[Federal Register Volume 79, Number 185 (Wednesday, September 24, 2014)]
[Proposed Rules]
[Pages 57347-57400]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-22001]
[[Page 57347]]
Vol. 79
Wednesday,
No. 185
September 24, 2014
Part III
Department of the Treasury
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Office of the Comptroller of the Currency
Board of Governors of The Federal Reserve System
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Federal Deposit Insurance Corporation
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Farm Credit Administration
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Federal Housing Finance Agency
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12 CFR Parts 45, 237, 349, et al.
Margin and Capital Requirements for Covered Swap Entities; Proposed
Rule
Federal Register / Vol. 79 , No. 185 / Wednesday, September 24, 2014
/ Proposed Rules
[[Page 57348]]
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 45
[Docket No. OCC-2011-0008]
RIN 1557-AD43
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
12 CFR Part 237
[Docket No. R-1415]
RIN 7100-AD74
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 349
RIN 3064-AE21
FARM CREDIT ADMINISTRATION
12 CFR Part 624
RIN 3052-AC69
FEDERAL HOUSING FINANCE AGENCY
12 CFR Part 1221
RIN 2590-AA45
Margin and Capital Requirements for Covered Swap Entities
AGENCY: Office of the Comptroller of the Currency, Treasury (``OCC'');
Board of Governors of the Federal Reserve System (``Board''); Federal
Deposit Insurance Corporation (``FDIC''); Farm Credit Administration
(``FCA''); and the Federal Housing Finance Agency (``FHFA'').
ACTION: Notice of proposed rulemaking and request for comment.
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SUMMARY: The OCC, Board, FDIC, FCA, and FHFA (each an ``Agency'' and,
collectively, the ``Agencies'') are seeking comment on a proposed joint
rule to establish minimum margin and capital requirements for
registered swap dealers, major swap participants, security-based swap
dealers, and major security-based swap participants for which one of
the Agencies is the prudential regulator. This proposed rule implements
sections 731 and 764 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act, which require the Agencies to adopt rules jointly to
establish capital requirements and initial and variation margin
requirements for such entities and their counterparties on all non-
cleared swaps and non-cleared security-based swaps in order to offset
the greater risk to such entities and the financial system arising from
the use of swaps and security-based swaps that are not cleared.
DATES: Comments should be received on or before November 24, 2014.
ADDRESSES: Interested parties are encouraged to submit written comments
jointly to all of the Agencies. Commenters are encouraged to use the
title ``Margin and Capital Requirements for Covered Swap Entities'' to
facilitate the organization and distribution of comments among the
Agencies.
Office of the Comptroller of the Currency. Because paper mail in
the Washington, DC area and at the OCC is subject to delay, commenters
are encouraged to submit comments by the Federal eRulemaking Portal or
email, if possible. Please use the title ``Margin and Capital
Requirements for Covered Swap Entities'' to facilitate the organization
and distribution of the comments. You may submit comments by any of the
following methods:
Federal eRulemaking Portal--``regulations.gov'': Go to
http://www.regulations.gov. Enter ``Docket ID OCC-2011-0008'' in the
Search Box and click ``Search''. Results can be filtered using the
filtering tools on the left side of the screen. Click on ``Comment
Now'' to submit public comments.
Click on the ``Help'' tab on the Regulations.gov home page
to get information on using Regulations.gov, including instructions for
submitting public comments.
Email: [email protected].
Mail: Legislative and Regulatory Activities Division,
Office of the Comptroller of the Currency, 400 7th Street SW., Suite
3E-218, Mail Stop 9W-11, Washington, DC 20219.
Hand Delivery/Courier: 400 7th Street SW., Suite 3E-218,
Mail Stop 9W-11, Washington, DC 20219.
Fax: (571) 465-4326.
Instructions: You must include ``OCC'' as the agency name and
``Docket ID OCC-2011-0008'' in your comment. In general, OCC will enter
all comments received into the docket and publish them on the
Regulations.gov Web site without change, including any business or
personal information that you provide such as name and address
information, email addresses, or phone numbers. Comments received,
including attachments and other supporting materials, are part of the
public record and subject to public disclosure. Do not enclose any
information in your comment or supporting materials that you consider
confidential or inappropriate for public disclosure.
You may review comments and other related materials that pertain to
this rulemaking action by any of the following methods:
Viewing Comments Electronically: Go to http://www.regulations.gov. Enter ``Docket ID OCC-2011-0008'' in the Search
box and click ``Search''. Comments can be filtered by Agency using the
filtering tools on the left side of the screen.
Click on the ``Help'' tab on the Regulations.gov home page
to get information on using Regulations.gov, including instructions for
viewing public comments, viewing other supporting and related
materials, and viewing the docket after the close of the comment
period.
