The Commodity Futures Trading Commission (CFTC or Commission) continues to advance its regulatory agenda amid the COVID-19 crisis. After an initial flurry of no-action letters that ameliorate compliance with a number of regulatory requirements made more difficult to fulfill due to social distancing, the CFTC has resumed progressing its customary workload and continues to advance Chairman Tarbert’s ambitious regulatory agenda. To that end, on April 14, the Commission held a virtual open meeting and unanimously approved two final rules on margin1 and privacy2 and voted to propose rules regarding bankruptcy,3 Form CPO-PQR4 and clearing requirements.5
The following summary will help market participants keep abreast of all final or pending regulatory developments at the Commission since the beginning of the pandemic. We anticipate that the chairman’s goal is for the Commission to take final action on many, if not all, of the matters pending before the Commission by the end of the year, notwithstanding the current emphasis on maintaining operations in the face of the pandemic.6
The Commission approved Bitnomial Exchange, LLC, located in Chicago, Illinois, as a designated contract market, effective April 20, 2020. This follows the earlier approval by the CFTC of a number of other trading platforms permitted to list bitcoin derivatives, including CME, 7 CX Futures Exchange, Bakkt, Erisx and Ledgerx.
In another action related to virtual currencies, the Commission, on March 24, 2020, unanimously approved final interpretive guidance with respect to what constitutes “actual delivery”8 of virtual currencies.9 The final interpretative guidance discusses two primary factors demonstrating actual delivery of retail commodity transactions in virtual currency:
- (1) a customer securing (i) possession and control of the entire quantity of the commodity, whether it was purchased on margin, using leverage or via any other financing arrangement, and (ii) the ability to use the entire quantity of the commodity freely in commerce (away from any particular execution venue) no later than 28 days from the date of the transaction and at all times thereafter; and
- (2) the offeror and counterparty seller (including any of their respective affiliates or other persons acting in concert with the offeror or counterparty seller on a similar basis) do not retain any interest in, legal right to or control over any of the commodity purchased on margin, using leverage or via other financing arrangement at the expiration of 28 days from the date of the transaction.
The final interpretive guidance will require market participants to evaluate what changes are necessary to their existing business models for virtual currency transactions and wallets. This step demonstrates the Commission’s commitment to remaining active in this space. As Chairman Tarbert stated, the Commission will “continue to do its part to encourage responsible fintech innovation through sound regulation.”
Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
On April 9, 2020, the CFTC published final rules (effective May 11, 2020) in connection with the phase-in of initial margin requirements for uncleared swaps.10 The final rules bifurcated what had previously been Phase 5, the final phase that would have applied to swaps counterparties with greater than $8 billion in average aggregate notional amount (AANA) of uncleared swaps, with a compliance date of September 1, 2020. The bifurcation resulted in Phase 5 applying only to swaps counterparties with greater than $50 billion in AANA (with a compliance date of September 1, 2020) and a new Phase 6 applying to swaps counterparties with greater than $8 billion in AANA (with a compliance date of September 1, 2021). This rulemaking was intended to implement the recommendation made in July 2019 by the Basel Committee on Banking Supervision and the Board of the International Organization of Securities Commissions (BCBS/IOSCO).11
Meanwhile, on April 3, 2020, BCBS/IOSCO recommended an additional one-year delay to the phase-in schedule for the initial margin requirements so that the Phase 5 compliance date is now September 1, 2021 (instead of 2020), and the Phase 6 date is September 1, 2022 (instead of 2021).12 This additional delay was a response to the challenges posed by the COVID-19 pandemic, including the need for firms to focus on managing risks due to increased market volatility. Because BCBS/IOSCO is an advisory body, its recommendations need to be implemented at a national level. The relevant national legislators and regulators have so far followed the phase-in recommendations of BCBS/IOSCO, so it is widely expected that they will do so again. As of this writing, however, the CFTC has not issued a proposed rule. This is certainly an area to watch as the CFTC winds up its agenda.
This final rule aims to safeguard customer data by requiring market participants to adopt specific policies and procedures addressing the security and protection of customer records and information. The rule restores the inadvertently deleted Detailed Requirements in Section 160.30, which provides market participants and their customers assurance that protection of sensitive information is paramount to maintain the safety and soundness of the markets. Market participants should evaluate their compliance regimes in light of the final rules.
