CFTC Issues No-Action Letters to Smooth the Road Away from the IBORs
On December 17, 2019, three different divisions of the United States' Commodity Futures Trading Commission (“CFTC”) issued no-action letters intended to facilitate the swaps market’s transition away from interbank offered rates (each, an “IBOR”) and toward alternative benchmarks. The letters responded to requests for relief made by the Alternative Reference Rates Committee (the “ARRC”), the group convened by the Federal Reserve to facilitate the transition away from USD LIBOR, the IBOR generally used for United States dollars, to the new reference rate chosen by the ARRC, known as the secured overnight financing rate, or SOFR.
The no-action letters provide market participants with conditional relief from many of the swaps regulatory reforms imposed by Title VII of the Dodd-Frank Act that would otherwise apply to transactions and transaction amendments that will be required to effect the transition away from the IBORs and toward risk free rates (each, an “RFR”) such as SOFR. In certain cases the relief that the no-action letters offer will expire at the end of 2021, by which time it is expected that the market will have completed the transition away from the IBORs.
CFTC Letter 19-26
Of the three no-action letters, CFTC Letter 19-26 is the farthest ranging and offers the broadest relief. In it, the Division of Swap Dealer and Intermediary Oversight (“DSIO”) provides conditional relief from numerous CFTC requirements, including in relation to margin, business conduct and swap documentation rules.
The no-action relief that DSIO provides is subject to conditions including, most prominently, that the IBORs become “Impaired Reference Rates” and that swaps be amended by means of a “Qualifying Amendment.” For purposes of the letter, “Impaired Reference Rate” means (i) an IBOR or another interest rate that the parties to a swap reasonably expect to be discontinued or reasonably determine has lost its relevance as a reliable benchmark due to a significant impairment or (ii) any other reference rate that succeeds any such interest rate. “Qualifying Amendment” means an amendment of an uncleared swap that references an Impaired Reference Rate solely to (i) provide new fallbacks to alternative reference rates triggered by a permanent discontinuation of such Impaired Reference Rate or by a determination by a benchmark administrator or a relevant authority that an Impaired Reference Rate is non-representative or (ii) accommodate the replacement of an Impaired Reference Rate.
DSIO states that it will not recommend that the CFTC commence an enforcement action on the basis of the following:
- Margin Requirements for Legacy Swaps: a failure by a swap dealer (each, an “SD”) to comply with the CFTC’s margin rules for uncleared swaps (the “CFTC Margin Rules”) in relation to an uncleared swap entered into prior to the relevant compliance date of the CFTC Margin Rules (each, a “CFTC Margin Rule Legacy Swap”) to the extent such compliance would be required by reason of a Qualifying Amendment of such swap;
- Margin Requirements for Basis Swaps: a failure by an SD to comply with the CFTC Margin Rules with respect to basis swaps that swap the Impaired Reference Rate basis of a portfolio of CFTC Margin Rule Legacy Swaps into an alternative reference rate basis, thus achieving substantially the same effect as would be obtained by an amendment of such swaps to accommodate the replacement of the Impaired Reference Rate, without lengthening the maturity or increasing the effective notional amount of such swaps;
- Margin Requirements for End Users: a failure of an SD to comply with the CFTC Margin Rules in relation to a Qualifying Amendment of an uncleared swap that was executed pursuant to an exception to mandatory clearing available to certain end users or certain cooperatives, or in relation to a similar amendment of a related loan agreement or other commercial arrangement, if the swap and the related commercial arrangement are both amended prior to December 31, 2021, such that the swap again qualifies as a swap used to hedge or mitigate commercial risk for purposes of the applicable CFTC regulations;
- Business Conduct Rules: an SD’s failure to comply with the CFTC’s business conduct standards (other than Rule 23.431(a), which requires an SD to make disclosures to counterparties relating to material risks and characteristics of a swap and material incentives and conflicts of interest) to the extent such compliance would be required as a consequence of a Qualifying Amendment of an uncleared swap;
- Swap Confirmations: an SD’s failure to provide a new confirmation, in accordance with CFTC Rule 23.501, of a swap in connection with a Qualifying Amendment of such swap that is accomplished by means of a multilateral protocol;