Viewing Comments Personally: You may personally inspect
and photocopy comments at the OCC, 400 7th Street SW., Washington, DC.
For security reasons, the OCC requires that visitors make an
appointment to inspect comments. You may do so by calling (202) 649-
6700. Upon arrival, visitors will be required to present valid
government-issued photo identification and to submit to a security
screening in order to inspect and photocopy comments.
Docket: You may also view or request available background
documents and project summaries using the methods described above.
Board of Governors of the Federal Reserve System: You may submit
comments, identified by Docket No. R-1415 and RIN 7100 AD74, by any of
the following methods:
Agency Web site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/apps/foia/proposedregs.aspx.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Email: [email protected]. Include the
docket number in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Address to Robert deV. Frierson, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and Constitution
Avenue NW., Washington, DC 20551.
All public comments will be made available on the Board's Web site
at http://www.federalreserve.gov/apps/foia/proposedregs.aspx as
submitted, unless modified for technical reasons. Accordingly, comments
will not be edited to remove any identifying or contact information.
Public comments may also be viewed electronically or in
[[Page 57349]]
paper in Room MP-500 of the Board's Martin Building (20th and C Streets
NW.) between 9:00 a.m. and 5:00 p.m. on weekdays.
Federal Deposit Insurance Corporation: You may submit comments,
identified by RIN 3064-AE21, by any of the following methods:
Agency Web site: http://www.fdic.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on
the Agency Web site.
Email: [email protected]. Include RIN 3064-AE21 on the
subject line of the message.
Mail: Robert E. Feldman, Executive Secretary, Attention:
Comments, Federal Deposit Insurance Corporation, 550 17th Street NW.,
Washington, DC 20429.
Hand Delivery: Comments may be hand delivered to the guard
station at the rear of the 550 17th Street Building (located on F
Street) on business days between 7:00 a.m. and 5:00 p.m.
Instructions: All comments received must include the agency name
and RIN for this rulemaking and will be posted without change to
https://www.fdic.gov/regulations/laws/federal/index.html, including any
personal information provided.
Federal Housing Finance Agency: You may submit your written
comments on the proposed rulemaking, identified by regulatory
information number: RIN 2590-AA45, by any of the following methods:
Agency Web site: www.fhfa.gov/open-for-comment-or-input.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments. If you submit your
comment to the Federal eRulemaking Portal, please also send it by email
to FHFA at [email protected] to ensure timely receipt by the Agency.
Please include ``RIN 2590-AA45'' in the subject line of the message.
Hand Delivery/Courier: The hand delivery address is:
Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA45,
Federal Housing Finance Agency, Constitution Center (OGC Eighth Floor),
400 7th St. SW., Washington, DC 20024. Deliver the package to the
Seventh Street entrance Guard Desk, First Floor, on business days
between 9:00 a.m. and 5:00 p.m.
U.S. Mail, United Parcel Service, Federal Express, or
Other Mail Service: The mailing address for comments is: Alfred M.
Pollard, General Counsel, Attention: Comments/RIN 2590-AA45, Federal
Housing Finance Agency, Constitution Center (OGC Eighth Floor), 400 7th
St. SW., Washington, DC 20024.
All comments received by the deadline will be posted for public
inspection without change, including any personal information you
provide, such as your name, address, email address and telephone number
on the FHFA Web site at http://www.fhfa.gov. Copies of all comments
timely received will be available for public inspection and copying at
the address above on government-business days between the hours of 10
a.m. and 3 p.m. To make an appointment to inspect comments please call
the Office of General Counsel at (202) 649-3804.
Farm Credit Administration: We offer a variety of methods for you
to submit your comments. For accuracy and efficiency reasons,
commenters are encouraged to submit comments by email or through the
FCA's Web site. As facsimiles (fax) are difficult for us to process and
achieve compliance with section 508 of the Rehabilitation Act, we are
no longer accepting comments submitted by fax. Regardless of the method
you use, please do not submit your comments multiple times via
different methods. You may submit comments by any of the following
methods:
Email: Send us an email at [email protected].
FCA Web site: http://www.fca.gov. Select ``Law &
Regulation,'' then ``FCA Regulations,'' then ``Public Comments,'' then
follow the directions for ``Submitting a Comment.''
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Mail: Barry F. Mardock, Deputy Director, Office of
Regulatory Policy, Farm Credit Administration, 1501 Farm Credit Drive,
McLean, VA 22102-5090.
You may review copies of all comments we receive at our office in
McLean, Virginia or on our Web site at http://www.fca.gov. Once you are
in the Web site, select ``Law & Regulation,'' then ``FCA Regulations,''
then ``Public Comments,'' and follow the directions for ``Reading
Submitted Public Comments.'' We will show your comments as submitted,
including any supporting data provided, but for technical reasons we
may omit items such as logos and special characters. Identifying
information that you provide, such as phone numbers and addresses, will
be publicly available. However, we will attempt to remove email
addresses to help reduce Internet spam.
