U.S. swap dealer banks received much needed breathing room, but not complete relief from the March 1, 2017 variation margin (VM) deadline for swaps and security-based swaps. On February 23, 2017, the Federal Reserve Board (FRB) and Office of the Comptroller of the Currency (OCC) recognized that, considering the scope and scale of documentation and operational changes necessary for swap dealer banks to achieve effective compliance for each of its non-cleared swap transactions, FRB and OCC examiners will focus on the bank’s good faith efforts to comply with the VM requirements, as soon as possible, but in no case later than September 1, 2017.

Significant Exposures

However, for swap counterparties that present significant exposures, the FRB and OCC expect swap dealer banks to be full compliance with the VM requirements by March 1, 2017. The FRB and OCC didn’t define what may constitute significant exposures.  For swap counterparties without significant exposures, the FRB and OCC expect swap dealer banks to make good faith efforts to comply with the final rule by September 1, 2017.  Swap dealer banks should prioritize compliance efforts based on the size of and risk inherent in the credit and market risk exposures presented by each counterparty.  Furthermore, banks must establish governance processes that assess and manage their current and potential future credit exposure to non-cleared swap counterparties, as well as any other market risk arising from such transactions.   The FRB and OCC indicated that their examiners will consider the bank’s implementation plan, including actions taken to update documentation, policies, procedures and processes, as well as its training program for staff on how to handle technical problems or other implementation challenges.

Impact on the Buy Side

The FRB and OCC announcement is important because the largest swap dealers are affiliated with U.S. banking institutions and most counterparties should not present significant exposures to banks affected by the guidance. While the FRB and OCC elected not to provide complete relief, the bank regulatory announcement is critical because the six-month VM rule grace period from the Commodity Futures Trading Commission only covered smaller non-bank and energy swap dealers.  Hopefully, European and Canadian regulators will follow their colleagues in the United States, Australia, Singapore and Hong Kong in postponing their VM deadlines to September 1, 2017.  Without global coordination of VM rules and deadlines, market participants could suffer from decreased liquidity and market fragmentation.  To prevent such trading disruptions, financial end users and other buy-side counterparties must continue to work diligently to establish VM compliant documentation with their dealers as soon as possible.