Now more than a year since a new Presidential administration took residence on Pennsylvania Avenue, consequential changes to derivatives laws are beginning to be introduced and gather steam. As part of Chatham’s ongoing efforts to have a positive impact on our clients and markets more broadly, we have put together this update to keep you informed regarding the state of play, as well as to share ways we are engaging to help bring about this positive impact.
At the regulatory level, CFTC Chairman Giancarlo has called for Reg Reform 2.0, and has emphasized the need for greater regulatory simplicity, more flexible trading rules, and better cross-border cooperation, among other priorities. The US Treasury Department released a report in October proposing changes to derivatives and other capital markets in response to a Presidential executive order. The Oval Office took a peek into the derivatives market again just last week, when Chairman Giancarlo visited President Trump to update him on concerns about the potential for a more aggressive regulatory posture towards US registrants from Europe. Speaking of which, European regulators have proposed amendments to its derivatives law, and European Parliament is poised to debate these amendments in the near term.
While many of the contemplated changes could provide meaningful relief to some market participants, the limited nature of the changes largely implies an endorsement of the G20’s reform blueprint. That is, the changes do not fundamentally challenge the core of today’s derivatives regulatory architecture – central clearing, reporting, trading, margin, and conduct rules. However, we believe the atmosphere is ripe for targeted changes beneficial to end users and smaller banks, and so we have remained engaged with policy makers to share ongoing pain points and solutions to address them.
Amidst the considerable array of policy initiatives and actions in the derivatives market, we wanted to call attention to several that we believe have the potential to positively impact some or all of our clients.
- Non-Financial End Users (e.g., real estate developers, REITs, corporates):
- Inter-affiliate trades & transaction costs (US): The House Financial Services Committee (HFSC) will hold a hearing on Wednesday to discuss eleven bills aimed at derivatives market fixes. Several of these are of consequence to corporate end users, including changes that would further clarify rules for inter-affiliate transactions and reduce transaction costs.
- Reporting rules (EU): European regulators and legislators have proposed to substantially exempt non-financial counterparties and intragroup transactions from derivatives reporting rules, considerably reducing administrative burdens for non-financial firms transacting in Europe.
- Financial End users (e.g., financial institutions, real estate/private equity funds):
- Expanding the end-user exemption (US): Among the bills being considered at the HFSC hearing is one that would expand the end-user exemption from clearing and margin for the benefit of financial end users.
- Clarifying the end-user exemption for real estate funds (US): The CFTC recently issued an interpretative letter, clarifying that certain real estate fund vehicles predominantly used to hedge currency risk are not commodity pools subject to clearing and margin rules.
- Clarifying scope of CFTC-EMIR margin rule substituted compliance determination (US): In a recent speech, CFTC Commissioner Giancarlo confirmed that entities classified as “financial” under either the CFTC or EMIR margin rules and “non-financial” under the other, may benefit from substituted compliance when trading with a bank subject to both sets of rules, which means they can apply the less burdensome of the two sets of rules.
- Expanding the end-user exemption (EU): European regulators are contemplating excluding securitisation special-purpose entities from clearing and margin rules. They also propose to further delay such rules for pension funds.
- Narrowing the FX product scope (EU): European regulators are contemplating eliminating the mandatory exchange of variation margin for physically-settled FX forwards and swaps.
- Small and Mid-Sized Banks:
- Volcker Rule (US): The Office of the Comptroller of the Currency this fall asked for industry comments on the Volcker rule, and the US Treasury Department also called for changes, signaling some possibility that the rules would be streamlined, clarified, and narrowed. Chatham and eighteen of our clients submitted a joint letter calling for a narrowed definition of proprietary trading, a reduction in scope of entities subject to the rule, and clarifications with respect to banks conducting back-to-back swap programs.
- Swap Dealer requirements for smaller banks (US): CFTC Chairman Giancarlo testified that he plans to present a proposal to the CFTC as to how to approach the $8 billion notional threshold exempting entities that conduct a small amount of swap dealing activity. In a letter to the CFTC, Chatham also requested that the Commission consider increasing the de minimis threshold for special entities, expanding accommodations for insured depository institutions, and expanding the small bank exemption.
In addition to these potential changes, we expect additional proposals from the CFTC as part of its Reg Reform 2.0, swaps reporting, and simplification initiatives. Chatham has shared numerous concerns pertinent to our clients as part of these and other initiatives (e.g., see our simplification comments, swaps reporting comments). Additionally, regulators globally under the auspices of the Financial Stability Board are reexamining reforms with a view toward ultimately proposing changes. Both Chatham and our clients have provided feedback to the FSB as part of this reexamination.
Our engagement in the policy sphere, both individually and collaboratively with clients and the Coalition for Derivatives End-Users, reflects several of our five purposes – i.e., to impact markets (by making them fair, safe, and transparent), and to impact clients (by earning each client’s trust and partnering with them for mutual success).