FOR FURTHER INFORMATION CONTACT:
OCC: Kurt Wilhelm, Director, Financial Markets Group, (202) 649-
6437, Carl Kaminski, Counsel, Legislative and Regulatory Activities
Division, (202) 649-5490, or Laura Gardy, Counsel, Securities and
Corporate Practices, (202) 649-5510, for persons who are deaf or hard
of hearing, TTY (202) 649-5597, Office of the Comptroller of the
Currency, 400 7th Street SW., Washington, DC 20219.
Board: Sean D. Campbell, Deputy Associate Director, Division of
Research and Statistics, (202) 452-3760, Victoria M. Szybillo, Counsel,
(202) 475-6325, or Anna M. Harrington, Senior Attorney, Legal Division,
(202) 452-6406, Elizabeth MacDonald, Senior Supervisory Financial
Analyst, Banking Supervision and Regulation, (202) 475-6316, Board of
Governors of the Federal Reserve System, 20th and C Streets NW.,
Washington, DC 20551.
FDIC: Bobby R. Bean, Associate Director, Capital Markets Branch,
[email protected], John Feid, Senior Policy Analyst, [email protected], Ryan
Clougherty, Capital Markets Policy Analyst, [email protected], Jacob
Doyle, Capital Markets Policy Analyst, [email protected], Division of
Risk Management Supervision, (202) 898-6888; Thomas F. Hearn, Counsel,
[email protected], or Catherine Topping, Counsel, [email protected],
Legal Division, Federal Deposit Insurance Corporation, 550 17th Street
NW., Washington, DC 20429.
FHFA: Robert Collender, Principal Policy Analyst, Office of Policy
Analysis and Research, (202) 649-3196, [email protected], or
Peggy K. Balsawer, Associate General Counsel, Office of General
Counsel, (202) 649-3060, [email protected], Federal Housing
Finance Agency, Constitution Center, 400 7th St. SW., Washington, DC
20024. The telephone number for the Telecommunications Device for the
Hearing Impaired is (800) 877-8339.
FCA: Timothy T. Nerdahl, Senior Financial Analyst, Jeremy R.
Edelstein, Financial Analyst, Office of Regulatory Policy, (703) 883-
4414, TTY (703) 883-4056, or Richard A. Katz, Senior Counsel, Office of
General Counsel, (703) 883-4020, TTY (703) 883-4056, Farm Credit
Administration, 1501 Farm Credit Drive, McLean, VA 22102-5090.
SUPPLEMENTARY INFORMATION:
I. Background
A. The Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the
``Act'' or ``Dodd-Frank Act'') was enacted on July 21, 2010.\1\ Title
VII of the Dodd-
[[Page 57350]]
Frank Act established a comprehensive new regulatory framework for
derivatives, which the Act generally characterizes as ``swaps'' (which
are defined in section 721 of the Dodd-Frank Act to include interest
rate swaps, commodity-based swaps, and broad-based credit swaps) and
``security-based swaps'' (which are defined in section 761 of the Dodd-
Frank Act to include single-name and narrow-based credit swaps and
equity-based swaps).\2\ For the remainder of this preamble, the term
``swaps'' refers to swaps and security-based swaps unless the context
requires otherwise.
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\1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\2\ See 7 U.S.C. 1a(47); 15 U.S.C. 78c(a)(68).
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As part of this new regulatory framework, sections 731 and 764 of
the Dodd-Frank Act add a new section, section 4s, to the Commodity
Exchange Act of 1936, as amended (``Commodity Exchange Act'') and a new
section, section 15F, to the Securities Exchange Act of 1934, as
amended (``Exchange Act''), respectively, which require the
registration by the Commodity Futures Trading Commission (the ``CFTC'')
and the Securities and Exchange Commission (the ``SEC'') of swap
dealers, major swap participants, security-based swap dealers, and
major security-based swap participants (each a ``swap entity'' and,
collectively, ``swap entities'').\3\ For swap entities that are
prudentially regulated by one of the Agencies,\4\ sections 731 and 764
of the Dodd-Frank Act require the Agencies to adopt rules jointly for
swap entities under their respective jurisdictions imposing (i) capital
requirements and (ii) initial and variation margin requirements on all
swaps not cleared by a central counterparty (``CCP'').\5\ Swap entities
that are prudentially regulated by one of the Agencies and therefore
subject to the proposed rule are referred to herein as ``covered swap
entities.''
