On 13 October 2017, the CTC and the EU announced substituted compliance determinations in respect of margin requirements for OTC derivatives. The determinations accept that the CFTC’s Final Margin Rule and EMIR’s risk mitigation and margin requirements are sufficiently comparable on a substantive outcomes basis. For those interested in reading the full text, we recommend the 6 page EU Implementing Decision, those with time to spare can find the 80 page CFTC version here. They cover the same substantive points, which are handily summarised below:
- Regulations in respect of operational risk mitigation techniques are judged to be fully equivalent:
- the frequency and thresholds for portfolio reconciliation;
- the deadlines for timely confirmation;
- requirements for portfolio compression on a ‘comply or explain’ basis;
- requirements for daily valuation of non-cleared transactions
- Differences exist in respect of dispute resolution procedures, but equivalence has been granted as they are they are judged to be of limited impact
- In-scope entities- IM thresholds of 8bn. EUR/USD are judged equivalent. No materiality threshold in the EU for VM
- VM/IM MTA- the EUR/USD 500,00 combined MTA is judged equivalent
- In-scope transactions- substituted compliance is granted to all transaction that are regulated in common by both jurisdictions. Note- Forward Foreign Exchange and physically-settled FX Swaps are therefore excluded from equivalence. Specific EU treatments for covered bonds are similarly unequal
- Initial Margin Calculations- the use of the SIMM or approved internal models and associated confidence levels, MPOs, historical data periods and stress amounts are judged equivalent
- Eligible Collateral- possible collateral elections, segregation arrangements and concentration limits are judged equivalent
Regulations with respect to professional secrecy and effective supervision and enforcement are judged to be equivalent. Each aspect of the determination is subject to mutual monitoring which may lead to repeal in part or whole.
Equivalence is already in force on the US side and will take effect from 3 November 2017 in the EU. It should be noted that the determination applies only to covered swap entities under the CFTC’s jurisdiction. Larger US firms under Prudential Regulation will not benefit.
The CFTC’s Chairman Giancarlo greeted the decision as a “significant milestone in cross border harmonization” and accordingly thanks all involved. Given that both regimes are closely in accord with the original BCBS guidelines and significant areas remain excluded; even allowing for European bureaucracy and the CFTC’s recent lack of Commissioners, it is difficult to see why the determination took so long. If equivalence had been granted prior to the onset of phase 2 VM CSA negotiations, the market might have at least achieved respectable compliance numbers by the deadline. The decision pays scant heed to transfer timing, a transatlantic discrepancy that was resolved by a semantic compromise with respect to “initiation”. More significantly, the determination excludes Forward FX and FX Swaps, two product types which are currently spurring VM CSA renegotiation and amendment in time for the 3 January deadline. While it is vanishingly unlikely that the EU would be able or willing to re-legislate to “de-EMIR” these in time for the deadline; rumours abound that ESMA will make it clear(ish) that enforcement will be less strict. Although, it seems likely that remaining EU FFX liquidity will move rapidly westwards early in the New Year, affected counterparties should not rely on a rumoured Regulatory fudge.