CFTC Cross-Border Margin Proposal

On June 29, 2015, the Commodity Futures Trading Commission ("CFTC") issued a proposed rule1 (the "Proposed Rule") on the cross-border application of the margin requirements with respect to uncleared swaps to be adopted by the CFTC pursuant to Section 731 of the Dodd-Frank Wall Street Reform and Consumer Protection Act2 (the "Dodd-Frank Act"). When the CFTC issued a proposed rule containing such margin requirements on October 3, 2014, the CFTC also issued an Advance Notice of Proposed Rulemaking ("ANPR") containing three alternative approaches with respect to the potential cross-border application of the proposed margin requirements.3 The Proposed Rule is distinct from all three approaches set forth in that ANPR. Although the Proposed Rule was unanimously approved, two of the four Commissioners expressed skepticism as to its merits.4

The Proposed Rule imposes varying compliance obligations on uncleared swap transactions depending on whether one or both counterparties thereto qualifies as:

a U.S. person; or a non-U.S. person: (1) whose obligations are guaranteed by a U.S. person; (2) that is a "Foreign Consolidated Subsidiary" of a U.S. person; or (3) acting through or by a U.S. branch. Swaps between two non-U.S. persons who do not meet any of these three criteria would qualify for an exclusion from the CFTC's proposed margin requirements. This Stroock Special Bulletin will describe the proposed compliance obligations set forth in the proposal, as well as the proposed tests to determine the status of a counterparty to a swap.

Scope of Margin Requirements Proposed on October 3, 2014

The Proposed Rule sets forth criteria for determining whether and to what extent particular entities would be subject to margin requirements with respect to particular uncleared swap transactions. However, the Proposed Rule does not change the substantive proposals for how the margin requirements with respect to covered swap transactions would apply. The most recent CFTC guidance on that issue was set forth in its October 3, 2014 proposed rule.5 A brief summary of that proposed rule is provided below.

Initial Margin Requirements

Minimum initial margin requirements would apply to uncleared swaps between: a "covered swap entity" ("CSE")—a swap dealer ("SD") or major swap participant ("MSP") for which there is not a prudential regulator—and an SD, MSP or "financial end user" (certain specified types of financial entities) with "material swaps exposure" (combined daily aggregate notional amount of uncleared derivatives exposure of an entity and its affiliates with all counterparties for a specified three months of the applicable calendar year exceeds $3 billion). Initial margin could be calculated based on a quantitative model that receives written approval from the CFTC or the applicable Prudential Regulator, or on a standardized margin schedule set forth in the proposals. Initial margin would only need to be collected when the aggregate credit exposure of all uncleared swaps or security-based swaps between the CSE and its affiliates and the covered counterparty and its affiliates exceeds $65 million. Initial margin would need to be held by a custodian who is: (1) not an affiliate of either counterparty; and (2) prohibited from rehypothecating, repledging, reusing or otherwise transferring the held funds or other property (with a limited exception for substitution of other funds or property that would qualify as eligible collateral or reinvestment in assets that would qualify as eligible collateral). Eligible collateral would consist of gold, U.S. dollars, other major currencies, any currency in which payment obligations under the swap are required to be settled and certain specified types of debt and equity securities. Initial margin would be exchanged daily on a bilateral basis, with a minimum transfer amount of $650,000. Variation Margin Requirements

Minimum variation margin requirements would apply to uncleared swaps between (1) a CSE and (2) an SD, MSP or financial end user. Netting would be allowed for variation margin owed with respect to uncleared swaps or security-based swaps executed pursuant to an eligible master netting agreement. Eligible collateral would consist only of U.S. dollars and any other currency in which payment obligations under the swap are required to be settled. Variation margin would be exchanged daily on a bilateral basis, with a minimum transfer amount of $650,000. Exclusion from Margin Rules

The Proposed Rule excludes uncleared swap transactions from compliance with CFTC margin requirements if they are entered into between two non-U.S. persons: (1) whose obligations are not guaranteed by a U.S. person; (2) that are not "Foreign Consolidated Subsidiaries" of a U.S. person; and (3) that are not acting through or by a U.S. branch. The tests for whether entities would qualify for this exclusion (the "Exclusion") are described in further detail below.

Treatment of Certain Swaps Entered into or Guaranteed by a U.S. Person

Under the Proposed Rule, the regulatory obligations of (1) U.S. person CSE counterparties and (2) non-U.S. person CSE counterparties whose obligations under an uncleared swap are guaranteed by a U.S. person are both dependent on the nature of the particular counterparty to a specific uncleared swap transaction.

If the counterparty would be another U.S. person or non-U.S. person whose obligations under the relevant swap would be guaranteed by a U.S. person (including any persons who are not CSEs, to the extent a transaction with such a person would be subject to the CFTC margin requirements), the uncleared swap transaction would be subject to the U.S. margin requirements in full.

If the counterparty would be any non-U.S. person whose obligations under the uncleared swap would not be guaranteed by a U.S. person (whether or not such a person is a CSE), the uncleared swap transaction would be subject to the U.S. variation margin requirements in full. Such an uncleared swap would also be subject to the U.S. initial margin requirements with respect to the amount to be collected by the U.S. or...