On October 22, 2015, five federal agencies adopted a joint final rule establishing minimum initial and variation margin requirements for non-cleared swaps entered into by a registered swap dealer, major swap participant, securitybased swap dealer or major security-based swap participant. The U.S. prudential regulators – the FDIC Board of Directors, the Office of the Comptroller of the Currency, the Federal Reserve Board, the Farm Credit Administration and the Federal Housing Finance Agency – adopted this final rule (PR final rule) [1] shortly before the U.S. Commodity Futures and Trading Commission (CFTC) adopted a substantially similar final rule on December 16, 2016, for margin requirements for non-cleared swaps entered into by a registered swap dealer or major swap participant that is not regulated by a U.S. prudential regulator (including non-bank subsidiaries of a bank holding company) (CFTC final rule[2] and, collectively with the PR final rule, the final rules). However, the CFTC final rule materially deviates from the PR final rule in several ways, as noted below.
Importantly, the U.S. prudential regulators and the CFTC each specified (in interim final rules) that the margin requirements do not apply to certain non-cleared swaps and non-cleared security-based swaps of financial institutions with total assets of ten billion dollars or less or commercial end-users that would otherwise be exempt from clearing.[3] The SEC has yet to issue final rules establishing margin requirements for security-based swap dealers and major security-based swap participants that are not regulated by a U.S. prudential regulator.
Hedge funds and other investment funds trading non-cleared swaps with registered swap dealers supervised by either the U.S. prudential regulators or the CFTC (covered swap dealers) will be indirectly impacted by the final rules and will likely face increased costs of trading non-cleared swaps as described below.
In a two-part guest series, Fabien Carruzzo and Philip Powers – partner and associate, respectively, at Kramer Levin – discuss the final rules and analyze their impact on hedge funds.
This first article addresses the calculation of a fund's material swaps exposure, as well as the requirements under the final rules for covered swap dealers to collect and post initial and variation margin with respect to non-cleared swaps with their counterparties. The second article will address minimum transfer amounts; eligible collateral and haircuts; netting of exposure; documentation and industry initiatives; compliance obligations under the final rules; and the practical implications of the final rules on hedge funds. For additional insight from Carruzzo, see "OTC Derivatives Clearing: How Does It Work and What Will Change?" (Jul. 14, 2011). For more from Kramer Levin practitioners, see "'Interval Alts' Combine Benefits of Alternative Mutual Funds and Traditional Hedge Funds" (Jul. 16, 2015).
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Originally published in the Hedge Fund Law Report Volume 9, Number 7
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
