Comparability Determination
In January 2016, the CFTC finalized margin regulations that require that all swap dealers and major swap participants (collectively, covered swap entities (CSEs)) to collect and post margin with certain counterparties to uncleared swaps.4 Several CFTC no-action letters followed (together with interpretation from the European Securities and Markets Authority) in recognition of the general market’s unpreparedness for the compliance deadlines.5 Under these regulations, CSEs must collect and post variation margin (VM) with respect to uncleared swaps with other CSEs or with financial end-user counterparties. The term “financial end user” includes a broad swath of financial entities, such as banks, trust companies, funds, investment advisors, and speculative trading operations. CSEs also must collect and post initial margin (IM) with other CSEs and financial end users that have a “material swaps exposure.” A financial end user has a material swaps exposure if it has “an average daily aggregate notional amount of uncleared swaps, uncleared security-based swaps, foreign exchange forwards, and foreign exchange swaps with all counterparties for June, July, and August of the previous calendar year that exceeds $8 billion.”6
CSEs and market participants located on both sides of the Atlantic faced the dilemma of where to comply with margin regulations (i.e., in the U.S. or the EU). To provide clarity, in May 2016, the CFTC released regulations on the cross-border application of the margin requirements.7 The cross-border margin regulations permit non-U.S. CSEs that enter into uncleared swaps with U.S. persons to comply with their home jurisdiction’s regulations in lieu of the CFTC’s if the CFTC has issued a comparability determination for that jurisdiction. Conversely, U.S. CSEs transacting with non-U.S. CSEs could agree to margin in accordance with U.S. or foreign margin regulations. The U.S. margin regulations directly apply to CSEs only. Therefore, the cross-border margin regulations do not allow U.S. non-CSEs to dictate which set of laws the non-U.S. CSE complies with. The CFTC issued its first comparability determination for Japan in September 2016, which allowed counterparties located in the U.S. and Japan to comply with either U.S. or Japanese margin requirements.8
The comparability determination for the EU is the second such determination issued by the CFTC thus far. The European Commission followed by issuing an Implementing Decision that recognizes the CFTC’s margin regulations as equivalent to the EU requirements.9 However, the European Commission will only treat the CFTC’s margin regime as equivalent to the extent that the U.S. and European regimes both require transactions to be margined. Persons cannot, for example, “game” the European regime to avoid margining foreign exchange forwards or swaps by opting to comply with the CFTC’s regulations. While the CFTC noted that several of the EU regulations are quite different from its own regulations, they are all comparable in outcome. We summarize the CFTC and European Commission’s determinations on EU uncleared margin in the table below:
| Topic |
CFTC Determination |
European Commission Determination |
| Products and Entities Subject to the Margin Requirements |
Comparable – Substituted Compliance |
Partially Comparable – Substituted Compliance to the Extent that Transaction is Subject to Margins Under Both EU and CFTC Regulations |
| Treatment of Inter-Affiliate Derivative Transactions |
Comparable – Substituted Compliance |
Partially Comparable – Substituted Compliance to the Extent that Transaction is Subject to Margins Under Both EU and CFTC Regulations |
Methodologies for the Calculation of IM and VM
|
Comparable – Substituted Compliance |
Comparable – Substituted Compliance |
Timing and Manner for Collection or Payment of IM and VM
|
Comparable – Substituted Compliance |
Comparable – Substituted Compliance |
Margin Threshold Levels or Amounts
|
Comparable – Substituted Compliance |
Comparable – Substituted Compliance |
Risk Management Controls for the Calculation of IM and VM
|
Comparable – Substituted Compliance |
Comparable – Substituted Compliance |
Eligible Collateral for IM and VM
|
Comparable – Substituted Compliance |
Comparable – Substituted Compliance |
Requirements for Custodial Arrangements, Segregation, and Rehypothecation
|
Comparable – Substituted Compliance |
Comparable – Substituted Compliance |
Requirements for Margin Documentation
|
Comparable – Substituted Compliance |
Comparable – Substituted Compliance |
Cross-Border Application of the Margin Rules
|
Comparable – Substituted Compliance |
Comparable – Substituted Compliance |
Therefore, a CSE that is subject to both the CFTC’s and the EU’s margin regulations may comply with either the U.S. or the EU’s margin regulations and rely on substituted compliance for all aspects of the CFTC’s margin regulations.