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\3\ See 7 U.S.C. 6s; 15 U.S.C. 78o-10. Section 731 of the Dodd-
Frank Act requires swap dealers and major swap participants to
register with the CFTC, which is vested with primary responsibility
for the oversight of the swaps market under Title VII of the Dodd-
Frank Act. Section 764 of the Dodd-Frank Act requires security-based
swap dealers and major security-based swap participants to register
with the SEC, which is vested with primary responsibility for the
oversight of the security-based swaps market under Title VII of the
Dodd-Frank Act. Section 712(d)(1) of the Dodd-Frank Act requires the
CFTC and SEC to issue joint rules further defining the terms swap,
security-based swap, swap dealer, major swap participant, security-
based swap dealer, and major security-based swap participant. The
CFTC and SEC issued final joint rulemakings with respect to these
definitions in May 2012 and August 2012, respectively. See 77 FR
30596 (May 23, 2012); 77 FR 39626 (July 5, 2012) (correction of
footnote in the SUPPLEMENTARY INFORMATION accompanying the rule);
and 77 FR 48207 (August 13, 2012). 17 CFR part 1; 17 CFR parts 230,
240 and 241.
\4\ Section 1a(39) of the Commodity Exchange Act defines the
term ``prudential regulator'' for purposes of the capital and margin
requirements applicable to swap dealers, major swap participants,
security-based swap dealers and major security-based swap
participants. The Board is the prudential regulator for any swap
entity that is (i) a State-chartered bank that is a member of the
Federal Reserve System, (ii) a State-chartered branch or agency of a
foreign bank, (iii) a foreign bank which does not operate an insured
branch, (iv) an organization operating under section 25A of the
Federal Reserve Act (an Edge corporation) or having an agreement
with the Board under section 25 of the Federal Reserve Act (an
Agreement corporation), and (v) a bank holding company, a foreign
bank that is treated as a bank holding company under section 8(a) of
the International Banking Act of 1978, as amended, or a savings and
loan holding company (on or after the transfer date established
under section 311 of the Dodd-Frank Act), or a subsidiary of such a
company or foreign bank (other than a subsidiary for which the OCC
or FDIC is the prudential regulator or that is required to be
registered with the CFTC or SEC as a swap dealer or major swap
participant or a security-based swap dealer or major security-based
swap participant, respectively). The OCC is the prudential regulator
for any swap entity that is (i) a national bank, (ii) a federally
chartered branch or agency of a foreign bank, or (iii) a Federal
savings association. The FDIC is the prudential regulator for any
swap entity that is (i) a State-chartered bank that is not a member
of the Federal Reserve System or (ii) a State savings association.
The FCA is the prudential regulator for any swap entity that is an
institution chartered under the Farm Credit Act of 1971, as amended
(the ``Farm Credit Act''). FHFA is the prudential regulator for any
swap entity that is a ``regulated entity'' under the Federal Housing
Enterprises Financial Safety and Soundness Act of 1992, as amended
(the ``Federal Housing Enterprises Financial Safety and Soundness
Act'') (i.e., the Federal National Mortgage Association (``Fannie
Mae'') and its affiliates, the Federal Home Loan Mortgage
Corporation (``Freddie Mac'') and its affiliates, and the Federal
Home Loan Banks). See 7 U.S.C. 1a(39). In addition, OCC regulations
provide that an operating subsidiary may engage only in activities
that are permissible for its parent to conduct directly and require
operating subsidiaries to conduct activities subject to the same
authorization, terms, and conditions as apply to the conduct of
those activities by the parent bank. FDIC regulations for
subsidiaries of state-chartered banks incorporate similar limits to
those imposed by the OCC for operating subsidiaries. Thus, if
operating subsidiaries of a national bank or subsidiaries of a
state-chartered bank engage in swap dealing below the aggregate de
minimis dealer registration exemption thresholds established by the
CFTC and SEC for registration as a swap dealer or security-based
swap dealer, those subsidiaries must comply with the banking
agencies' swap counterparty credit risk exposure safety and
soundness requirements, regardless of whether the parent bank is
registered as a swap dealer. If those subsidiaries engage in dealing
activities above the CFTC and SEC registration thresholds, the
subsidiaries must also comply with the margin requirements of this
rule.
\5\ See 7 U.S.C. 6s(e)(2)(A); 15 U.S.C. 78o-10(e)(2)(A). Section
6s(e)(1)(A) of the Commodity Exchange Act directs registered swap
dealers and major swap participants for which there is a prudential
regulator to comply with margin and capital rules issued by the
prudential regulators, while section 6s(e)(1)(B) directs registered
swap dealers and major swap participants for which there is not a
prudential regulator to comply with margin and capital rules issued
by the CFTC and SEC. Section 78o-10(e)(1) generally parallels
section 6s(e)(1), except that section 78o-10(e)(1)(A) refers to
registered security-based swap dealers and major security-based swap
participants for which ``there is not a prudential regulator.'' The
Agencies construe the ``not'' in section 78o-10(e)(1)(A) to have
been included by mistake, in conflict with section 78o-10(e)(2)(A),
and of no substantive meaning. Otherwise, registered security-based
swap dealers and major security-based swap participants for which
there is not a prudential regulator could be subject to multiple
capital and margin rules, and institutions regulated by the
prudential regulators and registered as security-based swap dealers
and major security-based swap participants might not be subject to
any capital and margin requirements under section 78o-10(e).
