ISDA and FIA weigh in on proposed Volcker Rule changes

By Brad Rosen, J.D.

The International Swaps Dealer Association (ISDA) and the Futures Industry Association (FIA) were two of 60 interested parties that recently submitted comment letters in response to proposed amendments published earlier this year by the SEC, the CFTC, and banking regulators (the “Volcker Agencies”) that would modify the language of the Volcker Rule’s prohibition on many forms of proprietary trading. ISDA’s comments centered around the theme that that the Volcker Rule should be revised to focus on its core purpose—prohibiting short-term speculative proprietary trading.

Meanwhile, FIA’s comments focused on the principal captured in the proposed amendments clarifying that FCM clearing services to covered funds is not the type of activity that was intended to be prohibited under the Volcker Rule. Public comments on the proposal were originally due September 17, 2018 but the time for submission was extended into October.

ISDA comments aimed at avoiding unnecessary interference in using derivatives. ISDA’s comments focused around eight points aimed at avoiding a final rule that would unnecessarily interfere with the ability of banking entities to use derivatives to engage in underwriting transactions, market-making related activities, and risk-mitigating hedging transactions. These eight points are as follows:

1. The “accounting test” set forth in the Proposal should not be implemented. This test, which captures all financial instruments recorded at fair value on a recurring basis under applicable accounting standards, is thought to exacerbate over-inclusive scoping problems, be inconsistent with the statute, and entail further unintended consequences.
2. All derivatives entered into hedge long-term liabilities, and investments in and cash flows from affiliates, should be excluded from the trading account definition.
3. The Volcker Agencies should expand the list of derivatives covered by the liquidity risk management exception and remove unnecessary and prescriptive compliance requirements from the liquidity risk management exception.
4. The Volcker Agencies should ensure that any final rule promotes and does not further prohibit or restrict the ability of banking entities to provide underwriting and market-making related services, and to engage in risk mitigating hedging activities.
5. ISDA supports those aspects of the proposal that would allow a banking entity to acquire an interest in a covered fund as a risk-mitigating hedge in connection with derivatives related to the covered fund.
6. ISDA supports the proposed revisions to the definition of “trading desk."
7. Trading derivatives in connection with U.S. and foreign government and agency securities should be permitted without further restriction.
8. ISDA supports the efforts of the Volcker Agencies to improve the TOTUS (trading outside the United States) exemption. 

FIA seeks regulatory clarity. In its comment letter, the FIA indicated its support of those provisions of the proposed amendments which are intended to clarify the activities in which banking entities may engage that are prohibited under applicable regulatory rules. Among such activities identified in the Federal Register release accompanying the proposed amendments are clearing services provided by FCMs to covered funds for which affiliates of the FCM are engaged in the services identified in CFTC Rule 75.14(a). This includes serving, directly or indirectly, as the investment manager, investment adviser, commodity trading advisor, or sponsor to the covered fund.

FIA noted that in 2017 the CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO) issued a no-action letter to an FCM in which the DSIO stated that it would not recommend that the CFTC take an enforcement action against the FCM, if the FCM were to provide clearing services to a covered fund notwithstanding Commission Rule 75.14(a). FIA also indicated that the Volcker Agencies have indicated its desire to extend the stated no-action relief all FCMs that provide futures, options and swaps clearing services to customers of affiliates. The other agencies further recognized that FCM clearing services to covered funds do not appear to be the type of activity that was intended to be limited under the Volcker Rule.

The FIA also asserted that modifications called for in the proposed amendment would enhance risk management efficiencies, as well as providing greater legal certainty to the market than would a simple extension of the existing no-action relief. Accordingly, FIA favors an amendment to Rule 75.14, which would specifically authorize an FCM to provide clearing services with respect to covered funds.