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CFTC Global Markets Advisory Committee Meeting

Commodity Futures Trading Commission

Global Markets Advisory Committee Meeting

Tuesday, May 19, 2020

Opening Statements

Commissioner Dawn D. Stump

In her opening statement, Stump emphasized that the markets the Commission regulates are global in nature, and as such, it is important to move forward with the Global Markets Advisory Committee (GMAC) agenda despite the COVID-19 pandemic. After summarizing the meeting agenda, Stump outlined the work of GMAC Subcommittee on Margin Requirements for Non-Cleared Swaps (“Subcommittee”) in producing a report that outlines several challenges posed by the upcoming implementation phases of margin requirements for non-cleared swaps and recommends a number of specific potential actions to mitigate these challenges.

Chairman Heath P. Tarbert

In his opening statement, Tarbert said that he agrees with the report’s recommendations as delaying the compliance deadline for Phases 5 and 6 by a year will allow firms to better allocate sufficient resources to respond to COVID-19 and continue their business continuity efforts. He stated that margin rules serve as a key systemic risk mitigant and specifically noted that the firms that would receive this extension are those with the smallest non-cleared swaps portfolios. He concluded by outlining his belief that the Commission should follow the example of their international regulatory counterparts in terms of this extension.

Commissioner Brian D. Quintenz

In commenting on the implementation of uncleared margin rules, Quintenz said that the compliance deadlines for Phases 5 and 6 will bring into scope a much larger and more diverse group of market participants. He noted that as these deadlines approach, it is important to reflect on how the uncleared margin regime can be improved to address some of the compliance challenges experienced in earlier stages. He said he is specifically interested in the Subcommittee’s recommendations regarding the provision of relief from initial margin calculations for small covered swap entities, compliance grace periods to allow firms time to establish the necessary custodian documentation after the initial margin threshold has been exceeded, and the alignment of timing and methodology for the material swaps exposure calculation with the global Basel Committee on Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO) framework. He outlined his support for a one-year delay regarding the Phase 5 and 6 compliance dates. He concluded by summarizing the necessity of this relief given the current circumstances wrought by the COVID-19 pandemic as well as the large number of firms brought into scope during Phases 5 and 6 and the estimated 7,000 initial margin relationships that need to be negotiated.

Commissioner Rostin Behnam

Behnam praised the report and the timely work of the GMAC in providing a depth of information on the market that helps the Commission in facilitating the effective functioning of the market.

Commissioner Dan M. Berkovitz

Berkovitz first praised the role of advisory committee meetings in improving the work and knowledge base of the Commission before noting his support for the previous extension of the compliance framework for non-cleared swaps. He stated that he is interested in learning more regarding the extent to which the stress on the economy has impacted counterparty credit risk.

Presentations

Presentation 1: International Coordination in the Time of COVID-19

  • Suyash Paliwal, Director, Office of International Affairs, Commodity Futures Trading Commission

Given the vantage point from the Office of International Affairs into the Commission’s manifold coordination efforts across the globe, Paliwal provided insight into international coordination between the various regulatory and supervisory authorities in response to the COVID-19 pandemic. Paliwal noted that while the impact of COVID-19 has resulted in one of the most volatile periods the derivatives markets have ever experienced, the resilience and robustness of these markets allowed them to serve as “shock-absorbers” for risk. He continued that the regulatory ecosystem put in place in the wake of the financial crisis of 2007 – 2008 essentially worked as it should, highlighting the practice of central clearing and the mitigation of counterparty credit risk as recent volatility was channeled as designed into the clearing ecosystem. Paliwal also noted that the reforms implemented by the Commission since 2008 will continue to ensure that the swaps markets remain transparent, fair and competitive throughout this unprecedented period. He emphasized the significant amount of international coordination between the Commission, the Financial Stability Board (FSB), BCBS and IOSCO in facilitating information sharing and the issuance of appropriate, informed and timely responses and relief. He concluded by highlighting the various no-action letters put forth by the Commission in response to COVID-19 and stated that a one-year delay in the Phase 5 and 6 compliance dates for non-cleared swaps margin requirements is a change worthy of consideration.

