In this Ropes & Gray podcast, asset management partners Isabel Dische and Leigh Fraser discuss the three no-action letters that were published by the CFTC on December 17, 2019 to provide relief to market participants as they transition swaps that reference the London Interbank Offered Rate (LIBOR) and other interbank offered rates (or IBORs) to swaps that reference alternative benchmarks.
Isabel Dische: Hello, and thank you for joining us today on this Ropes & Gray podcast, the latest in our series of podcasts and webinars focused on CFTC and derivatives issues. I'm Isabel Dische, a partner in our asset management group based in New York. Joining me today is Leigh Fraser, an asset management partner in our Boston office who heads our firm's private funds practice. Today, we are going to be talking about three no-action letters that were published by the CFTC on December 17, 2019 to provide relief to market participants as they transition swaps that reference LIBOR and other interbank offered rates to swaps that reference alternative benchmarks. By way of background, the potential discontinuation of LIBOR at the end of 2021 introduces uncertainty about how swaps referencing LIBOR or other interbank benchmarks will operate following such discontinuation. To address these concerns, market participants may decide to amend their existing swaps even before a rate is discontinued. In both cases, such amendments to the benchmark rate may trigger the need for additional amendments and/or conversions to maintain the economics of the swap. And such amendments may involve ancillary changes to existing trade terms to conform to different market conventions, such as day count fractions. The need for these rate transition-related changes had introduced uncertainty around a number of derivatives regulations under Dodd-Frank.
Leigh Fraser: Yes, that's right. Many of the derivatives rules treat legacy swaps differently than swaps entered into on or after the applicable compliance date. For example, uncleared swaps entered into prior to the relevant compliance date are not subject to margin requirements under the CFTC margin rules. This raised the question whether amendments to existing swaps to facilitate a rate transition could bring these swaps into scope for margin rule purposes, thereby having a materially adverse effect on the parties' economic obligations under such swaps. Because of this and comparable issues under other derivatives rules, the Alternative Reference Rates Committee had requested relief from the CFTC from certain CFTC regulations to eliminate possible impediments to an orderly rate transition. In No-Action Letter 19-26, the Division of Swap Dealer and Intermediary Oversight, or DSIO, has provided no-action relief with respect to certain qualifying amendments to include new reference rate fallbacks and also to make other changes to accommodate the replacement of a reference rate (such as changes in reset dates), as long as the changes do not either extend the maximum maturity of the swap or a portfolio of swaps, or increase the total effective notional amount of the swap or portfolio of swaps, in each case beyond what is necessary to accommodate the differences between market conventions for the initial and replacement rates. In particular, the DSIO will not recommend enforcement action against a swap dealer for a failure to comply with swap dealer registration requirements, margin rules, business conduct requirements, confirmation, documentation and reconciliation requirements, and certain other requirements applicable to certain end users, solely to the extent such compliance would be required as a consequence of a qualifying amendment to a legacy swap. The DSIO expressly noted that such amendments advance an important public policy objective and are not for the purpose of evading these regulatory regimes.
Similarly, in No-Action Letters 19-27 and 19-28, the Division of Market Oversight and the Division of Clearing and Risk, respectively, provided time-limited relief (in each case until December 31, 2021) from the trade execution requirement and the swap clearing requirement and related exceptions and exemptions with respect to IBOR-linked swaps that are amended or created by a rate transition mechanism for the sole purpose of accommodating the rate replacement. The relief from the clearing requirement does not apply to swaps that were voluntarily submitted for clearing. Likewise, relief applies only if the amended legacy swap has the same counterparties as the original swap, has the same maximum maturity, the same average weighted maturity, and the same total effective notional amount, and if the legacy swap is being amended for the sole purpose of changing the floating rate fallback provision.
Isabel Dische: It also is worth mentioning that the rate transition introduces uncertainty for certain end users who have used swaps to hedge or mitigate commercial risks, and in particular if those swaps and any rate replacement-related amendments will still qualify for exemption from the clearing requirement. No-Action Letter 19-28 provides comfort to such parties where such swaps and/or the underlying commercial agreement are being amended on or before December 31, 2021 in connection with the rate transition, or if an existing fallback provision is activated; provided that the amended uncleared swap again qualifies as a swap that is used to hedge or mitigate commercial risks.
Leigh Fraser: Thank you, Isabel, for joining me today for this discussion. And thank you to our listeners. Needless to say, the derivatives regulatory regime is a complex one, and today's discussion is intended as a high-level overview of the December 2019 no-action relief granted by the CFTC. For more information on the topics we have discussed or other topics of interest to the asset management, CFTC and derivatives communities, please visit our website at www.ropesgray.com. And of course, we can help you navigate any of the topics we discussed. Please don't hesitate to get in touch. You can also subscribe and listen to this series wherever you regularly listen to podcasts, including on Apple, Google and Spotify. Thanks again for listening.
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