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Sections 731 and 764 of the Dodd-Frank Act also require the CFTC
and SEC separately to adopt rules imposing capital and margin
requirements for swap entities for which there is no prudential
regulator.\6\ The Dodd-Frank Act requires the CFTC, SEC, and the
Agencies to establish and maintain, to the maximum extent practicable,
capital and margin requirements that are comparable, and to consult
with each other periodically (but no less than annually) regarding
these requirements.\7\
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\6\ See 7 U.S.C. 6s(e)(2)(B); 15 U.S.C. 78o-10(e)(2)(B).
\7\ See 7 U.S.C. 6s(e)(2)(A); 6s(e)(3)(D); 15 U.S.C. 78o-
10(e)(2)(A), 78o-10(e)(3)(D). Staff of the Agencies have consulted
with staff of the CFTC and SEC in developing the proposed rule.
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The capital and margin standards for swap entities imposed under
sections 731 and 764 of the Dodd-Frank Act are intended to offset the
greater risk to the swap entity and the financial system arising from
non-cleared swaps.\8\ Sections 731 and 764 of the Dodd-Frank Act
require that the capital and margin requirements imposed on swap
entities must, to offset such risk, (i) help ensure the safety and
soundness of the swap entity and (ii) be appropriate for the greater
risk associated with non-cleared swaps.\9\ In addition, sections 731
and 764 of the Dodd-Frank Act require the Agencies, in establishing
capital requirements for entities designated as covered swap entities
for a single type or single class or category of swap or
[[Page 57351]]
activities, to take into account the risks associated with other types,
classes, or categories of swaps engaged in, and the other activities
conducted by swap entities that are not otherwise subject to
regulation.\10\ Sections 731 and 764 become effective not less than 60
days after publication of the final rule or regulation implementing
these sections.
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\8\ See 7 U.S.C. 6s(e)(3)(A); 15 U.S.C. 78o-10(e)(3)(A).
\9\ See 7 U.S.C. 6s(e)(3)(A); 15 U.S.C. 78o-10(e)(3)(A). In
addition, section 1313 of the Federal Housing Enterprises Financial
Safety and Soundness Act of 1992 requires the Director of FHFA, when
promulgating regulations relating to the Federal Home Loan Banks, to
consider the following differences between the Federal Home Loan
Banks and Fannie Mae and Freddie Mac: Cooperative ownership
structure; mission of providing liquidity to members; affordable
housing and community development mission; capital structure; and
joint and several liability. See 12 U.S.C. 4513. The Director of
FHFA also may consider any other differences that are deemed
appropriate. For purposes of this proposed rule, FHFA considered the
differences as they relate to the above factors. FHFA requests
comments from the public about whether differences related to these
factors should result in any revisions to the proposal.
\10\ See 7 U.S.C. 6s(e)(2)(C); 15 U.S.C. 78o-10(e)(2)(C). In
addition, the margin requirements imposed by the Agencies must
permit the use of noncash collateral, as the Agencies determine to
be consistent with (i) preserving the financial integrity of the
markets trading swaps and (ii) preserving the stability of the U.S.
financial system. See 7 U.S.C. 6s(e)(3)(C); 15 U.S.C. 78o-
10(e)(3)(C).
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In addition to the Dodd-Frank Act authorities mentioned above, the
Agencies also have safety and soundness authority over the entities
they supervise.\11\ The Dodd-Frank Act specified that the provisions of
its Title VII shall not be construed as divesting any Agency of its
authority to establish or enforce prudential or other standards under
other law.\12\
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\11\ 12 U.S.C. 221 et seq., 12 U.S.C. 1818, 12 U.S.C. 1841 et
seq., 12 U.S.C. 3101 et seq. and 12 U.S.C. 1461 et seq. (Board); 12
U.S.C. 2001 et seq.; 12 U.S.C. 2241 through 2274; 12 U.S.C. 2279aa-
11; 12 U.S.C. 2279bb through bb-7 (FCA); 12 U.S.C. 4513 (FHFA).
\12\ See Dodd-Frank Act sections 741(c) and 764(b).
