The Regulatory Margin Self-Disclosure Letter, published on 30 June 2016 by the International Swaps and Derivatives Association, Inc. ("ISDA") (the "Letter"), represents one of the first major steps taken by the derivatives industry towards facilitating compliance with the rules of various regulatory regimes for the collection and posting of initial and variation margin for non-cleared derivatives. These rules have been proposed or adopted in the EU, in the U.S., in Canada, in Japan and in Switzerland and in each case are based on the framework published by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions. Other regulators around the globe, such as those in Hong Kong and Australia, are expected to follow suit.
While many of these rules will come into effect on different timelines (notably given the recent announcement of a delay to implementation in the EU), compliance dates in the US remain imminent for the time being and market participants need to prepare. Accordingly, with respect to each non-cleared swap (and each non-cleared swaps trading relationship more generally), each party to that non-cleared swap will need to determine if and when that swap will become subject to regulatory initial and variation margin requirements. This determination will be based on which regime(s) will apply to that particular trading relationship and which margin requirements will apply under those applicable regimes. Whether a regime is applicable (and which margin requirements are applicable under that regime) depends both on the status of the party making the determination as well as the status of its counterparty to that non-cleared swap. Once these determinations are made with respect to a swap (and a non-cleared swaps trading relationship more generally), this will in turn allow the counterparties to enter into regulatory-compliant margin and segregation documentation for in scope non-cleared swaps and enable counterparties to determine whether substituted compliance or exemptions would be applicable.
These determinations will often be difficult to make given the complexity of OTC derivatives trading relationships that can arise as a result of, among other factors, entities within a group being organized in different jurisdictions around the globe (whether as separate entities or an agency, a branch or a subsidiary of another entity), guarantees being provided within a group, consolidation of group financial statements, back-to-back trades being executed within a group, and the location of booking of particular trades within a group. Accordingly, ISDA has been working with market participants to create a tool to facilitate the exchange of information between counterparties to non-cleared swaps and, where necessary, the opening of a dialogue between parties to enable the parties to make these determinations.
To that end, ISDA has published the Letter as a standard form for the sharing of information regarding an entity's status under each applicable regime with that entity's non-cleared swaps trading counterparties. While market participants are not obliged to complete and deliver a Letter to any other market participant with which it trades non-cleared swaps, the information disclosed in a Letter will likely be necessary to determine if and when compliance with one or more of these new regulatory margin regimes will be required. Accordingly, each party to a non-cleared swap should complete a Letter (as Principal) and deliver that Letter to each of its non-cleared swaps counterparties (each as Recipient). For example, with respect to a German bank trading non-cleared swaps with a CFTC registered swap dealer, the German bank will complete and provide a Letter as Principal to the CFTC registered swap dealer as Recipient, and the CFTC registered swap dealer will complete and provide a Letter as Principal to the German bank as Recipient. In the first case, the CFTC registered swap dealer will likely need the German bank to complete the U.S. CFTC section of the Letter in order to determine whether and how the CFTC rules will apply to the relationship. In the second case, the German bank will likely need the CFTC registered swap dealer to disclose whether it is a third country entity for the purposes of EMIR (and will, if it is itself a swap dealer subject to US PR Rules, need the CFTC registered swap dealer to complete the US PR Margin Requirements section of the Letter).
With respect to the structure of the Letter, the first section is intended to be completed by all market participants delivering a Letter as Principal as it sets out general information for the Principal including contact information and whether the Principal is a multi-branch entity. The remaining sections set out jurisdiction or regulator-specific information about the Principal and are organized by jurisdiction. Separate sections are provided for Canada, the EU, Japan, Switzerland, and the U.S. (both CFTC and U.S. prudential regulators). Each of these sections seeks to collect information on (1) a group's average aggregate notional amount (or "AANA") of OTC derivatives for purposes of determining whether an entity and/or group will be subject to a particular regime's margin requirements based on jurisdictional thresholds and calculation requirements; (2) the cross-border status of a party; and (3) the applicability of any available entity or transaction specific exemptions (such as the hedging exemption in the U.S.).
Definitions are included for each jurisdiction in order to guide a Principal completing a form but it is likely that a party will have to perform additional commercial and legal analysis to complete the Letter. So for example for EMIR the Letter merely refers to the EMIR RTS provision without giving guidance as to how the calculation should be undertaken. For a more detailed explanation of the calculation of AANA in the EU and other related definitions and considerations, see our previous client alert. For the U.S. please see this sister briefing on the calculation of AANA.
While the parties can exchange paper versions of the Letter, the Letter will also be available on ISDA Amend. Both the Letter and the ISDA Amend build out are structured in a modular fashion so that market participants can complete as much or as little of the Letter as they wish. A market participant will also be able to deliver a different version of the Letter to each of its counterparties to non-cleared swaps if only portions of the Letter would apply to a particular non-cleared swaps trading relationship. On ISDA Amend, it is expected that the Recipient will be able to identify which sections of the Letter should be completed by a Principal from which it expects to receive a Letter, but the Principal should complete all applicable sections. Returning to the previous example with a German bank and a CFTC registered swap dealer, the CFTC registered swap dealer will be able to communicate to the German bank via ISDA Amend which jurisdictional information it would like the bank to complete in the Letter given the regimes to which the dealer expects the trading relationship to be subject – and the German bank should in any case consider whether any additional information should be provided.. We understand that the ISDA Amend service will be available two to three months from publication of the Letter, which is potentially not timely enough for the US regimes if the 1 September deadline does not move. If bilateral communication is necessary between the parties outside of ISDA Amend, the Principal to each Letter provides contact information in the general information section for such purpose.
Completion of the Letter is going to be time-consuming and less than straightforward for many market participants, particularly where multiple jurisdictional sections are relevant and/or where the organisational structures of the Principal and the Recipient are complex. Investment managers acting on behalf of multiple funds will, we think, be particularly challenged as they will have to reach out separately to their external clients in order to obtain the necessary information.
For more information about the matters discussed in this alert, please contact any of the lawyers named above or your usual Fieldfisher contact.