As the US and much of the world faces a Black Swan event in the form of the COVID-19 pandemic, Commodity Futures Trading Commission (CFTC) chairman Heath Tarbert today announced a one year extension for larger entities facing compliance with initial margin (IM) requirements for uncleared swaps, making the new compliance date September 1, 2021 for Phase 5.
Two months ago, the Commission voted to extend the IM compliance schedule for those entities with the smallest swaps portfolios. That extension split Phase 5 of the schedule in two, creating a new Phase 6 composed of entities with swaps portfolios between $8 billion and $50 billion in average aggregate notional amount (AANA).
The Commission deferred the compliance deadline for entities in this new Phase 6 for one year. In his statement, Tarbert notes that this was due to the complex operational burdens these entities will face and the fact these entities account for less than 3% of total uncleared swaps AANA. Phase 5, which comprises larger entities with swaps portfolios of $50-750 billion in AANA, remained subject to the prior compliance deadline.
“These timelines did not factor in the most severe economic downturn the world has witnessed since the Great Depression,” said Tarbert in a statement. “Today we are doing so. Accordingly, I support our interim final rule (IFR) deferring the compliance date for the Commission’s initial margin requirements for uncleared swaps in response to the coronavirus pandemic. This rule would provide a one-year extension for Phase 5 entities, which would otherwise become subject to initial margin requirements in just three months, on September 1, 2020. I believe issuing this IFR is appropriate from both a substance and a process perspective.”
Explaining his position, Tarbert noted that economies across the world have largely shut down in response to social distancing needs. Market volatility has reached historic levels and financial firms have been forced into a near total remote working situation. “These extraordinary market conditions and operational shifts demand that financial firms – including those regulated by the CFTC – devote an inordinate amount of time and resources to day-to-day operational, business continuity and risk management efforts,” he said.
Preparation for compliance with IM requirements requires procuring compliant documentation; setting up custodial arrangements; and establishing internal processes for the calculation, collection, and posting of initial margin, among other things, he explained. “These steps are both time intensive and resource intensive,” Tarbert said. “For many firms, the intense effort necessary to meet the imminent compliance deadline would divert focus and resources from their respective coronavirus responses. Moreover, working from home has made it difficult to access required legal and operational documentation and communicate with counterparties.”
Recognising these concerns, he noted, the Basel Committee on Banking Supervision and International Organization of Securities Commissions have jointly extended their initial margin compliance schedule. Several BCBS/IOSCO members have already taken steps to implement this relief.
“As I have said before, the CFTC’s margin rules are a key systemic risk mitigant,” he added. “However, the market participants receiving an extension under this IFR have some of the smallest uncleared swaps portfolios. Indeed, Phase 5 entities collectively represent only 8% of total AANA across all margin phases.
“We must balance the critical need to marshal scarce operational resources for pandemic response against the relatively small risks posed by a one-year compliance delay. The circumstances here weigh clearly in favour of being consistent with our international counterparts in granting the extension.
Tarbert also explained that extenuating circumstances lead him to believe that prior notcie and comment, as per usual processes, is not an ideal regulatory vehicle. Therefore, he explained, providing a public comment period before issuing the extension would be both impracticable and contrary to the public interest.
“Challenges related to the coronavirus pandemic have already become dire,” he said, “and because the current deadline for Phase 5 firms is only three months away, initial margin preparation demands are extremely pressing right now. If we opened even the shortest permissible comment period and incorporated those comments into a final rule, any relief issued likely would already be moot. Although we are soliciting comments on the IFR, we believe that Phase 5 entities need relief that is effective now in order to maintain focus on the real business continuity and risk-management issues they are facing today.”
By contrast, because the Phase 6 compliance date is not until September 2021, the CFTC will address an extension for Phase 6 through the traditional notice-and-comment rulemaking process, he added, promising to provide clarity and certainty “in the very near term”.