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Many of the transactions involving qualified financial contracts
(“QFC”) with Silicon Valley Bank (“SVB”)
and Signature Bank constitute Commodity Futures Trading Commission
(“CFTC”) jurisdictional transactions that may be
affected by recent SVB and Signature Bank failures. Note that under
the authority of the Federal Deposit Insurance Act
(“FDIA”) practically all obligations and transactions
with SVB and Signature Bank have been transferred to new entities
that are not in Federal Deposit Insurance Corporation
(“FDIC”) receivership: Silicon Valley Bridge Bank, N.A.
(“SVB Bridge”) and Signature Bridge Bank, N.A.
(“Signature Bridge”), respectively. Below we briefly
discuss these practical CFTC-related implications.
1) Which contracts and transactions are subject to the
CFTC’s jurisdiction?
a) Commodity Spot and Deliverable Forwards. For all
QFCs involving “commodities,” which include foreign
exchange (“FX”), cryptos, broad-based security indices,
credit events, interest rates, gold, energy, etc. (but not
securities), the CFTC has anti-fraud and anti-manipulation
jurisdiction. This means that any counterparty to these trades must
act reasonably and not engage in fraudulent activity, such as
insider trading or cornering the market no matter what the market
conditions are. Typically these QFCs are traded on
“spot” (e.g., deliverable within 2 business
days) or on deliverable forward basis between commercial
participants in their line of business.
b) Commodity Derivatives. QFCs qualifying as commodity
swaps, options on swaps, futures, or options on futures are
considered derivatives over which the CFTC has exclusive
jurisdiction, meaning that the CFTC can proscribe the rules how
these transactions are executed, reported, documented, who can
trade them, and where and how. This category also includes swaps
that are required to be cleared and traded (e.g., interest
rate and credit default swaps) as well as those that are not so
required.
c) FX Contracts. These QFCs fall into the above
categories, with one exception – foreign exchange forwards
(“FXF”) and foreign exchange swaps (“FXS”)
that are exempted from some of the CFTC regulations. Therefore, FX
QFCs may include: (a) spot and deliverable forward FX contracts,
(b) FXF and FXS, and (c) cross-currency swaps and all other
FX-related swaps and options, including non-deliverable forwards
(“NDFs”).
d) Scope. In reviewing your transactions with SVB
Bridge and Signature Bridge, you need to specifically classify the
type of transactions you have with these counterparties because
CFTC regulatory implications with each will be different. Note that
a similar analysis would need to be conducted for security-based
swaps (“SBS”) under Securities and Exchange Commission
(“SEC”) regulations.
2) What commodity derivatives are impacted?
a) Commodity Futures. Futures and options on futures
are executed on an exchange (“DCM”) and cleared through
a derivatives clearing organization (“DCO”). Even if
SVB or Signature Bank were initially counterparties to any of the
futures trades, the DCO and exchanges will be working directly with
SVB Bridge and Signature Bridge, and no counterparties will be
affected. Likewise, all National Futures Association
(“NFA”) members trading with these bridge banks, such
as futures commission merchants (“FCMs”), introducing
brokers (“IB”) or commodity trading advisers
(“CTAs”), will need to review and update their
documentation, such as FCM, IB or CTA agreements.
b) Commodity Swaps. Any over-the-counter
(“OTC”) swap that has not been cleared through a DCO
and that had SVB or Signature Bank as a counterparty will be
affected – this includes all commodity swaps and options.
Likewise, all commodity swaps with SVB and Signature Bank executed
through a swap execution facility (“SEF”) or a DCO will
be affected.
3) How are swaps specifically affected?
a) Reporting – Modifications, Transfer and
Terminations. As a result of the FDIC receivership, the
counterparty to the swap has changed – it is no longer SVB or
Signature Bank, but SVB Bridge and Signature Bridge, respectively,
and any swap or an option would have been transferred to the
relevant bridge entity by the FDIC. Part 45 of the CFTC regulations
requires that a reporting counterparty (usually a swap dealer) send
a report of a “life-cycle” event to the swap data
repository (“SDR”) regardless of whether the swap was
executed OTC or through a SEF/DCM. A life-cycle event includes a
“counterparty change resulting from assignment or novation, a
partial or full termination of the swap; a change to the end date
for the swap; a change in cash flow or rates originally reported;
availability of legal entity identifier for a swap counterparty
previously identified by some other identifier; or a corporate
action affecting a security or securities on which a swap is based
(e.g., merger, dividend, a stock split or
bankruptcy).” Part 45.1. Therefore, at a minimum, a reporting
counterparty will need to send a report of the change of the
counterparty identity from SVB or Signature Bank to the relevant
bridge bank. The report must be sent to the SDR no later than the
end of the second (2nd) business day of the occurrence of the event
(i.e., Wednesday, March 15, 2023). It does not matter that the
counterparty had changed as a result of the FDIC receivership
(i.e., without your consent). If a transaction is
terminated before the original term (e.g., on a consensual
basis or as a result of the exercise of an early termination right
by a counterparty), that would also constitute a life-cycle event
and will need to be reported to an SDR.
