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At the end of last month, the Financial Conduct Authority’s (FCA) request for comments officially came to a close on the Consultation Paper (CP24/14) it published in late July seeking comments on proposed changes to the derivatives trading obligation (DTO) and post-trade risk reduction services (PTRRS).

The DTO requires certain financial and non-financial counterparties to conclude transactions in specific standardised and liquid OTC derivatives (as selected by the FCA) on regulated trading venues or equivalent third country venues only. PTRRS encompass a variety of services which enable market participants to reduce non-market risks arising from their existing positions and can often involve the creation of contracts which fall under the DTO.

The stated aim of the proposals is to improve the UK’s regulation of derivative secondary markets, reduce systemic risk in derivatives markets and avoid fragmentation and disruption for firms trading over-the-counter (OTC) derivatives subject to the DTO.

Based on the responses received, the FCA intends to publish its direction on the modification of the DTO at some point this quarter. As we wait for the results, here is a brief recap of the proposed changes:

Key Proposals

The Consultation Paper includes proposals on three distinct but interconnected aspects of the DTO:

1. Inclusion of SOFR OIS in DTO

Driven, in large part, by the global transition from LIBOR to risk-free rates, the FCA proposes to include certain overnight index swaps based on the US Secured Overnight Financing Rate (SOFR) (i.e. interest rate swaps referencing SOFR) within the classes of derivatives subject to the DTO. This follows the Bank of England’s inclusion of SOFR OIS under its clearing obligation and the US CFTC’s trading mandate for these instruments.

The FCA intends to implement these changes by amending the UK regulatory technical standards which contain the DTO (onshored Commission Delegated Regulation (EU) 2017/2417) to bring these derivative instruments in-scope.

2. Expansion of PTRR Services Exemptions

The FCA proposes to expand the list of PTRR services exempted from the DTO, to support firms’ risk management practices and to reduce systemic risk in financial markets.

The proposals include extending the exemption for portfolio compression to portfolio rebalancing and basis risk optimization, two widely used risk reduction services.

The Consultation Paper also sets out the characteristics that risk reduction services would need to satisfy for trades used to conduct them to be eligible for exemption. In addition, it seeks to  require providers of PTTR services to comply with new disclosure and notification obligations.

3. Power to Suspend or Modify DTO

Lastly, the proposal outlines how the FCA intends to use its powers to suspend or modify the DTO. These are currently contained in temporary transitional powers (TTP) under Part 7 of the Financial Services and Markets Act 2000 (Amendment) (EU Exit) Regulations 2019, but they expire at the end of this year on 31 December 2024.

The FCA was granted a new power to suspend or modify the DTO pursuant to The Financial Services and Markets Act 2023, which inserted Article 28a into the onshored Regulation (EU) No 600/2014 on Markets in Financial Instruments Regulation, if it considers it necessary for the purpose of preventing or mitigating disruption to financial markets and advancing one or more of its operational objectives.

The Consultation Paper sets out the ways in which the FCA intends to use these powers in a similar way it used the TTP, with the aim of preventing market fragmentation and disruption for firms trading OTC derivatives subject to the DTO. They will repeat an existing direction that allows firms subject to the DTO to trade with, or on behalf of, EU clients subject to the DTO on EU venues, provided that certain conditions are met.

Key Stakeholders

These proposals are likely to impact a number of stakeholders, including:

  • Providers of PTRR services
  • Trading venues that admit to trading or trade derivatives
  • Investment firms and banks dealing in derivatives
  • UK branches of overseas firms undertaking investment services and activities

The proposals are also of interest to Approved Publication Arrangements (APAs), central counterparties (CCPs), law firms, consultancies and their related trade associations.

Next Steps

The FCA’s call for comments on the proposals recently came to an end on 30 September 2024. Based on the responses, the FCA will finalize the draft rules, guidance, technical standards, and policy statement, with the direction on the modification of the DTO expected to be published over the next few months. Stay tuned for further updates and, in the meantime, the Consultation Paper can be viewed here and the full text of the proposed draft amendments can be found in Appendix 1.

Man Watching through window blinds

Unfortunately, based on a reputation for being somewhat boiler-plate, notice provisions are often not given the care and attention in negotiations they deserve. In practice, however, notice provisions are crucial – if they are incorrect or service of notice is impossible, you cannot enforce your rights. For the derivatives market, ISDA has proposed an innovative technological solution called the Notices Hub to keep notice provisions up-to-date, and to allow effective service of notice even in times of stress.

Read more about it in Mayer Brown’s recent derivatives/litigation Legal Update.