Common Approach to Derivatives Trading Venues
Together with the comparability determination for the EU, the CFTC released a document entitled “A Common Approach on Certain Derivatives Trading Venues.” The document explains that the CFTC and European Commission are working together to develop a framework for resolving the jurisdictional and compliance clash between the CFTC’s and EU’s trade execution requirements. In the EU, counterparties must comply with the trading obligation under Article 28 of the Markets in Financial Instruments Regulation (MiFIR) and execute mandated derivatives on EU-authorized trading venues. In the U.S., persons must execute swaps subject to the CFTC’s trade execution requirement on registered swap execution facilities (SEFs) or designated contract markets (DCMs).
The CFTC and European Commission are working to put in place a framework to allow persons to execute swaps on U.S. platforms in compliance with the EU’s regulations and on EU platforms in compliance with the CFTC’s regulations. To establish such a regime, the European Commission will consider adoption of an equivalence decision that would recognize CFTC-registered SEFs and DCMs as eligible venues for the execution of mandated derivatives. In the U.S., the CFTC will propose regulations exempting EU-authorized swap trading venues, including multilateral trading facilities (MTFs) and organized trading facilities (OTFs), from the requirement to register as SEFs, provided that the trading venue is subject to comparable, comprehensive supervision and regulation.10
The Common Approach release notes that the CFTC and European Commission “will work as expeditiously as practicable to ensure that this arrangement is put into place and operating in a coordinated manner, and will continuously monitor the impacts resulting from the implementation to asses whether any further action is appropriate.” This determination will follow the previously released comparability determination for EU dually-registered derivatives clearing organizations and other central counterparties.11
Lingering issues remain with respect to complying with U.S. and EU swap data reporting requirements. For example, if a swap between a U.S. and a non-U.S. person is traded on an EU trading venue (MTF or OTF), will the counterparties be required to submit swap data reports in both the U.S. and EU? Conversely, if such a transaction is executed on a U.S. platform, will the counterparties each have to submit swap data to jurisdictional trade data repositories?
-
The EU Comparability Determination is available here.
- The Common Approach release is available here.
- See, for example, Chairman Giancarlo’s January 2015 speech on market fragmentation, available here.
- See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants; Final Rule, 81 Fed. Reg. 636, 638 (Jan. 6, 2016).
- See CFTC Letter No. 17-11 (Feb. 13, 2017), available at cftc.gov; CFTC Letter No. 17-05 (Feb. 1, 2017), available at cftc.gov; CFTC Letter No. 17-12 (Feb. 13, 2017), available at cftc.gov; ESMA, “Variation margin exchange under the EMIR RTS on OTC derivatives,” (Feb. 23, 2017), available at esma.europa.eu.
- 17 C.F.R. section 23.151.
- See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants—Cross-Border Application of the Margin Requirements, 81 Fed. Reg. page 34818 (May 31, 2016).
- The Comparability Determination for Japan is available here.
- The European Commission’s Implementing Decision is available here.
- The CFTC will promulgate regulations and guidance that will allow non-U.S. EU-registered facilities to operate in the U.S. under certain conditions. This determination will not affect the current regime applicable to foreign boards of trade with respect to futures and Part 30 of the CFTC’s regulations with respect to non-U.S. brokers.
- See Comparability Determination for the European Union: Dually-Registered Derivatives Clearing Organizations and Central Counterparties, 81 Fed. Reg. 15,260 (Mar. 22, 2016).
Client Alert 2017-272