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The capital and margin requirements for non-cleared swaps under
sections 731 and 764 of the Dodd-Frank Act complement other Dodd-Frank
Act provisions that require all sufficiently standardized swaps to be
cleared through a derivatives clearing organization or clearing
agency.\13\ This requirement is consistent with the consensus of the G-
20 leaders to clear derivatives through central counterparties where
appropriate.\14\
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\13\ See 7 U.S.C. 2(h); 15 U.S.C. 78c-3. Certain types of
counterparties (e.g., counterparties that are not financial entities
and are using swaps to hedge or mitigate commercial risks) are
exempt from this mandatory clearing requirement and may elect not to
clear a swap that would otherwise be subject to the clearing
requirement.
\14\ G-20 Leaders, June 2010 Toronto Summit Declaration, Annex
II, ] 25. The dealer community has also recognized the importance of
clearing--beginning in 2009, in an effort led by the Federal Reserve
Bank of New York, the dealer community agreed to increase central
clearing for certain credit derivatives and interest rate
derivatives. See Press Release, Federal Reserve Bank of New York,
New York Fed Welcomes Further Industry Commitments on Over-the-
Counter Derivatives (June 2, 2009), available at www.newyorkfed.org/newsevents/news/markets/2009/ma090602.html.
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In the derivatives clearing process, CCPs manage credit risk
through a range of controls and methods, including a margining regime
that imposes both initial margin and variation margin requirements on
parties to cleared transactions.\15\ Thus, the mandatory clearing
requirement established by the Dodd-Frank Act for swaps effectively
will require any party to any transaction subject to the clearing
mandate to post initial and variation margin in connection with that
transaction.
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\15\ CCPs interpose themselves between counterparties to a swap
transaction, becoming the buyer to the seller and the seller to the
buyer and, in the process, taking on the credit risk that each party
poses to the other. For example, when a swaps contract between two
parties that are members of a CCP is executed and submitted for
clearing, it is typically replaced by two new contracts--separate
contracts between the CCP and each of the two original
counterparties. At that point, the original counterparties are no
longer counterparties to each other; instead, each faces the CCP as
its counterparty, and the CCP assumes the counterparty credit risk
of each of the original counterparties.
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However, if a particular swap is not cleared because it is not
subject to the mandatory clearing requirement (or because one of the
parties to a particular swap is eligible for, and uses, an exemption
from the mandatory clearing requirement), that swap will be a ``non-
cleared'' swap and may be subject to the capital and margin
requirements for such transactions established under sections 731 and
764 of the Dodd-Frank Act.
The swaps-related provisions of Title VII of the Dodd-Frank Act,
including sections 731 and 764, are intended in general to reduce risk,
increase transparency, promote market integrity within the financial
system, and, in particular, address a number of weaknesses in the
regulation and structure of the swaps markets that were revealed during
the financial crisis of 2008 and 2009. During the financial crisis, the
opacity of swap transactions among dealers and between dealers and
their counterparties created uncertainty about whether market
participants were significantly exposed to the risk of a default by a
swap counterparty. By imposing a regulatory margin requirement on non-
cleared swaps, the Dodd-Frank Act reduces the uncertainty around the
possible exposures arising from non-cleared swaps.
Further, the most recent financial crisis revealed that a number of
significant participants in the swaps markets had taken on excessive
risk through the use of swaps without sufficient financial resources to
make good on their contracts. By imposing an initial and variation
margin requirement on non-cleared swaps, sections 731 and 764 of the
Dodd-Frank Act will reduce the ability of firms to take on excessive
risks through swaps without sufficient financial resources.
Additionally, the minimum margin requirement will reduce the amount by
which firms can leverage the underlying risk associated with the swap
contract.
The Agencies originally published proposed rules to implement
sections 731 and 764 of the Act in May 2011 (the ``2011
proposal'').\16\ Over 100 comments were received in response to the
2011 proposal from a variety of commenters, including banks, asset
managers, commercial end users, and various trade associations. Like
the current proposal, the 2011 proposal was issued pursuant to the
Dodd-Frank Act and each Agency's safety and soundness authority.
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\16\ 76 FR 27564 (May 11, 2011).
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B. Other Dodd-Frank Act Provisions Affecting the Margin and Capital
Rule
The applicability of the prudential regulators' margin requirements
rely in part on regulatory action taken by the CFTC, the SEC, and the
Secretary of the Treasury. The margin requirements will apply to an
entity listed as prudentially regulated by the Agencies under the
definition of ``prudential regulator'' in the Commodity Exchange Act
\17\ if that entity: (1) Is a swap dealer, major swap participant,
security-based swap dealer, major security-based swap participant and
(2) enters into a non-cleared swap. In addition, as a means of ensuring
the safety and soundness of the covered swap entity's non-cleared swap
activities under the proposed rule, the requirements would apply to all
of a covered swap entity's swap and security-based swap activities
without regard to whether the entity has registered as both a swaps
entity and a security-based swaps entity. Thus, for example, for an
entity that is a swap dealer but not a security-based swap dealer or
major security-based swap participant, the proposed rule's requirements
would apply to all of that swap dealer's non-cleared swaps and
security-based swaps.
