CFTC’s cross-border swap-margin proposal revives end-user concerns.
Non-financial corporates mostly got what they wanted when regulators exempted them from swap margin requirements. However, a proposal on cross-border swap rules, for which comments are due September 14, 2015, is a reminder that loose ends remain and the over-the-counter swap market may ultimately become less friendly to corporate hedgers.
The Commodity Futures Trading Commission’s proposal, issued July 14, tackles the cross-border application of margin rules for non-bank swap dealers and major swap participants. Prudential regulators and the CFTC have exempted non-financial corporates from their broader proposed rules for swap margins, issued last September and December respectively, though still to be finalized.
And although the CFTC has issued no-action relief exempting the centralized treasury units (CTUs) of multinational corporates (MNCs) from margin requirements, the regulator could decide to remove it at some point. Plus, there’s still some uncertainty about how the issue will play out in the final swap-margin rules.
“The CFTC has issued much appreciated no action relief that assists many end-users,” said Michael Bopp, a partner at Gibson, Dunn & Crutcher. “Nevertheless, the growing community of end-users that employ CTUs to efficiently hedge risk is advocating for a legislative solution to the underlying ambiguity in Dodd-Frank.”
A bill currently circulating, the Moore-Stivers Bill, which has bipartisan support, would do exactly that. However, fractious politics may impede its progress this fall, and legislative sessions before elections tend to be less productive, casting doubt on its passage before elections in fall 2016.
“This narrowly tailored, bipartisan bill, as amended by the Moore amendment, will provide much-needed relief and fix a language glitch in the Dodd-Frank Act that denies some end-users the clearing exception that Congress passed specifically for them,” noted the Coalition for Derivative End-Users in a July 28 letter to leaders of the House Committee on Financial Services.
Luke Zubrod, director of risk and regulatory advisory at Chatham Financial, said that the prudential regulators’ margin proposal issued last September is ultimately more important for corporate end-users, because it applies to transactions executed with bank swap dealers. Corporate end-users may use non-bank swap dealers, which will be subject to the CFTC’s eventual rule, for commodity-related swaps but generally deal with banks.
“However, in substance the two rule proposals are largely the same and regulators will seek to make them so in the final rules,” Mr. Zubrod said, adding that the prudential regulators’ cross-border framework was stitched into its broader margin proposal.
The CFTC’s cross-border rule will have limited direct impact on corporates. However, the regulator’s cross-border regulatory framework does apply margin to a US bank’s non-guaranteed foreign affiliates, on the theory that banks will be motivated by reputational concerns to save a failing affiliate.
“The question for the markets at large, including end users, is whether the CFTC applies this framework across the board to all of its rules,” Mr. Zubrod said. “To the extent it does, it may further contribute to the complexity that befalls risk management that crosses borders, insomuch as it would increase the degree to which an end user might be subject to both US and non-US rules simultaneously.”
Mr. Zubrod said it is likely rules from both sets of regulators, including the CFTC’s cross-border rules, will be finalized by year-end. He added that regulators in the US and in Europe have succeeded in resolving what were significant differences between their proposed rule sets—an earlier concern—and are now focused on fine tuning. A communiqué stemming from the G20’s meeting earlier this week in Ankara emphasized relatively specific issues, such as reducing legal barriers to sharing swaps data and strengthening clearinghouses, rather than more sweeping ones.
“We continue to expect, on the basis of the substantial work done internationally, that US rules will be substantially harmonized across regulators and with European counterparts,” Mr. Zubrod said.
More generally, the proposed swap-margin rules along with other measures impacting the swap market, such as Basel III requirements that go into effect over the next several years, may make the market more costly and less attractive for banks to participate in, potentially prompting some to exit. Banks also tend to pass on higher costs to customers, possibly raising the cost of bank services for corporates.
The current proposal should not impact bank capital, at least not directly, but it could have swap market implications that are problematic for corporates. Jeffrey Steiner, counsel in the Washington, D.C., office of Gibson Dunn, noted that the current proposal significantly changes the CFTC’s original guidance on cross-border swaps
Under the guidance, a foreign affiliate of a US bank swap dealer that is not guaranteed by a “US person” and is separately capitalized, could act as counterparty for a similarly independent, non-US treasury affiliate of a US corporate, without having to comply with rules stemming from the Dodd-Frank Act. Under the proposal, however, if that foreign bank affiliate is consolidated in the US parent’s financial statements, the Dodd-Frank rules apply, when appropriate. Likewise, a non-US bank swap dealer acting as counterparty to a non-US corporate treasury affiliate that is consolidated in its parent’s financial statements would also have to comply with applicable Dodd-Frank rules.
Mr. Steiner said that a final rule following the proposal as currently written could end causing inconsistencies or duplication between jurisdictions, up fragmenting the swap market more. “When markets fragment and participants have to duplicate their books, costs typically go up and it can create operational complications for corporate end-users that were used to using one bank counterparty and now need to seek alternative counterparties,” Mr. Steiner said.