As we discussed in our earlier alert, the Commission previously proposed to codify the current no-action treatment relating to US-based personnel who arrange, negotiate or execute swaps on behalf of a non-US swap dealer and would amend the definition of “US person.” At its recent meeting, the Commission approved as final a rule codifying CFTC No-Action Letter 19-22,13 amending the definition of “financial end user” to exclude the European Stability Mechanism from margin requirements.14 The rule will become effective on June 10, 2020.
The proposed amendments to Part 190 of the CFTC’s rules would be the first comprehensive update to the bankruptcy regulations in 37 years. Notably, the amendments include new sections addressing virtual currencies. The proposed amendments also, for the first time, permit discretion to appointed trustees in dealing with potential derivatives clearing organization (DCO) failures. It also proposes that futures commission merchants (FCMs) and DCOs must segregate customer collateral in their books and records, but allows them to commingle the applicable collateral in one account. In addition, the CFTC’s proposal provides clarity on how letters of credit should be handled and reflects technological advancements in communications such as email. The proposed amendments provide commodity brokers with an updated framework in the event of a bankruptcy.
Comments on the proposal are due on or before July 7, 2020.
Clearing Requirement for Swaps
Also at its April 14 meeting, the Commission proposed amendments to codify existing Commission guidance and no-action relief from the clearing requirement of Section 2(h)(1) of the Commodity Exchange Act, 7 U.S.C. §1 et seq. (the Act), for swaps entered into by certain central banks, sovereign entities and international financial institutions. The Commission is also proposing amendments to exempt from required clearing swaps entered into by certain bank holding companies, savings and loan holding companies, and community development financial institutions.
The comment period will be open for 60 days following publication in the Federal Register.
The Commission has prioritized reexamining and rationalizing its reporting rules for swaps. The swap data reporting rules were among the first rules adopted following enactment of the Dodd-Frank Act. Since then, a consensus has developed that there could be a closer alignment between the data required to be reported and its uses. To that end, the Commission launched a far-ranging review of its swap data requirements—the Division of Market Oversight’s “Roadmap to Achieve High Quality Swaps Data.”
During its April 14 meeting, the Commission proposed a total of four rulemakings that address swaps reporting in whole or in part. Of these, three proposals are technical in nature or codify existing no-action relief. However, the fourth proposes changes in the swap data elements that are required to be reported; by harmonizing these reporting elements with international standards, these proposed changes may reduce certain reporting burdens.
The first proposes to amend data reporting requirements to swap data repositories (SDRs).15 The proposed amendments modify the requirements for registration of SDRs. In addition, the Commission is proposing a number of technical amendments that would clarify ambiguities, resolve inconsistencies and relocate certain provisions. The proposed amendments with the greatest potential impact would modify existing requirements for SDRs to establish policies and procedures to confirm the accuracy of swap data with both counterparties to a swap, and require reporting counterparties to verify the accuracy of swap data pursuant to those procedures. The comment period closes on May 20, 2020.
The second and third proposals would codify no-action relief relating to trading on swap execution facilities (SEFs), specifically the processing by SEFs of package trades, execution of block trades and the resolution of error trades.16 The relief applicable to each of these types of transactions has a related reporting component, which would be effectuated in proposed changes to the real-time swap reporting rules under Part 43 of the Commission’s rules.17 In addition, the Commission is proposing that redundant swaps created in the course of a prime broker’s agency swap transactions need not be reported. The comment period closes on May 22, 2020, for the second proposal and May 20, 2020, for the third.
The fourth proposal18 is based on feedback that the Commission received in connection with its Roadmap review. The proposed revisions would streamline the requirements for reporting new swaps, redefine swap reporting data to harmonize with international technical guidance, and reduce reporting burdens for reporting counterparties that are not swap dealers or major swap participants. For example, among the proposed changes, the Commission would combine two separate swap creation reports of primary economic terms and confirmation data into one swap creation report, removing duplication and the possible introduction of inconsistent data. In addition, clearinghouses would be permitted additional time to report swap creation data and post-trade allocation creation data, and the Commission is proposing to remove the requirement that the foreign trade repository be reported for international swaps. The Commission is also removing the requirement that state data be reported on a continuing basis. In addition, the Commission is proposing to add reporting on margin and collateral for swap dealers, major swap participants and DCOs, but to remove valuation reporting for non-swap dealers. Finally, the Commission is proposing a number of technical changes that better recognize reliance on international standards in determining the Legal Entity Identifier. The comment period ends on May 22, 2020.
