Regulatory Certainty is Crucial

ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.

It is said that nothing in this world is certain except for death and taxes. That’s true enough for financial markets, where gains can turn to losses in the blink of an eye. But it should be possible to achieve a level of certainty and consistency in how financial markets regulation is interpreted and applied.

Fortunately, participants in the US derivatives market received an important clarification from the Commodity Futures Trading Commission (CFTC) earlier this month that will ensure users aren’t subject to unnecessary costs and operational burdens. Following a request from ISDA, the CFTC made clear that legacy swaps should not be subject to non-cleared margin requirements following certain immaterial amendments to those swaps.

The clarification means US derivatives users can be sure legacy swaps that are currently exempt from the non-cleared margin rules won’t come into scope purely because of minor changes that occur for administrative reasons and don’t affect the economics of the swap – for instance, a change in contact information for a counterparty.

The no-action relief also covers amendments due to multilateral compression activity, partial terminations or novations and swaption exercises. Ensuring amended legacy swaps won’t become subject to the additional costs of complying with margin requirements removes a disincentive to engage in important risk-reduction activities like compression. It also aligns with the treatment of legacy swaps under the CFTC’s clearing mandate, as well as the approach taken by numerous regulators overseas.

But while this no-action relief provides some important certainty for US derivatives market participants, regulatory clarification is required in other areas – including whether firms subject to US margin rules can rely on a March 5 statement made by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions.

That statement noted that counterparty relationships with exposures below the €50 million initial margin (IM) exchange threshold aren’t required to meet documentation, custodial or operational requirements.

This is helpful: according to ISDA analysis, the majority of the 9,500 relationships that will come into scope globally under phase five of the margin rules in September 2020 will not actually be required to post IM because their exposures fall below the €50 million threshold. Despite this, new documentation would need to be negotiated with every counterparty and two custodial accounts for each relationship would need to be set up – a significant operational lift and a big stretch on industry resources.

Providing certainty that documentation and custodial requirements will not initially apply for these relationships will enable the industry to focus its efforts on ensuring larger firms that are likely to post IM are ready to comply.

We agree with a recommendation made by CFTC chairman J. Christopher Giancarlo for US regulators to issue guidance that unambiguously provides relief for counterparty relationships that don’t exceed the $50 million IM exchange threshold under US requirements.

With just 72 days until the start of the phase-four implementation and 15 months until phase five, this clarification is needed sooner rather than later. Death and taxes really don’t need to be the only certainties in this world.

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