On October 31st, the CFTC’s Office of the Chief Economist (the “OCE”) issued a report about “Phase 5” of the uncleared margin rules (“UMR”) that are slated to go into effect on September 1, 2020.  The purpose of the report was “to guide regulators in their responses to industry requests for relief” from the scheduled application of Phase 5.

This post will provide an overview of the main conclusions of the report.  Any potential implementation of revisions to the UMR consistent with the conclusions in the report would have the effect of reducing the number of market participants subject to UMR, thereby simplifying compliance processes and burdens on entities that may have otherwise been impacted by the UMR.  It is too early to forecast whether regulators will propose and ultimately implement revisions to the UMR based upon this report.  Although, we believe that its issuance is a noteworthy development.

At the outset, the UMR are complex and their application to any particular trading activities should be undertaken in consultation with counsel familiar with these rules.  This post is not legal advice.

The UMR adopted by the CFTC and bank regulators in the U.S. (and abroad) require an entity to come into scope with initial margin (“IM”) requirements when that entity’s Average Aggregate Notional Amount (“AANA”) exceeds a given threshold.  Under the U.S. UMR, the AANA equals the daily average of swaps over June, July, and August of the previous year.  An entity that has AANA in excess of the applicable threshold is referred to as having material swaps exposure (“MSE”).  An entity must include physically-settled foreign exchange (“FX”) forwards and swaps in its AANA calculations, even though the UMR do not subject those FX trades to IM requirements.

The UMR set Phase 1 for September 1, 2016, and set the second and third phases for September 1st of the next two years.   Phase 4 is scheduled for September 1, 2019, and will require a swap dealer to exchange initial margin (IM) with any counterparty that is a financial entity or other swap dealer with an AANA of $750 billion or more.  Phase 5, which  is scheduled for September 1, 2020, will apply to any entity that has AANA of $8 billion or more.  In other words, on and after September 1, 2020, the UMR will apply IM requirements to financial entities and swap dealers with MSE of $8 billion or more.

The OCE’s Phase 5 report explained that market participants and derivatives industry representatives have raised concerns that Phase 5 will “cast too wide of a net,” and apply the UMR to smaller financial end users that are not creating the systemic risk that IM requirements were designed to mitigate in the first instance.  The purpose of the report was to guide regulators in their responses to the concerns raised by market participants and derivatives industry representatives.

The following is a summary of the main conclusions, as presented in the report:

  • While Phases 1 through 4 capture just over 40 entities, Phase 5 could bring 700 entities in scope, which together encompass only 11% of the AANA across all phases.
  • Nearly 60% of entities coming into scope in Phase 5 have AANAs of less than $25 billion, and over 75% have AANAs less than $50 billion.  These subsets of entities comprise about 15% and 30% of total Phase 5 AANA, respectively.
  • Phase 5 entities will span a variety of business sectors.  The average AANA of newly in-scope swap dealers, however, will be many times that of any other sector.
  • Excluding physically-settled FX swaps from AANA could reduce the number of Phase 5 entities by nearly 30%.
  • Phase 5 compliance could require implementing nearly 7,000 IM relationships.  Excluding physically-settled FX swaps from AANA could reduce that number to 5,000. Page 1 of the report (emphasis added).

In short, any revisions to the UMR based upon these conclusions would have the effect of reducing the number of market participants subject to UMR.  Whether regulators propose and ultimately implement any such revisions remains to be seen; however, we believe that the potential for regulatory relief afforded by the conclusions put forward by OCE makes the issuance of the report a noteworthy development for many derivatives market participants.

The report is available here.

Good day.  Good to be aware of – or we would not have posted this. DR2.