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\17\ See Dodd-Frank Act section 721; 7 U.S.C. 1(a)(39).
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On May 23, 2012, the CFTC and SEC adopted a final joint rule
defining ``swap dealer,'' ``major swap participant,'' ``security-based
swap dealer,'' and ``major security-based swap dealer.'' These
definitions include quantitative thresholds in the relevant activity
that affect whether an entity subject to the ``prudential regulator''
definition also will be subject to the margin regulations being
proposed.\18\
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\18\ See 77 FR 30596 (May 23, 2012), 77 FR 39626 (July 5, 2012)
(correction of footnote in SUPPLEMENTARY INFORMATION accompanying
the rule) and 77 FR 48207 (August 13, 2012); 17 CFR part 1; 17 CFR
parts 230, 240, and 241.
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On August 13, 2012, the CFTC and SEC adopted a final joint rule
defining ``swap,'' ``security-based swap,'' ``foreign exchange swap,''
and ``foreign
[[Page 57352]]
exchange forward.'' \19\ On November 16, 2012, the Secretary of the
Treasury made a determination pursuant to sections 1a(47)(E) and 1(b)
of the Commodity Exchange Act to exempt foreign exchange swaps and
foreign exchange forwards from certain swap requirements, including
margin requirements, that Title VII of the Dodd-Frank Act added to the
Commodity Exchange Act.\20\
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\19\ See 77 FR 48207 (August 13, 2012); 17 CFR part 1; 17 CFR
parts 230, 240, and 241.
\20\ 77 FR 69694 (November 20, 2013).
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The CFTC has adopted a final rule requiring registration by
entities meeting the substantive definition of swap dealer or major
swap participant and engaging in relevant activities above the
applicable quantitative thresholds.\21\ As of June 29, 2014, 102
entities have registered as swap dealers, and 2 entities have
registered as major swap participants, neither of which are insured
depository institutions or otherwise among the entities listed in the
prudential regulator definition. The SEC has not yet imposed a
registration requirement on entities that meet the definition of
``security-based swap dealer,'' or ``major security-based swap
participant.''
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\21\ 77 FR 2613 (January 1, 2012); 17 CFR 23.21.
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The CFTC and SEC have also adopted policies addressing how the
Commodity Exchange Act's and Exchange Act's swap requirements will
apply to ``cross-border swaps.'' \22\
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\22\ 78 FR 45292 (July 26, 2013); 17 CFR part 1; 79 FR 39067
(July 9, 2014); 17 CFR parts 240, 241, and 250.
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C. The 2013 International Framework
Following the release of the Agencies' 2011 proposal, the Basel
Committee on Banking Supervision (``BCBS'') and the Board of the
International Organization of Securities Commissions (``IOSCO'')
proposed an international framework for margin requirements on non-
cleared swaps with the goal of creating an international standard for
non-cleared swaps (the ``2012 international framework'').\23\ Following
the issuance of the 2012 international framework, the Agencies re-
opened the comment period on the Agencies' 2011 proposal to allow for
additional comment in relation to the 2012 international framework.\24\
The 2012 international framework was also subject to extensive public
comment before being finalized in September 2013 (the ``2013
international framework'').\25\
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\23\ See BCBS and IOSCO ``Consultative Document--Margin
requirements for non-centrally cleared derivatives'' (July 2012),
available at http://www.bis.org/publ/bcbs226.pdf and ``Second
consultative document--Margin requirements for non-centrally cleared
derivatives'' (February 2013), available at http://www.bis.org/publ/bcbs242.pdf.
\24\ 77 FR 60057 (October 2, 2012).
\25\ See BCBS and IOSCO ``Margin requirements for non-centrally
cleared derivatives,'' (September 2013), available at https://www.bis.org/publ/bcbs261.pdf.
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The 2013 international framework articulates eight key principles
for non-cleared derivatives margin rules, which are described in
further detail below. These principles represent the minimum standards
approved by BCBS and IOSCO and recommended to the regulatory
authorities in member jurisdictions of these organizations. Key
principles 1 through 8 are described below.\26\
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\26\ The 2013 international framework refers to swaps as
``derivatives.'' For purposes of the discussion in this section, the
terms ``swaps'' and ``derivatives'' can be used interchangeably.
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1. Appropriate Margining Practices Should Be in Place With Respect to
All Non-Cleared Derivative Transactions
The 2013 international framework recommends that appropriate
margining practices be in place with respect to all derivative
transactions that are not cleared by CCPs. The 2013 international
framework does not include a margin requirement for physically settled
foreign exchange (FX) forwards and swaps.\27\ The framework would also
not apply initial margin requirements to the fixed physically settled
FX component of cross-currency swaps.
