Coordinated Relief by Global Regulators Provide Flexibility on ISDA Variation Margin Compliance
On February 13, 2017, the Commodity Futures Trading Commission (CFTC) and Swap Dealer and Intermediary Oversight (DSIO) announced a time-limited no-action letter confirming that, from March 1, 2017 to September 1, 2017, DSIO will not recommend an enforcement action against a swap dealer for its failure to comply with the variation margin (VM) requirements by the March 1, 2017 compliance date. The VM requirements are a part of a globally agreed framework that aims to ensure safer derivatives markets by limiting the counterparty risk from derivatives trading partners. This announcement follows the ‘big bang’ open letter to the regulatory bodies from the International Swap Dealers Association (ISDA) and other industry associations.
The no-action letter provides some breathing room but not complete relief from the March 1, 2017 compliance date. The European Supervisory Authorities (ESAs), the competent authorities (CAs) and the Financial Conduct Authority (FCA) published a statement on February 23, 2017 to state its disappointment with the compliance efforts and highlight that the implementation is mainly a challenge for smaller firms that may not be in a position to fully obtain variation margin compliance by 1 March 2017. The FCA confirmed that it will, therefore, take a risk-based approach and use judgement as to the adequacy of progress, considering the position of firms and the credibility of their plans on a case-by-case basis.
Within a few hours of the ESA announcement, the Federal Reserve Bank (Fed) and office of the Comptroller of the Currency (OCC) issued their statement and restated the need for swap counterparties with ‘significant exposure’ to be fully compliant with the VM requirements by March 1, 2017 without providing any threshold for ‘significant exposure’. However, swap counterparties without significant exposures, are expected to show good faith efforts to comply with the final rule by September 1, 2017. The Fed announcement was key as the U.S. banking institutions and their affiliates make up the largest swap dealers and most counterparties should not present substantial exposures to banks affected by the guidance. While the Fed announcement did not provide complete relief, the announcement was important as the six-month grace period from CFTC only covered smaller non-bank and energy swap dealers. The Office of the Superintendent of Financial Institutions (OSFI) published a similar letter recommending the Federally Regulated Financial Institutions (FRFIs) in Canada to prioritize their compliance efforts with counterparties to whom they have the greatest exposure in terms of inherent credit and market risk. The Japanese Financial Services Agency made a similar announcement to confirm that it will delay implementation on VM requirements for Japanese swap counterparties with cross-border trades in jurisdictions where VM requirements have not been implemented. A similar announcement followed from the regulators in Australia, Hong Kong and Singapore.
Most industry participants have been skeptical of the March 1 compliance deadline over the past year. ISDA had published reports with count of remediated Credit Support Annexes (CSAs) over the past month which showed that less than 15% of the 159,000 impacted CSAs were fully revised. As regulators contest, the work on this mandate does not end with the revisions made on the CSA; these documents needed to be reviewed and set-up into reference data tools to initiate trading. The next six months may provide a much-needed breather for certain swap counterparties and gives the global regulators an opportunity to agree on a consistent framework for VM requirements.