CFTC chairman asks FRB to issue guidance on implementation of impending Phase Five margin requirements

By Brad Rosen, J.D.

In a letter to Federal Reserve Board Vice Chairman Randal Quarles dated April 29, 2019, CFTC Chairman J. Christopher Giancarlo laid out a number of significant issues concerning the “Phase Five” implementation requirements for initial margin on uncleared swaps which are scheduled to take effect in September 2020.

New requirements will impose significant costs on smaller firms. Giancarlo explained in the letter that, “As market participants prepare for Phase Five, many of the smaller entities are realizing that, while their notional amounts exceed $8 billion, their calculated margin amounts are less than $50 million.” Identifying the central problem, Giancarlo noted these firms “will soon be required to incur the time and expense of preparing to exchange initial margin even though they will not be required to exchange margin.”

Under the current uncleared margin rules, swap market participants do not have to exchange initial margin unless the calculated amount of margin exceeds $50 million. Additionally, entities with a notional amount of swaps of less than $8 billion are out of scope of the rules. As a consequence, they do not have to establish custodial services, document margin relationships, or operationalize margin exchange.

Chairman’s recommendations. Giancarlo noted the agency’s Office of Chief Economist (OCE) and Division of Swap Dealer and Intermediary Oversight (DSIO) had analyzed market data in response to domestic and international concerns that many small market participants will be brought into scope in the Phase Five implementation. Based on this analysis, Giancarlo made the following specific recommendations:

• U.S. regulators issue regulatory guidance clarifying that a U.S. regulated entity need not have in place systems and documentation to exchange initial margin on uncleared swaps with a given counterparty if its calculated bilateral initial margin amount with that counterparty is less than $50 million; and,
• Global regulators further engage with the Basel Committee on Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO) to reflect in global principles its recent confirmation that the implementation framework does not specify documentation, custodial, or operational requirements if the bilateral initial margin amount does not exceed the framework's €50 million initial margin threshold.

Consternation over Phase Five abounds. At a recent meeting of the CFTC’s Global Risk Advisory Committee (GMAC), regulators and industry participants alike expressed their consternation and concerns over potential negative consequences associated with implementing the Phase Five requirements during a panel dedicated to the topic. During the meeting, it was noted that:

• The International Swaps and Derivatives Association (ISDA) estimates Phase Five will bring 1100 entities into the scope, compared to only 34 for Phases One through Three;
• Entities impacted by Phase Five are concentrated around the low end of the threshold, especially entities involved in non-financial activities; and,
• Concerns abound around administrative congestion, as each new swap relationship will require investment manager documentation, custodial relationships, and the demand for high quality collateral. 

In his letter, Chairman Giancarlo concluded that uncleared margin rules in the U.S. clearly recognize that small market participants should be granted some form of relief from initial margin requirements. He noted, “This is because small entities contribute little to systemic risk, and would, in any case, exchange only small amounts of initial margin.”