractions. However, a qualifying amendment may not include any amendment that:
  • Changes the counterparties to the original uncleared legacy IRS or uncleared legacy swaption.
  • Extends the maximum maturity of an uncleared legacy IRS or uncleared legacy swaption or a portfolio of such swaps beyond what is necessary to accommodate the differences between market conventions for an IRR or discount rate used by a CCP and its replacement.
  • Increases the total effective notional amount of an uncleared legacy IRS or uncleared legacy swaption or the aggregate total effective notional amount of a portfolio of such swaps beyond what will accommodate the differences between market conventions for an IRR or a discount rate used by a CCP and its replacement.
In the letter, DCR reminds market participants that swap counterparties retain responsibility for determining which of their swaps qualify as uncleared legacy IRS or uncleared legacy swaptions.
Note that No-Action 20-25 does not apply to swaps that have been submitted for clearing voluntarily.

End-User Relief Under No-Action 20-25

Also under No-Action 20-25, DCR provides no-action relief for eligible end users:
  • From clearing requirements when the eligible end user is making a qualifying amendment to a covered IRS solely to transition an IBOR to an alternative benchmark.
  • From compliance with the hedging and risk-mitigation requirement when electing an exception or exemption from the IRS clearing requirement when the eligible end user amends its underlying commercial agreement if the amendment is made solely to transition an IBOR to an alternative benchmark.
Under No-Action 20-25, eligible end users are defined as:
  • Non-financial entities electing an exception under CFTC Regulation 50.50(a)-(c).
  • Financial entities electing an exception under CFTC Regulation 50.50 (a)-(d).
  • Exempt cooperatives electing an exemption under CFTC Regulation 50.51.
  • Entities identified by the CFTC in a recent proposed rule under proposed regulations:
    • 50.77 (community development financial institutions);
    • 50.79 (savings and loan holding companies).
Covered IRS include any IRS that:
  • Qualified as a swap used to hedge or mitigate commercial risk under CFTC Regulation 50.50(c) at the time of execution.
  • Qualified as a swap for which an eligible end user:
    • elected an exception or exemption from the IRS clearing requirement;
    • notified its swap counterparty of such election; and
    • was, to the best of the eligible end user's knowledge, reported to a SDR at the time the applicable exception/exemption was elected.