Presentation 2: Presentation of Report and Recommendations from the GMAC Subcommittee on Margin Requirements for Non-Cleared Swaps

  • Wendy Yun, Co-Chair (Derivatives Committee), SIFMA AMG (Presenter)

Wendy Yun, on behalf of the Securities Industry and Financial Markets Association (SIFMA) Asset Management Group (AMG) Derivatives Committee, presented the Report and Recommendations from the GMAC Subcommittee on Margin Requirements for Non-Cleared Swaps (the “Report”). Yun began the presentation by noting that there are still significant scoping implementation challenges faced by counterparties subject to the final phases of implementation of the uncleared margin requirements. Yun explained that the Report consisted of recommendations to address some of these issues for Phase 5, 6, and beyond. Overall, the focus of the Report was to recommend certain changes to the margin requirements that would make the CFTC’s rules more workable without compromising the overall goals of the Commission. Specifically, Yun went on to outline the Report’s “Immediate Term Recommendations” which are expected to have the most beneficial impact prior to the Phase 5 compliance date, and the “Later Term Recommendations,” which is expected to have the most beneficial impact if adopted before the Phase 6 compliance date.

Yun outlined five separate Immediate Term Recommendations. The recommendations were: (1) Confirm Interpretation that a Covered Swap Entity (“CSE”) Can Continue to Trade with a Separately Managed Account (“SMA”) Client in the Case of an Inadvertent Breach of the $50M IM Threshold; (2) Removal of Certain Collateral Eligibility Restrictions on Money Market Funds; (3) Removal of Consolidation Requirement for Seeded Funds; (4) Relief Relating to IM Calculations for Small Covered Swap Entities; and (5) Provide a Grace Period to Reduce Congestion and Facilitate Compliance.

Yun then described the four “Later Term Recommendations”, which consisted of: (1) Application of separate IM threshold to each separately managed account of an SMA client; (2) Codification for Relief Related to Minimum Transfer Amount; (3) Codification for Relief Related to Minimum Transfer Amount; and (4) Removal of Deliverable FX from MSE Calculation.

After describing each of the nine total recommendations to the GMAC, Yun noted that on April 23, 2020 the Subcommittee voted to adopt the recommendations to improve the scope and implementation of the uncleared margin rule (UMR) and referred them to the GMAC.

Question & Answer

Following the presentations, the GMAC Chair Angie Karna, Nomura Securities International, Inc., began the Q&A session by asking whether the forbearance recommendation would still be necessary in the event the CFTC implements the BCBS-IOSCO recommended one-year delay. Darcy Bradbury, DE Shaw, responded that the Subcommittee spent a lot of time thinking about that question. However, Bradbury went on to explain that the Subcommittee narrowed the focus of their recommendations, focusing on the “big crowd, small pipe” problem. Bradbury went on to further explain that while custodians are recommending that a time period of 8+ months prior to the relevant implementation deadline is needed to establish the necessary documentation, unanticipated facts and circumstances could quickly change a firm’s status as an in-scope entity. These unanticipated issues could catch firms by surprise and create a panic to come into compliance as quickly as possible or face trade disruptions. Dominick Falco, BNY Mellon Markets, agreed with Bradbury and further noted that, from their experience in prior phases, many firms will need to establish new custodial relationships and therefore face lengthy know-your-customer (KYC) processes to set up required documentation.

Yun and Masahiro Yamada, JP Morgan Securities LLC, also responded to Karna’s question. Yun further emphasized that with respect to SMAs, asset managers will have no knowledge outside of their own mandate and therefore won’t be able to predict whether they will cross the regulatory thresholds. Yamada then noted that his firm would be willing to support the six-month delay as long as there is global consistency.

