The CFTC recently published Brexit-related Letter No. 20-42 (December 4, 2020) in response to a request from the International Swaps and Derivatives Association, Inc. (ISDA). In its request, ISDA stated that the expiration of the Brexit transition period – set for December 31, 2020 – potentially raises the need for swap dealers to transfer uncleared swaps between affiliates as part of their strategic response to Brexit. In the interest of an orderly such process, ISDA requested relief for swap dealers to be able to voluntarily transfer “legacy” swaps (i.e., entered into prior to the applicable margin or clearing compliance date) between affiliates, solely in preparation for or response to the end of the Brexit transition period, without triggering the margin and clearing requirements.
Letter No. 20-42 grants no-action relief that should help facilitate an orderly response to Brexit by covered swap dealers, and also provide assurance to end-users and other market participants that Brexit will not result in a cascading application of the margin and clearing requirements to legacy swaps.
The CFTC margin rule, promulgated in January 2016, establishes requirements for a covered swap dealer to collect and post initial and variation margin for its uncleared swaps. (The CFTC’s margin requirements apply only to swap dealers for which there is not a “prudential regulator” such as the Board of Governors of the Federal Reserve System or certain other banking regulators. Swap dealers for which there is a prudential regulator must meet the margin requirements for uncleared swaps established by the applicable prudential regulator.) An uncleared swap entered into prior to the particular compliance date applicable to the swap dealer and its counterparty (a “margin legacy swap”) is generally not subject to the margin requirements. However, a margin legacy swap that is amended or novated after the applicable compliance date may, as a result, lose its “legacy” status and become subject to the margin requirements.
Similarly, CFTC clearing determinations generally require certain types of swaps (to date, certain classes of interest rate swaps and credit default swaps) to be centrally cleared, unless entered into prior to the relevant clearing compliance date (a “clearing legacy swap”). However, similar to the scenario under the margin requirements, a clearing legacy swap that is assigned after the relevant clearing compliance date may, as a result, lose its “legacy” status and become subject to the clearing requirements.
Letter No. 20-42 provides that a legacy swap will not become subject to the margin or clearing requirements solely as a result of an amendment entered into under certain conditions set forth in the letter. These conditions include, among others, that: (i) solely in connection with planning for or response to the expiration of the Brexit transition period, one or both parties transfers the swap to a qualifying affiliate (or a branch or other authorized form of establishment of the transferor) and the parties make no other transfers of the swap; and (ii) the amendment is entered into and takes effect within one year of the expiration of the Brexit transition period.
Given the CFTC’s desire to enhance certainty around the Brexit transition and the attendant complexity of the situation, further CFTC relief and other pronouncements may be expected. (See also “Extension of Brexit No-Action Letters” in this newsletter.)