b) Reporting – Bridge Banks’ Perspective.
In the event that a QFC reporting counterparty was SVB or Signature
Bank (which would be the case if their counterparty was a
non-financial entity or a financial end-user), this regulatory
obligation will transfer to the bridge banks along with the QFCs.
Therefore, it would remain SVB Bridge’s and Signature
Bridge’s obligation to make the required reports under Part
45 of CFTC regulations (and Part 43 if applicable). According to
FDIC’s March 14, 2023 financial institutions letter, Tax
Identification Numbers, accounts details and pre-failure
identification should remain in effect; presumably, legal entity
identifiers (“LEIs”) used for swaps reporting should
also remain active.
c) Clearing Issues. In addition to reviewing and
assessing each transaction, it is necessary to assess the status of
the successor entity – the bridge bank. All clearing
determinations will need to be made for the successor bridge
entity, although, most likely, the outcome will be the same. Same
considerations would apply for third-party entities that will be
clearing these swaps.
d) Uncleared Margin Issues. Similarly to clearing, all
decisions relating to uncleared swaps also will need to be made
with respect to initial and variation margin.
4) Are there swap dealer unique requirements?
a) External Business Conduct Standards. Registered swap
dealers must follow Part 23 of the CFTC regulations. All of these
rules remain applicable, including reporting, disclosure,
documentation, know your customer, suitability, etc. For example,
if an old trade with SVB was terminated, and a new trade with SVB
Bridge was negotiated as a separate trade, then the swap dealer
will need to provide mid-market marks (and then daily marks) under
CFTC regulation 23.431 to SVB Bridge.
b) Receivership. Note that the transfer to a new entity
(e.g., a bridge bank by the FDIC) does not qualify as an
execution of a new transaction, and therefore it is not necessary
to provide mid-market marks to the bridge bank for transferred
trades.
5) What other considerations should we keep in mind?
a) Compliance Policy. First and foremost, you need to
act reasonably, in good faith and consistently with your compliance
policies and procedures as well as the documentation executed with
SVB and Signature Bank that is now transferred to the bridge
bank.
b) ISDA Documentation. There are numerous
documentation-related matters that ultimately will need to be
worked through, including the review of ISDA’s 2018
Resolution Stay Protocol’s applicability, or a review of the
transfer or downgrade provisions. Note that because of the stay of
termination and the transfer of QFCs to the bridge banks that are
not in receivership, there are currently no actionable events of
default or termination rights unless there is another separate
default (or a default arises in the future).
c) Looking Forward. During the time of market
instability, companies trading CFTC-jurisdictional contracts are
well advised to take the following steps:
- clearly identify all CFTC-jurisdictional (and other)
transactions with your counterparties (e.g., are these
commodity products or securities products); - clearly identify and assess from the regulatory perspective the
types of transactions you have (e.g., whether these are
spots, forwards, futures, options on futures, cleared or uncleared
swaps, OTC options, FXF and FXS, NDFs, etc.); - clearly identify all regulatory obligations related to these
transactions (e.g., who is required to conduct the
reporting, documentation, monitor position limits, post and collect
margin, facilitate the clearing of these transactions, maintain the
collateral, etc.); - verify your counterparty’s regulatory status
(e.g., if they are a registered or a de minimis swap
dealer, a CTA, FCM, IB or any other regulated entity such as a
broker dealer regulated by the SEC); - assess the impact of any potential regulatory or enforcement
action on your counterparty (e.g., by the SEC or U.S.
Department of Justice); and - assess the efficacy of your internal disaster recovery and
business continuity programs, and create a detailed plan of action
in the event your counterparty fails or you have reasonable grounds
for insecurity.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