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Artificial intelligence (AI) is transforming the financial industry, and the derivatives market is no exception. A new whitepaper from ISDA Future Leaders in Derivatives (IFLD), a professional development program for emerging leaders in the derivatives market, explores the potential use of generative artificial intelligence (GenAI) in the derivatives markets. GenAI is a branch of AI that can create novel data, such as text, images, audio and video, based on existing data and algorithms.

The whitepaper, “GenAI in the Derivatives Market: a Future Perspective”, was developed by the third cohort of IFLD participants, who began working together in October 2023. The 38 individuals in the group represent buy- and sell-side institutions, law firms and service providers from around the world, including Robyn Llewellyn from Mayer Brown. After being selected for the IFLD program, they were asked to engage with stakeholders, develop positions and produce a whitepaper on the topic of GenAI in the derivatives market. They were also given access to ISDA’s training materials, resources and staff expertise to support the project and their own professional development.

The whitepaper identifies a range of potential use cases for GenAI in the derivatives market, including document creation, market insight and risk profiling. It also explores regulatory issues in key jurisdictions and addresses the challenges and risks associated with the use of GenAI. The paper concludes with a set of recommendations for stakeholders, such as investing in talent development, fostering collaboration and knowledge sharing with technology providers, prioritising ethical AI principles and engaging with policymakers to promote an appropriate regulatory framework.

Mayer Brown is proud to have contributed to this whitepaper, which provides a valuable insight into the future development of GenAI in the derivatives market. We congratulate the IFLD participants for their achievements and look forward to continuing our involvement in the IFLD program and supporting ISDA’s initiatives to make the global derivatives markets safer and more efficient.

*GenAI assisted in the preparation of this blog post.

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Crypto is booming again. Are you a bull? In which case you might like to purchase a derivative to gain a leveraged long exposure (a call option or long forward/future). Are you a bear? In which case you might like to purchase a derivative to hedge your downside (a put option or short forward/future). All of these are now possible in private and public crypto derivative markets. Either way, you might be curious to understand more about these fascinating, nascent markets.

You are in luck because the Mayer Brown team have written a practice note for Practical Law, giving an overview of crypto derivatives – the forms they typically take and how they are documented. A link can be found below. Please contact us if you would like a pdf copy of the note, or would like to discuss crypto derivatives in more detail.

Crypto Derivatives: Overview | Practical Law (thomsonreuters.com)

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In Banca Nazionale del Lavoro, Commerzbank and Dexia Credit Local v Provincia di Catanzaro [2023] EWHC 3309 (Comm), the High Court granted summary judgment in favour of the joint bank claimants against the Italian public authority, Provincia di Catanzaro (“Catanzaro”). This is the latest in a succession of cases in which Italian local authorities have relied on Italian law arguments as to capacity, authority and/or validity as a basis for arguments that English-law governed derivative transactions on standard ISDA terms and subject to exclusive English jurisdiction, to which they had agreed, are invalid.

Continue Reading Respect my authority: considering capacity to enter into swaps
International flags

Despite some counter-revolutionary forces, especially in the US, it seems likely that environmental, social and governance (ESG) concerns will continue to be increasingly significant factors in the structuring and execution of derivative transactions. We have covered the growth of the ESG derivative market (sometimes referred to as sustainability-linked derivatives) on the Long and Short of It previously.

Sustainability-linked derivatives (SLDs) are derivatives which embed an ESG-linked cash-flow in a traditional derivative instrument (such as an increase in spread linked to a failure by a counterparty to meet an ESG target). Unlike in other ESG financial products, the use of proceeds of a sustainability-linked derivative is not usually controlled (although sometimes counterparties may agree that any increased spread paid as a result of a failure to meet an ESG target will be applied for a sustainable purpose). Typically, SLDs are documented under an ISDA Master Agreement, and the ESG-related terms are contained in the trade confirmation.

In previous surveys, ISDA has reported common themes in ESG related provisions in SLDs, but noted a lack of standardization, which may hold back the growth of this important market and detrimentally affect the efficiency of trading in SLDs. Accordingly, ISDA has recently launched a clause library for SLDs, designed to provide standardized drafting options for market participants to use when negotiating SLD transactions with counterparties. The aim is to improve efficiency in the market but maintaining flexibility for SLDs to be tailored to meet firms’ sustainability and financing needs.   

