United States: COVID-19: CFTC Advances Regulatory Agenda Despite COVID-19 Pandemic

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

Final Actions

Digital Assets

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.

Consumer Privacy

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.

Cross-Border

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.

Proposed Rules

Bankruptcy

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.

Reporting

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.

Capital Rule

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.

COVID-19-Related Relief

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.

Conclusion

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.

1. Amendments to Part 23 Margin Requirements for the European Stability Mechanism.
2. Amendment to Part 160 Consumer Financial Information Privacy Regulation.
3. Amendments to Part 190 Bankruptcy Regulations.
4. Amendments to Compliance Requirements for Commodity Pool Operators on Form CPO-PQR.
5. Amendments to Part 50 Clearing Requirements for Central Banks, Sovereigns, International Financial Institutions, Bank Holding Companies and Community Development Financial Institutions.
6. Chairman Tarbert acknowledged that in light of the pandemic, market participants may require additional time to submit comments to these amendments and agreed to review comments received after the comment deadlines if feasible. On April 10, 2020, the Commission's vote (3-2) to extend certain currently open comment periods is available here: https://www.cftc.gov/PressRoom/PressReleases/8146-20.
7. Cboe ceased offering bitcoin futures early last year, and CX-though permitted-never listed bitcoin derivatives.
8. The Commission first offered guidance in an enforcement action (see In re BFXNA Inc. d/b/a Bitfinex, CFTC Docket No. 16-19 (2016), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfbfxnaorder060216.pdf), in which the CFTC indicated that "actual delivery" had not occurred in virtual currency transactions where (1) purchasers' bitcoin was initially held in an omnibus account, (2) the Bitfinex virtual currency exchange exclusively held control over all private keys necessary to transfer out the bitcoin assets, and (3) Bitfinex had not transferred possession and control to the purchasers until all liens were satisfied. As a result, the leveraged bitcoin transactions that Bitfinex permitted customers to engage in were found to be illegal, off-exchange retail commodity transactions.
9. The final interpretive guidance comes a little over two years since its initial proposed interpretation.
10. Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 85 Fed. Reg. 19,878 (Apr. 9, 2020).
11. The CFTC's initial rules had been proposed on October 24, 2019. The Prudential regulators also proposed and released for public comment a rule to the same effect on October 28, 2019, but their final rule has not been published.
12. Press Release, Bank for International Settlements, Basel Committee and IOSCO announce deferral of final implementation phases of the margin requirements for non-centrally cleared derivatives (Apr. 3, 2020), https://www.bis.org/press/p200403a.htm.
13. On April 14, 2020, the Division of Swap Dealer and Intermediary Oversight (DSIO) issued CFTC No-Action Letter 20-14, which extends Letter 19-22 until the effective date of final Commission action.
14. Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 85 Fed. Reg. 27,674 (May 11, 2020).
15. Certain Swap Data Repository and Data Reporting Requirements, 85 Fed. Reg. 21,339 (Apr. 17, 2020).
16. Swap Execution Facility Requirements and Real-Time Reporting Requirements, 85 Fed. Reg. 9407 (proposed Feb. 19, 2020).
17. Real-Time Public Reporting Requirements, 85 Fed. Reg. 21,516 (proposed Apr. 17, 2020).
18. Swap Data Recordkeeping and Reporting Requirements, 85 Fed Reg. 21,578 (proposed Apr. 17, 2020).
19. Amendments to Compliance Requirements for Commodity Pool Operators on Form CPO-PQR, 85 Fed. Reg. 26,378 (proposed May 4, 2020).
20. Capital Requirements of Swap Dealers and Major Swap Participants, 84 Fed. Reg. 69,664 (Dec. 19, 2019).
21. A criminal history background check of the principal or applicant for AP registration is performed and is of a type that would reveal matters constituting statutory disqualification from registration, and it does not reveal any such matters, other than those disclosed in the person's Form 8-R. A person with authority to bind the registrant or applicant for registration listing such principal, or sponsoring such applicant for AP registration, signs and submits a certification that the background check was completed and that it did not disclose any matters that constitute a statutory disqualification. The registrant or applicant for registration listing such principal, or sponsoring such applicant for AP registration, maintains records documenting the completion and the results of the criminal history background check in accordance with Regulation 1.31. Principals and APs of registrants and applicants for registration relying upon this relief submit fingerprints to NFA within 30 days of NFA's public announcement that it has resumed fingerprint processing.
22. The FCM or IB includes a covered loan as a liability on its balance sheet. The FCM or IB creates and retains documentation of the basis of the add-back, including a record of its computation of the Forgivable Expense Amount, a record of costs and payments making up that amount, and a record of any estimate of the limits under Section 1106(d) with the basis of such estimate. The amount of the add-back cannot exceed the balance sheet liability for the covered loan that the firm reasonably expects to be forgiven pursuant to Section 1106, and as such, the add-back amount cannot increase net capital by more than the balance sheet liability for such covered loan. The add-back is reported on line 3070 (Long term debt pursuant to regulation 1.17(c)(4)(vi)) of the Statement of the Computation of the Minimum Capital Requirements of the applicable Form 1-FR-IB or Form 1-FR-FCM, with an explanation on a separate page, provided that IBs and FCMs that are dually registered with the SEC as brokers or dealers may continue to file a FOCUS Report in lieu of a Form 1-FR-IB or Form 1-FR-FCM; and an FCM or IB that files a FOCUS Report reports the Forgivable Expense Amount add-back on line 3525 (Other (deductions) or allowable credits) as directed by the FINRA April 2, 2020, FAQ.
23. If filed by May 15, 2020, or June 15, 2020, respectively.
24. Provided that the annual certified financial statements for its operated commodity pools are filed with the NFA and distributed to pool participants no later than 45 days after the due date. An additional 180-day extension is available.
25. Provided that such statements are distributed to participants within 45 days of the end of the reporting period for all reporting periods ending on or before April 30, 2020.
26. Inclusive of start and end dates.