- Swap Trading Relationship Documentation: an SD’s failure to comply with CFTC Rule 23.504, which requires SDs to enter into swap trading relationship documentation with a counterparty prior to entering into any swap with such counterparty, to the extent such compliance would be required as a consequence of a Qualifying Amendment of an uncleared swap that was entered into prior to the date the SD was required to be in compliance with such rule;
- Portfolio Reconciliation: an SD’s failure to comply with the discrepancy resolution timing requirements contained in CFTC Rules 23.502(a)(4) and (b)(4), which require, among other things, that an SD “immediately” resolve any identified discrepancy in a material term of a swap with another SD, to the extent such compliance would be required as a consequence of a Qualifying Amendment of an uncleared swap;
- De Minimis Exception to “Swap Dealer” Definition: a failure to count a swap that references an Impaired Reference Rate, solely to the extent such swap would be required to be counted as a consequence of a Qualifying Amendment to such swap, for purposes of the de minimis exception to the CFTC’s definition of “swap dealer,” which permits an entity to engage in up to $8 billion in notional amount of swap dealing activity per 12-month period without being required to register as an SD;
- Eligible Contract Participant Status: any person’s failure to qualify, as a result of a Qualifying Amendment to an uncleared swap that causes a temporary mismatch in interest rates, as an eligible contract participant (“ECP”) pursuant to Section 1a(18)(A)(xi) of the Commodity Exchange Act (“CEA”), which provides ECP status to an individual who has amounts invested on a discretionary basis in excess of $5,000,000 and who enters into a swap to manage the risk associated with an asset owned or liability incurred, or reasonably likely to be owned or incurred, by the individual; and
- End User Documentation: an SD’s failure to obtain, in connection with a Qualifying Amendment of an uncleared swap, documentation that its counterparty is hedging or mitigating a commercial risk for purposes of an exception to mandatory clearing available to certain end users or cooperatives, if the SD has previously obtained such documentation.
CFTC Letter 19-28
In CFTC Letter 19-28, the CFTC’s Division of Risk and Clearing (“DRC”) provides no-action relief in relation to the CFTC’s mandatory clearing requirements. First, it provides relief to market participants that have relied on one of the exceptions to mandatory clearing available to certain end users or cooperatives. Second, it provides relief in relation to certain new amendments of legacy interest rate swaps that predate mandatory clearing.
The no-action relief that DRC provides in CFTC Letter 19-28 is predicated in part on swaps becoming amended by means of a “Fallback Amendment,” defined as an amendment of fallback provisions (or addition of contractual terms) to modify the process for selecting the new floating rate term of an interest rate swap that is not available because the rate is unavailable, permanently discontinued, or determined to be non-representative by the benchmark administrator or relevant authority.
Relief for End Users and Cooperatives
CFTC Letter 19-28 states that, in connection with a Fallback Amendment, DCR will not recommend enforcement action for failure to clear a swap against an end user or cooperative that has relied on one of the exceptions to mandatory clearing that are available to available to such entities. Those exceptions require, among other things, that the end user or cooperative claiming the exception use the relevant swap to hedge or mitigate commercial risk, a requirement that in turn requires congruence between the swap and the loan or other commercial obligation being hedged. The relief is intended to provide for a transition period, until December 31, 2021, during which an end user or cooperative may continue to rely on the applicable exception from clearing even if temporarily its relevant swap and the related commercial obligation do not reference the same floating rate.
In order for this relief to be available, among other things, it must be the case that (i) the swap or related commercial agreement is amended by execution of a Fallback Amendment (or similar contractual provision in the commercial agreement), (ii) the commercial agreement is amended for the sole purpose of changing the existing floating rate to an applicable RFR or (iii) an existing fallback provision in a commercial agreement is activated because the floating rate is unavailable, is permanently discontinued, or has been determined to be non-representative by a relevant benchmark administrator or authority. Further, the commercial arrangement and the uncleared swap must both be amended prior to December 31, 2021, such that the swap once again qualifies as a swap used to hedge or mitigate commercial risk for purposes of the CFTC’s rules.
