Dodd-Frank Update: Non-Cleared Swap Collateralization is here, sort of!

On September 1st, 2016 the CFTC issued a No Action Relief Letter that extends the date that the CFTC will enforce compliance with Non-Cleared Swaps Collateralization regulations that also went into effect on September 1st, 2016. The No Action period lasts 30-days.

Collateralization, or bi-lateral margining, of non-cleared swaps is long debated Dodd-Frank regulation designed to provide security to mitigate  risks of a systemic credit collapse due to performance default on Swap transactions. The rule largely impacts transactions between Swap Dealers. Essentially, counterparties are required to post initial and, in some cases, maintenance margin with their transaction counterparty when Swaps are not cleared with a Designated Clearing Organization (DCO). To encourage clearing, bi-lateral collateral requirements for non-cleared swap margining is typically much higher than clearing through a DCO and the counterparties do not have the advantage of netting across counterparties.

As a No Action Relief Letter, it is expected Swap Dealers will demonstrate focused effort and integrity to implement, test and enforce compliance with these regulations during this 30-day period. It is not to be deemed a postponement.

Press Release:

No Action Letter:

Lack of Institutional Readiness

This Letter of No Action appears to be triggered by issues related to industry-wide readiness, and not by alignment of cross-border regulations. Though, CFTC leadership addresses both.

In a public statement, CFTC Chairman Massad, specifically, attributes the main driver to smaller financial institutions and foreign entities that are lagging putting in place and testing custodial arrangements due to the abundance of related activity, bandwidth of personnel and few providers of custodial services.

Chairman Massad Statement:

Industry Fear of Non-Compliance

Pivotal Risk Advisors notes, that for some registered Swap Dealers concerns with continuity and adequate testing of transaction data,  reporting, and cross-institution collateralization processes is also a challenge.

Recently sanctions were placed on Deutsche Bank AG by the CFTC for non-compliance of Dodd-Frank reporting regulation. According to the CFTC summary and Deutsche Bank statements, non-compliance was largely driven by reoccurring technology failures. As a result, there are industry-wide concerns that regulators will allow very little forgiveness while the kinks of complying with untested rules are being worked out. Compliance with non-cleared swap margining will require complex data structures, new processes, regular bi-lateral or custodial financial transfers and regular reporting – of which, because regulatory standards are new, there are few tested or accepted industry best practices.

Regulatory risks lie deeper than the high cost of non-compliance. Despite small dollar value of the fines, loss of workforce time, costs of preparing an investigative response and investment in after-care is an additional strain on resources to provide leadership, troubleshoot issues and invest in more adequate solutions. Failure puts not only dollars at risk, but theoretically, “the license to operate.”

Press release regarding Deutsche Bank sanctions:

Risk of Regulatory Arbitrage

Despite this Letter of No Action, CFTC Commissioner Giancarlo voiced frustration that US regulators have chosen not to delay enforcement, unlike their non-US counterparts, who have recently delayed the mutually agreed coordinated effort due to global readiness. Commissioner Giancarlo particularly cites disappointment of the choice of “sticking to an arbitrary deadline (rather) than the health of American markets and American market participants.”

Pivotal Risk Advisors agrees that U.S. financial institutions and, most importantly, the businesses they serve, can be at a great disadvantage during the indefinite period when only U.S. markets are required to comply with non-cleared swap margining regulations. Uncoordinated global regulations can result in higher U.S. transaction costs, wider bid-ask spreads, and lower transaction liquidity by creating regulatory arbitrage as transactions go overseas. The end result will be less hedging transactions by commercial participants and/or a flight to lower cost markets with less regulations and deeper liquidity.

Pivotal Risk Advisors also notes that lack of coordination across regulators creates significant continuity issues in transaction data retention and resource constraints as a result of a lack of continuity between global compliance processes for Swap Dealers. There will be additional challenges of processing similar transactions under many different or contrary regulations.

Commissioner Giancarlo’s Statement:

Readiness is Paramount

Given recent regulatory events cited in this summary, Pivotal Risk Advisors believes it is important Swap Dealers and even the those that deem themselves “end-users” pay close attention to non-cleared swap transaction documentation, record keeping, potential collateral exposure monitoring, process design and shadow reporting to assure they are adequately prepared to mitigate regulatory compliance risks in the event of a sweeping data request and counterparty performance failure.

Pivotal Risk Advisors works with clients to improve regulatory compliance readiness and integrated risk management in an efficient manner that is appropriate for each entities unique business objectives, risk tolerances and operating models.

For more information about Pivotal Risk Advisor’s consulting services, please contact Sid Jacobson at

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