The ISDA SLD Clause Library (which can be found on the ISDA MyLibrary platform) provides standard-form drafting options in several key areas, including:

  • KPI compliance: provisions stipulating what evidence of sustainability performance must be delivered and when. Typically, parties will assess their KPIs in respect of the relevant observation period to determine a KPI achievement score. This score will be verified by a third-party verification agent. KPI compliance certificates will be delivered for monitoring purposes (or alternatively parties can refer to sustainability disclosures on their websites);
  • Sustainability consequences: mechanisms to adjust cashflows depending on whether relevant ESG targets have been met, depending on the type of transaction/definitions incorporated;
  • Disruption/review: options available to counterparties following disruption and review events;
  • Disputes: there are suggested provisions for resolving disputes in relation to the validity of the facts contained in a KPI compliance certificate or supporting documentation. The provisions are not intended to replace any other disputes provisions that the parties have agreed more generally for the transaction or their trading relationship. If the parties fail to resolve a dispute, a third party may adjudicate, the relevant sustainability consequence will not occur or the transaction could be de-linked from the sustainability provisions.

Please speak to your Mayer Brown contact if you would like assistance with SLD transactions.

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Financial products that provide structured returns (exposure to a range of asset classes while attempting to mitigate credit or other risks) such as separately managed accounts, actively managed certificates and related products, are becoming increasingly popular. These products may be issued in varying formats that may subject to different regulatory frameworks. Some products may be issued through special purpose entities or fund vehicles, and some may be subject to active management or be designed to replicate the returns associated with an actively managed strategy. In Europe and jurisdictions outside of the United States, these products may be subject to a number of regulations that differ from the regulations applicable to similar vehicles in the United States.

Join us for an online discussion with Vestr on the growth of the market in Europe, and a conversation on the legal and regulatory considerations applicable to sales of such products into the United States and/or to U.S. persons, including those arising under the U.S. securities and other laws.

Register here.

United States
9:00 a.m. – 10:00 a.m. EST
8:00 a.m. – 9:00 a.m. CST
7:00 a.m. – 8:00 a.m. MST
6:00 a.m. – 7:00 a.m. PST
Europe
2:00 p.m. – 3:00 p.m. GMT
3:00 p.m. – 4:00 p.m. CET
 
Check list

Effectively delivering notices under commercial contracts is not as straight-forward as it maybe ought to be, with different contracts requiring different methods of delivery, different content and different timelines. Often these boiler-plate provisions are not treated with the same vigour as the commercial provisions of a contract in negotiations, meaning they can be left containing ambiguity. And this ambiguity will also often come to light at very worrisome times, like where a default notice is being delivered to close out transactions.

Continue Reading On Notice: developments in delivery of notices under the ISDA Master Agreement
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The underlying rationale for emissions trading is that derivatives could save the planet or, at the least, could be an influence for good.

Emissions trading is an asset class which is purely a creature of regulation, and that leads to many intricacies, nuances, and traps for the unwary, which are not found in other types of product or derivative. Interest in emissions for trading, and as underlying assets for OTC derivatives and structured products, is on the rise again. Please join a Mayer Brown webinar where Mayer Brown partners, Edmund Parker (Derivatives & Structured Products) and Tim Baines (Environment & Climate Change), based in London, and Matt Kluchenek, based in the US, will discuss key issues including:

  • The underlying asset: relevance of the Paris Agreement; the COPs; and EU, UK and US climate change action initiatives;
  • Emissions trading and crediting regimes, including the voluntary market;
  • ISDA, EFET, and IETA documentation;
  • Regulatory treatment of emissions products in the US (i.e., as Swaps, Futures or Forwards).

Register here.

Key Event Information

Date & Time
Tuesday, September 26, 2023
11:00 a.m. – 12:00 p.m. EDT
Europe
4:00 p.m. – 5:00 p.m. BST
5:00 p.m. – 6:00 p.m. CEST

Printing Euro banknotes

Whether to address funding diversification objectives, liquidity management plans, risk-based capital concerns, or other goals, many issuers consider establishing repackaging programs. These programs can take many forms but generally raise a number of structuring and legal considerations that should be addressed early in the planning process. Join our experts in an upcoming webinar discussion of repack programs where, in addition to providing some background on market developments, we will discuss the following:

  • Compartment/multi-series vehicles or series LLCs and choice of jurisdiction,
  • Rule 144A and Regulation S programs and investor qualifications,
  • Investment Company Act and commodity pool issues,
  • US and European risk retention requirements in capital relief transactions,
  • Emissions Certificates repackagings,
  • Addressing the Volcker Rule, and
  • Swap and other derivatives related considerations.

Key Event Information

Date & Time
Thursday, September 7, 2023
10:00 a.m. – 11:00 a.m. EDT

Register here.