Community banks and other small financial institutions will not have to post margin for their noncleared swap transactions. On August 1, 2016, the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, and the Farm Credit Administration (the Agencies) announced their final rules exempting banks, savings associations, Farm Credit System institutions, and credit unions with $10 billion or less in total assets (Community Banks) from the margin requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). The Agencies’ final rule exempting Community Banks from the Dodd-Frank Act margin rules codifies a provision attached to the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA).

The Margin Rules

The Agencies and the Commodity Futures Trading Commission (CFTC) have adopted initial and variation margin requirements on swaps not cleared by a central clearinghouse pursuant to Sections 731 and 764 of the Dodd-Frank Act (the Margin Rules). The Margin Rules establish minimum initial and variation margin requirements for bank and nonbank swap dealers when trading swaps with certain counterparties. Under the Margin Rules, there are four separate swap counterparty types: (1) swap dealers; (2) financial end users with material swaps exposure; (3) financial end users without material swaps exposure; and (4) nonfinancial end users. Swap dealers will be required to exchange initial and variation margin from other swap dealers and financial end users with material swaps exposure and to exchange variation margin with financial end users without material swaps exposure. Financial end users generally include depository institutions and other enumerated entities active in the financial industry. Based on the CFTC’s definitions, financial end users could have been required to post initial and variation margin to swap dealers even though depository institutions with $10 billion or less in total assets are afforded relief from the mandatory clearing requirement under the Commodity Exchange Act (CEA).

TRIPRA to the Rescue

TRIPRA amends Sections 731 and 764 of the Dodd-Frank Act so that a Community Bank will not be required to post initial and variation margin if it qualifies for an exemption to the CEA’s mandatory clearing requirements. To qualify for a clearing exception, a Community Bank must (1) qualify for the small-bank exclusion from the definition of “financial entity” in the CEA because it is a depository institution with $10 billion or less in total assets; (2) use swaps to hedge or mitigate commercial risk; and (3) report certain information, including how it generally meets its financial obligations associated with entering into noncleared swaps, to a registered swap data repository. Swap dealers require Community Banks seeking to avail themselves of the clearing exception to make these representations in their swap trading documentation. A Community Bank can make these representations by adhering to the ISDA March 2013 DF Protocol or an equivalent bilateral agreement with its swap dealer.

Next Steps for Banks

Under the Margin Rules, swap dealers and certain large counterparties based in the United States are scheduled to begin exchanging initial and variation margin on September 1, 2016. For financial end users, compliance with the initial margin requirement is phased in annually after this date, while compliance with the variation margin requirement is scheduled to begin as of March 1, 2017.

To serve financial end users such as medium-sized and regional banks that are not swap dealers we published a five-part series summarizing the Margin Rules (based on the CFTC’s proposed rules). Our first installment summarized certain key definitions and the importance of determining status as a “covered swap entity” or “financial end user.” Our second, third and fourth installments in the series addressed collateral requirements, custody and documentation requirements, and margin calculation, respectively.

Our final installment reviewed certain cross-border aspects and recommended action points for financial end users.  In that installment we summarized the cross-border regimes proposed by the CFTC and finalized by the U.S. banking agency “prudential regulators” in their joint final rule governing noncleared swaps margin, adopted on October 22, 2015. We concluded with a cross-jurisdictional survey of key provisions in certain noncleared derivatives Margin Rules, including those proposed in Canada and Europe, along with recommended action points for financial end users.