Similarly, and subject to similar conditions and limitations, CFTC Letter 19-28 also provides relief with respect to the filing of required reports by end users and cooperatives regarding their use of the end user exception.
Uncleared Legacy Interest Rate Swaps
CFTC Letter 19-28 also provides time-limited no-action relief from clearing requirements for Fallback Amendments of “Uncleared Legacy Swaps,” uncleared interest rate swaps that would have been subject to mandatory clearing under CFTC regulations if they had been transacted after the implementation of mandatory clearing.
Until December 31, 2021, DCR will not recommend that the CFTC take enforcement action against any person for a failure to comply with mandatory clearing requirements with respect to an Uncleared Legacy Swap that is amended by means of a Fallback Amendment. For this relief to be available, among other things, the legacy swap must originally reference one of several IBORs enumerated in the letter and must be amended for the sole purpose of changing the floating rate fallback provisions to reference an RFR.
CFTC Letter 19-27
In CFTC Letter 19-27, the Division of Market Oversight (“DMO”) provides, with respect to swaps that are amended or created as part of the transition away from the IBORs, relief from the trade execution requirement, under which swaps that are subject to mandatory clearing must generally be executed on an exchange or swap execution facility unless no exchange or swap execution facility makes such swap available to trade.
Until December 31, 2021, DMO will not recommend that the CFTC take enforcement action against any person for failure to comply with the trade execution requirement with respect to an IBOR-linked swap that is amended or created for the sole purpose of accommodating the replacement of the applicable IBOR with an RFR. For the relief to be available, the relevant swaps must be amended or created by means of an “IBOR Transition Mechanism,” a term defined to include (i) the execution of new swaps referencing an RFR, (ii) amendments of IBOR-linked swaps to provide fallbacks to new RFRs that are triggered when the applicable IBOR is unavailable, permanently discontinued or determined to be non-representative or (iii) amendments of IBOR-linked swaps to reference RFRs that are effected prior to the cessation of the applicable IBOR.
 Division of Swap Dealer and Intermediary Oversight, CFTC Letter 19-26, No-Action Positions to Facilitate an Orderly Transition of Swaps from Inter-Bank Offered Rates to Alternative Benchmarks (Dec. 17, 2019); Division of Market Oversight, CFTC Letter 19-27, Staff No-Action Relief from the Trade Execution Requirement to Facilitate an Orderly Transition from Inter-Bank Offered Rates to Alternative Risk-Free Rates (Dec. 17, 2019); and Division of Risk and Clearing, CFTC Letter 19-28, Staff No-Action Relief from the Swap Clearing Requirement for Amendments to Legacy Uncleared Swaps to Facilitate Orderly Transition from Inter-Bank Offered Rates to Alternative Risk-Free Rates (Dec. 17, 2019).
 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §§ 701–74, 124 Stat. 1376, 1641–802 (2010) (codified as amended in scattered sections of 7, 12 and 15 U.S.C. (2012)).
 The CFTC Margin Rules provide that they will not apply to legacy transactions entered into before the applicable compliance date of the CFTC Margin Rules, but only if such legacy transactions are within a netting portfolio that contains only swaps entered into before that compliance date. See CFTC Rule 23.153. However, the CFTC Margin Rules do not generally address the circumstances in which an amendment of an uncleared swap may be deemed to constitute a new transaction, thus potentially causing the CFTC Margin Rules to apply to it and its entire netting portfolio.
 See CFTC Rule 23.150(b) (exempting from margin requirements swaps executed pursuant to the exceptions for mandatory clearing for certain end users and cooperatives); CFTC Rules 50.50 and 50.51; discussion below under the heading “Relief for End Users and Cooperatives” regarding CFTC Letter 19-28.
 The International Swaps and Derivatives Association (ISDA) is in the process of formulating a protocol to enable market participants to include fallbacks within legacy IBOR contracts on a multilateral basis.
 See the definition of “Swap dealer” contained in CFTC Rule 1.3.
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