The coronavirus pandemic has roiled the global markets by displacing individuals, creating uncertainty regarding enforcement of documentation and raising questions about margin delivery in a brave, and volatile, new world. This alert summarizes some of the key developments affecting the derivatives markets in the United States since the onset of the COVID-19 outbreak. Market participants should be aware that the financial landscape is evolving daily as a result of this global pandemic and that the information contained below is subject to change.

ISDA Initiatives

The International Swaps and Derivatives Association ("ISDA"), the trade association for the swaps and derivatives industry, has addressed the challenges wrought by the COVID-19 in several significant ways.

On March 25, 2020, ISDA, together with other trade associations representing a variety of financial market industries, submitted a letter to the Basel Committee on Banking Supervision ("BCBS") and the International Organization of Securities Commissions ("IOSCO") requesting a suspension of the phase-in dates for the last two compliance deadlines (September 1, 2020 and September 1, 2021, based on the average aggregate notional swap amounts for entities not otherwise subject to the prior compliance phase-in dates) for the initial margin requirements affecting non-centrally cleared derivatives. ISDA and the other trade organizations had expressed concerns about staff displacement, custodian onboarding and electronic document execution in light of the global COVID-19 pandemic and the resulting effect of the pandemic on realistically meeting the phase-in deadlines. On April 3, 2020, BCBS and IOSCO announced an extension of the final two implementation phases of the initial margin requirements for non-centrally cleared derivatives by one year, i.e., to September 1, 2021 and September 1, 2022 and published the revised deadlines on their respective websites.

In addition to its role in the BCBS/IOSCO deferral, ISDA has been actively monitoring and reporting on global market closures, limitations and suspensions during the COVID-19 pandemic and surveying, as well as updating, the status of insolvency regimes and short-selling regulations in over 80 jurisdictions.

ISDA has also been actively involved in the transition from the London Interbank Offered Rate ("LIBOR") to alternative risk-free rates, which is scheduled to occur at the end of 2021. It is currently unclear whether the LIBOR phase-out will occur as scheduled or whether the COVID-19 pandemic and the resulting market instability will lead to regulatory or legislative action to delay the transition. In light of this uncertainty, derivatives market participants are continuing to continue with their transition planning as if benchmark transition will proceed on schedule across all jurisdictions.

Finally, ISDA has released a memorandum dated April 8, 2020 regarding the giving of notice under Section 12(a) of the ISDA Master Agreement in cases when strict compliance with that section is impossible. The memorandum's reasoning is that New York law is likely to allow notice by other means, although the case law cited in the memorandum cautions that the notice would have to be effective to achieve the intended purpose.

Derivatives Documentation

Another critical area that ISDA and its members have been addressing is the effect of COVID-19 on derivatives legal documentation and related issues, particularly around payment and collateral delivery obligations. One such issue is whether a force majeure (in the 2002 ISDA Master Agreement, but not the 1992 one) or a separately negotiated impossibility test has occurred as a result of the pandemic, thereby triggering a termination event under the ISDA Master Agreement. Although a full analysis of the processes set into motion under ISDA documentation upon the occurrence of a force majeure is beyond the scope of this alert, it is important to note that the conditions for these trigger events, including the resulting impracticability or impossibility of performance, are hard to satisfy. This is assuming that a force majeure has arguably even occurred in the first place, as the term is not defined with any specificity in the ISDA Master Agreement. Moreover, the use of force majeure as a termination trigger assumes that the parties have already given effect to any applicable provision, disruption fallback or remedy provided in the parties' ISDA documentation, which may result in a delay of performance but not an outright termination event.

Finally, the "frustration of purpose" excuse of performance under contract law because of the supervening pandemic (i.e., no fault of either party) will likewise be difficult to apply in the case of ISDA documentation. Historically, US courts have been reluctant to enforce non-performance by a party of its obligations under a contract on the basis of frustration of purpose because of the seriousness of the outcome. However, as in the case of force majeure, frustration of purpose involves a heavily fact-specific analysis.

CFTC Relief

The Commodity Futures Trading Commission ("CFTC") and the National Futures Association ("NFA") have likewise provided relief to intermediaries in the swaps industry in the wake of the COVID-19 pandemic. Starting on March 17, 2020, the CFTC, through its Division of Swap Dealer and Intermediary Oversight ("DSIO"), has issued a number of no-action letters providing time-limited relief to various intermediaries in the swaps and futures industries that have been impacted by social distancing measures. For example, in CFTC Letter No. 20-06 the DSIO granted temporary no-action relief to swap dealers from CFTC regulations requiring recording of oral and telephonic communications and time-stamping, as well as temporary relief from the requirement to furnish annual compliance reports to the CFTC. Similar relief was afforded to swap execution facilities in CFTC Letter No. 20-07 and 20-08 in connection with CFTC regulations requiring recording of communications, recordkeeping related to maintaining an audit trail and monitoring related to audit trail reconstruction. In CFTC Letter No. 20-02, the DSIO granted time-limited relief to members of designated contract markets and swap execution facilities from time-stamping requirements when located in socially-distanced locations. In connection with the relief described above, the NFA, as the self-regulatory organization of the derivatives and futures industry, adopted its own regulatory relief to dovetail with the CFTC measures.

In addition, in CFTC Staff Letter No. 20-10, the DSIO issued temporary relief for an insured depository institution for the purpose of permitting certain commodity swaps to be excluded in the major swap participant registration threshold calculation. The CFTC noted that market volatility and low oil prices had led to an unprecedented increase in the depository institution's swap exposure, which would likely return to previously trending levels once energy prices stabilized.

Given the volatility in the financial markets during the pandemic, it is likely that the foregoing measures represent only the beginning of regulatory responses to an unpredictable course of events. One thing is clear: ISDA, the CFTC and other key players are poised to facilitate the orderly functioning of the derivatives markets and to respond quickly with targeted action or relief, as applicable, to navigate the industry's members through murky waters.

Should you be interested in additional briefing papers and/or webinars covering a wide array of COVID-19 issues that our clients have found helpful, please visit:

United States Guidance: Dentons COVID-19 US Hub

Global Guidance: Dentons COVID-19 Global Hub