On December 22 and 23, 2014, the Commodity Futures Trading Commission’s (CFTC’s) Division of Clearing and Risk (DCR) issued extensions of previously granted “no-action relief” to Japan Securities Clearing Corporation (JSCC) located in Tokyo, Japan, and Eurex Clearing AG (Eurex Clearing) located in Eschborn, Germany, respectively. The relief allows JSCC and Eurex Clearing to continue to clear swaps for certain United States persons (US persons) without being registered with the CFTC as derivatives clearing organizations (DCOs).
As discussed in our previous blog post, CFTC staff extends no-action relief – allows four foreign clearing organizations to continue clearing swaps for US persons, the CFTC granted similar extensions of previously granted no-action relief to four other foreign clearing organizations earlier in December. However, unlike these four foreign clearing organizations, which intend to apply to be exempt DCOs, both JSCC and Eurex Clearing have submitted applications to become registered DCOs. In this post, we will describe the specifics of the relief provided to JSCC (DCR Letter No. 14-155) and Eurex Clearing (DCR Letter No. 14-156) and why this relief was necessary.
The need for relief and relief provided
In 2010, the Japanese Financial Instruments and Exchange Act (FIEA) was amended to require the phased implementation of mandatory clearing of certain derivatives. The first phase of the clearing requirements became effective on November 1, 2012 and required certain market participants operating in Japan to clear, among other products, Japanese Yen-denominated interest rate swaps referencing the London Interbank Offered Rate (LIBOR) (JPY LIBOR IRS) through either a licensed domestic or foreign financial instruments clearing organization or a clearing organization that has entered into a linkage with such licensed clearing organization. As of November 1, 2012, JSCC was the only entity that held such a license, and it had no linkage arrangement with any other clearing organization. As such, all market participants operating in Japan that were (and are) required to clear JPY LIBOR IRS must do so through JSCC. This includes certain US persons that operate in Japan through their non-US branches.
On November 29, 2012, the CFTC finalized its first clearing requirement (Clearing Requirement Determination Under Section 2(h) of the CEA; Final Rule), which requires market participants subject to the CFTC’s jurisdiction to clear, among other products, JPY LIBOR IRS through a registered DCO. As a result, certain market participants in the JPY LIBOR IRS market were subjected to conflicting clearing requirements in Japan and the United States. Specifically, the Japanese clearing requirement required them to clear through JSCC while the CFTC’s clearing requirement required them to clear through a registered DCO (and JSCC was not registered as such). These conflicting requirements would have made it impossible for, as an example, a US bank, provisionally registered with the CFTC as a swap dealer, to trade JPY LIBOR IRS though its Tokyo branch. Accordingly, JSCC sought no-action relief from DCR.
DCR provided relief to JSCC on December 17, 2012 (DCR Letter No. 12-56) because JSCC committed to apply for registered-DCO status with the CFTC and in recognition of the following considerations:
- the interplay of differing regulatory regimes with respect to the mandatory clearing of swaps does not discourage clearing;
- it is critical to address potential disruptions to the market and its participants caused by conflicting requirements and/or existing market infrastructure; and
- global migration to a cleared environment will take time.
The relief provided in DCR Letter No. 12-56 was extended on December 19, 2013 (DCR Letter No. 13-73), but was due to expire on December 31, 2014.
In the meantime, JSCC filed a materially complete application with the CFTC to become a registered DCO on February 25, 2014 and submitted supplemental information in response to DCR’s questions concerning the application. In order to address certain differences between US and Japanese law, however, JSCC requested that DCR extend its review of the application and also requested that DCR extend the no-action relief. DCR granted this relief on December 22, 2014.
The conditions of the latest no-action relief granted to JSCC are:
- Clearing activity is limited to swaps in which one or more counterparties to the swap is a JSCC qualified clearing participant or a parent or affiliate of a JSCC qualified clearing participant. Any such party may comply with its obligations under the CFTC’s clearing requirement by clearing its JPY LIBOR IRS swaps through JSCC. No swaps traded by a US customer may be cleared;
- The relief covers (i) any interest rate swap covered by the Japanese clearing requirement; (ii) overnight index swaps, and (iii) JPY Tokyo Interbank Offered Rate (TIBOR) interest rate swaps;
- The no-action relief expires at the earlier of the date on which JSCC registers as a DCO or December 31, 2015; and
- Any JSCC qualified clearing participant that clears a swap that has previously been reported (alpha swap) to a CFTC-registered swap data repository (SDR) must report data regarding the two swaps (beta and gamma swaps) that result from the novation of the swap that has been submitted for clearing.
Germany is a member state of the European Union. Hitherto, there is no clearing requirement in the European Union, so the potential for conflicting clearing requirements has not arisen. However, Eurex Clearing filed an initial application with the CFTC to become a registered DCO on May 17, 2011, which has yet to be granted. While its application is being considered, Eurex Clearing requested that DCR provide no-action relief to allow it to start clearing swaps for certain US persons before it had become registered.
DCR provided Eurex Clearing with initial relief on July 11, 2013 (DCR Letter No. 13-44), noting that it was appropriate to do so in order to promote competition and enhance choice in clearing services for IRS and Index credit default swaps (Index CDS), particularly iTraxx products. As noted earlier in this post, the CFTC’s first clearing requirement was finalized on November 29, 2012 and certain IRS and Index CDS products cleared by Eurex Clearing are among those covered by the CFTC clearing requirement. The relief from DCR Letter No. 13-44 was subsequently extended on March 10, 2014 (DCR Letter No. 14-27).
The relief from DCR Letter No. 14-27 was due to expire on December 31, 2014, but the review period for the CFTC’s consideration of Eurex Clearing’s DCO application was extended to September 30, 2015. Therefore, Eurex Clearing requested a further extension of its no-action relief to maintain the status quo during the pendency of its application for registration.
DCR granted Eurex Clearing’s request on December 23, 2014, subject to the following conditions:
- Clearing activity must be limited to prospective US clearing members in connection with their proprietary (with reference to CFTC Regulation 1.3(y) as to the definition of “proprietary account”) IRS clearing business. No swaps traded by a US customer may be cleared;
- Clearing activity is limited to IRS currently accepted for clearing by Eurex Clearing (identified in the attachment to DCR Letter No. 14-156) for US clearing members;
- The no-action relief expires at the earlier of the date on which Eurex Clearing becomes registered as a DCO or December 31, 2015; and
- Any clearing member that clears a swap that has previously been reported (alpha swap) to a CFTC-registered swap data repository (SDR) must report data regarding the two swaps (beta and gamma swaps) that result from the novation of the swap that has been submitted for clearing.