Karna then asked the Subcommittee members if they could highlight what makes SMAs different from other potential participants in the next two phases, such as end users. Betsy Cochrane, Barings LLC, responded that SMAs are unique vehicles typically utilized by large pension funds and other institutional investors in order to get exposures to strategies with reduced fees and to maintain a diversity of portfolios in a controlled manner. This includes, as Cochrane stated, obtaining a diversity among investment managers. Yun added that end users will either trade with themselves or operate through a limited use of asset managers, while pensions and the like may have a higher multiple of asset managers and will likely not be involved in trading themselves.

Suprna VedBrat, Blackrock, then asked Yun to provide more detail on the recommendation relating to the flat initial margin allocation and noted that from an asset manager perspective, it is important that firms have certainty and it is necessary to have the ability to hedge. She further noted that she is concerned there could be a cliff edge issue where one SMA entity exceeds the threshold limit. Yun responded that there is a concern it will be difficult for the CSE and managers to continuously monitor the $50 million threshold on a dynamic basis and the flat initial margin amount recommendation would provide more certainty by granting dealers the ability to use a flat initial margin amount per asset manager. Sachiyo Sakemi, Blackrock, added that in addition the flat initial margin proposal, asset managers would still need the recommended interpretation from the Commission that they see each SMA relationship as separate.

Karna then asked if there was discussion about whether a flat IM threshold of $10 million could result in an aggregate going beyond the $50 million threshold, and how the CFTC could prevent managers from setting up more accounts to breach the threshold intentionally. Cochrane responded that the CFTC has anti-evasion powers that could be used in that instance, even though that scenario was unlikely. Yun agreed and noted that other natural guardrails exist. Specifically, she explained that associated costs to establish an SMA significantly outweigh any costs levied upon firms complying with the margin requirements. Karna then asked who was responsible for compliance under this proposal. Yun and Cochrane explained that it would be the covered swap entity given their regulatory obligation.

Yamada commented that the complexity of these problems is well documented in the report, particularly within Appendix C. He stated that he believes that the discussed proposal is an elegant solution that balances the overall goals of eliminating the buildup of margin risk and doing something that acknowledges the practical realities of the structure of the market. He then emphasized that given the friction with setting up SMAs, there is a less of a concern for abuse.

Karna asked whether the recommended seeded funds exemption could lead to market abuse. Cochrane responded that much like SMAs, the likelihood of this happening is low because it is expensive. Further, she added that these funds are set up to allow U.S. fund sponsors to develop new products and establish track records to market as well as distribute their products to the market.

Karna asked whether, as a general matter, the recommendations in the report would need to be adopted by the U.S. prudential regulators and other jurisdictions like the E.U. Tara Kruse, ISDA, responded that the answer varies based on the recommendations. Kruse stated that with respect to some recommendations, the U.S. is the outlier and changes elsewhere wouldn’t be needed, but for others, international harmonization would be necessary.

Stump asked, in the context of seeded funds, for an explanation as to what the current BCBS-IOSCO standard is. Cochrane explained that the BCBS has exempted all investment funds from having to be consolidated with sponsors and that the Report’s recommendation would be consistent with other jurisdictions such as Japan, the E.U., and Canada. She further noted that the recommendations took language from the BCBS recommendation and added additional language.

Ashley Belich, RBC Capital Markets, commented that many firms like RBC are in a unique scenario where they are faced with multiple rulesets that are not completely aligned. She further added that without agency action on a number of these recommendations, these inconsistencies will create complex operational issues for large dealers and clients.

VedBrat then noted her concern that most money market funds are not currently eligible as collateral and as such, added her support for the recommendation to allow money market funds to be used as eligible collateral. Falco added to that comment, stating that money market funds account for much of the collateral being segregated today and that many clients in the Phase 5 timeframe are looking to employ this strategy as soon as possible.

Stump asked, with regard to the period and method of calculation for material swaps exposure, whether there are any issues market participants are anticipating. Kruse responded that market participants near the bottom of the $8 billion threshold are going to have to run multiple, separate calculations at different time periods every year to determine whether they are in or out of scope. She explained that this was burdensome and stated that she hopes the U.S. will consider aligning with the BCBS.

The GMAC voted 17-1 (with four abstentions) to adopt the Report and recommend it to the Commission.

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