With the next 10 days being crucial in the Brexit process, following the UK House of Commons rejecting the draft withdrawal agreement for a third time and the European Council calling an emergency summit for April 10, 2019, the Commodity Futures Trading Commission (“CFTC”) and the US banking, farm credit and housing agencies have issued interim final regulations to address regulatory requirements of certain swap transactions subject to US regulations in the event of a non-negotiated withdrawal of Britain from the EU, sometimes referred to as a “hard” Brexit. These interim final rules would take effect only if a hard Brexit occurs.
Under regulations (the “Swap Margin Rules”) adopted by the CFTC and federal banking, farm credit and housing agencies (the “Agencies”), swap dealers and security-based swap dealers under the Agencies’ respective jurisdictions are required to exchange margin with their financial counterparties for swaps not otherwise centrally cleared (“uncleared swaps”). You can access previous blog posts on the Agencies’ Swap Margin Rules here and here.
Dates for required compliance with the Swap Margin Rules are being phased in over a 4 year period between September 1, 2016, and September 1, 2020. Dealers are permitted to maintain in their portfolio swaps that were entered into prior to the effective date for that swap (referred to as “legacy” swaps) until they expire in accordance with the terms of the swap. These uncleared legacy swaps generally are not subject to the margin requirements under the Swap Margin Rules.
Under the regulations, however, certain changes could be made to the legacy swap that may cause it to lose its legacy treatment under the Swap Margin Rules. The Swap Margin Rules also allow certain changes that would not cause the swap to lose its legacy status; for example an amendment to the swap agreement in order to comply with the QFC mandatory stay provision regulations. When the Agencies adopted the final Swap Margin Rules, they declined (as explained here and here) to provide a more general exemption for other novation or amendment of a legacy swap.
The Brexit effect
There are UK financial services firms, such as CFTC-registered swap dealers, that conduct swap dealing activities subject to the Swap Margin Rules. One of the consequences of a hard Brexit could be the inability of a UK financial services firm to continue to provide those services in the EU under the current EU “passporting” regime that allows financial entities in the EU to engage in regulated financial activities in any country in the EU. If passporting no longer is available, some UK financial services firms may need to transfer their swaps with EU counterparties to an affiliate or other firm located in the EU or the United States. Affected dealers, however, were concerned that such a transfer could cause the transferred legacy swap to lose its legacy status and become subject to the margin requirements under the Swap Margin Rules.
In order to provide some certainty on this point, the Agencies’ interim final amendments to their respective Swap Margin Rules provide that a transfer of a legacy UK-EU swap by a UK firm to an EU or US affiliate or other firm would not cause the swap to lose its legacy status, provided certain conditions were met, including that the transfer was solely in connection with a Brexit without a negotiated withdrawal agreement between the UK and the EU, and there were no amendments to the swap’s notional amount, payment amount calculation method and maturity date.
More information on Brexit may be found on our Inside Brexit blog.