Commodity Pool Operators
The proposed amendments to Commission Regulation 4.27 and Form CPO-PQR aim to simplify the collection of data from certain registered commodity pool operators (CPOs) and provide the CFTC with better oversight of CPOs, their operated commodity pools and their respective roles in the commodity interest markets.19 Notably, this marks the first significant amendment to the regulation or forms since 2012. If adopted, the amendments would provide market participants with a more streamlined approach and less overlap with similar reporting requirements enforced by the Securities and Exchange Commission (SEC). Comments on the proposal are due on or before June 12, 2020.
On December 19, 2019, the Commission reopened the comment period for capital requirements for swap dealers.20 Among other things, the proposed capital rule allows swap dealers to elect the approach to capital requirement: a bank-based approach; a net-liquid assets approach; or, for “non-financial” entities, a tangible net worth approach. Despite the reopened comment period ending on March 3, 2020, the Commission has not moved to finalize the rule.
The staff has issued practical and targeted relief through a series of no-action letters to assist the derivatives industry in addressing the challenges it faces in responding to the COVID-19 pandemic. A number of these (Letters 20-02 through 20-09) were discussed in our Client Alert dated March 19, 2020. Additional relief granted since then includes the following:
- CFTC Staff Letter No. 20-16, Additional Relief to Market Participants in Response to COVID-19 (April 24, 2020): DSIO has issued additional targeted no-action relief to registrants listing new principals and to applicants for registration as associated persons (APs) from the fingerprint card submission requirements until July 23, 2020, or until further notice from the National Futures Association (NFA) subject to certain conditions.21
- CFTC Staff Letter No. 20-15, Temporary Relief for Futures Commission Merchants and Introducing Brokers to Address Net Capital Treatment of Covered Loans under the CARES Act (April 23, 2020): DSIO will not recommend that the Commission take an enforcement action against any FCM or introducing broker (IB) that receives a Paycheck Protection Program covered loan and, in computing its net capital under Regulation 1.17, adds back to its capital the eligible Forgivable Expense Amount, subject to certain conditions.22
- CFTC Staff Letter No. 20-12, No-Action Position for Foreign Brokers Exempt Pursuant to Commission Regulation 30.5 to Handle U.S. Futures Market Orders in Response to the COVID-19 Pandemic (March 31, 2020): Allows certain foreign affiliates of FCMs that are exempt from registration with the Commission by CFTC Regulation 30.5 to accept orders from US persons for execution on US contract markets in the event an affiliated FCM’s US personnel are unable to handle the order flow of US customers due to their absence from normal business sites.
- CFTC Letter No. 20-11, Temporary Relief for Commodity Pool Operators (Mar. 20, 2020): DSIO provided temporary relief to CPOs from the following Commission regulations: (1) no annual (small or midsize CPOs) or quarterly (large CPOs) reporting23; (2) no CPO pool annual report due on or before April 30, 202024; (3) no monthly or quarterly periodic account statements.25
- CFTC Letter No. 20-10, Temporary Relief for an Insured Depository Institution Permitting Certain Commodity Swaps to be Excluded in the Major Swap Participant Registration Threshold Calculation (Mar. 20, 2020): DSIO will not recommend enforcement action from March 20, 2020, to September 30, 2020,26 against an insured depository institution if it does not count Excluded Swaps; i.e., the swap is excluded from counting toward the swap dealer de minimis threshold or from being considered swap dealing activity and the commodity underlying the swap is crude oil, natural gas or natural gas liquids, in its aggregate uncollateralized outward exposure calculation.
The CFTC continues to forge ahead with completing pending rulemakings and pressing ahead with new rulemakings. These rulemakings reach across markets and market players including reporting, margin, capital, CPO disclosure and bankruptcy. It is clear that the COVID-19 crisis has not slowed the Commission’s progress. Even though several of these rulemakings are technical in nature and/or codify existing relief, market participants should keep abreast of these developments as some may require review of, and adjustments to, their current operations.