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\27\ The 2013 international framework states that variation
margin standards for physically settled FX forwards and swaps should
be addressed by national supervisors in a manner consistent with the
BCBS supervisory guidance recommendations for these products. See
BCBS ``Supervisory guidance for managing risks associated with the
settlement of foreign exchange transactions,'' (February 2013),
available at: https://www.bis.org/publ/bcbs241.pdf (BCBS FX
supervisory guidance). The Board implemented the BCBS FX supervisory
guidance in SR letter 13-24 ``Managing Foreign Exchange Settlement
Risks for Physically Settled Transactions'' (December 23, 2013)
available at http://www.federalreserve.gov/bankinforeg/srletters/sr1324.htm. As discussed elsewhere in this preamble, in 2012, the
Secretary of the Treasury made a determination that physically-
settled foreign exchange forwards and swaps are not to be considered
swaps under the Dodd-Frank Act. 77 FR 69694 (November 20, 2012).
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2. Financial Firms and Systemically Important Nonfinancial Entities
(Covered Entities) Must Exchange Initial and Variation Margin
The 2013 international framework recommends bilateral exchange of
initial and variation margin for non-cleared derivatives between
covered entities. The precise definition of ``covered entities'' is to
be determined by each national regulator, but in general should include
financial firms and systemically important nonfinancial entities.
Sovereigns, central banks, certain multilateral development banks, the
Bank for International Settlements (BIS), and non-systemic,
nonfinancial firms are not included as covered entities.
Under the 2013 international framework, all covered entities that
engage in non-cleared derivatives should exchange, on a bilateral
basis, the full amount of variation margin with a zero threshold on a
regular basis (e.g., daily). All covered entities are also expected to
exchange, on a bilateral basis, initial margin with a threshold not to
exceed [euro]50 million. The threshold applies on a consolidated group,
rather than legal entity, basis. In addition, and in light of the
permitted initial margin threshold, the 2013 international framework
recommends that entities with non-cleared derivative activity of
[euro]8 billion notional or more would be subject to initial margin
requirements.
3. The Methodologies for Calculating Initial and Variation Margin
Should (i) Be Consistent Across Covered Entities, and (ii) Ensure That
All Counterparty Risk Exposures Are Covered With a High Degree of
Confidence
The 2013 international framework states that the potential future
exposure of a non-cleared derivative should reflect an estimate of an
increase in the value of the instrument that is consistent with a one-
tailed 99% confidence level over a 10-day horizon (or longer, if
variation margin is not collected on a daily basis), based on
historical data that incorporates a period of significant financial
stress.
The 2013 international framework permits the amount of initial
margin to be calculated by reference to internal models approved by the
relevant national regulator or a standardized margin schedule, but
covered entities should not ``cherry pick'' between the two calculation
methods. Models may allow for conceptually sound and empirically
demonstrable portfolio risk offsets where there is an enforceable
netting agreement in effect. However, portfolio risk offsets may only
be recognized within, and not across, certain well-defined asset
classes: Credit, equity, interest rates and foreign exchange, and
commodities. A covered entity using the standardized margin schedule
may adjust the gross initial margin amount (notional exposure
multiplied by the relevant percentage in the table) by a ``net-to-gross
ratio,'' which is also used in the bank counterparty credit risk
capital rules to reflect a degree of netting of derivative
[[Page 57353]]
positions that are subject to an enforceable netting agreement.
4. To Ensure That Assets Collected as Collateral Can Be Liquidated in a
Reasonable Amount of Time To Generate Proceeds That Could Sufficiently
Protect Covered Entities From Losses in the Event of a Counterparty
Default, These Assets Should Be Highly Liquid and Should, After
Accounting for an Appropriate Haircut, Be Able To Hold Their Value in a
Time of Financial Stress
The 2013 international framework recommends that national
supervisors develop a definitive list of eligible collateral assets.
The 2013 international framework includes examples of permissible
collateral types, provides a schedule of standardized haircuts, and
indicates that model-based haircuts may be appropriate. In the event
that a dispute arises over the value of eligible collateral, the 2013
international framework provides that both parties should make all
necessary and appropriate efforts, including timely initiation of
dispute resolution protocols, to resolve the dispute and exchange any
required margin in a timely fashion.
5. Initial Margin Should Be Exchanged on a Gross Basis and Held in Such
a Way as To Ensure That (i) the Margin Collected Is Immediately
Available to the Collecting Party in the Event of the Counterparty's
Default, and (ii) the Collected Margin Is Subject to Arrangements That
Fully Protect the Posting Party
The 2013 international framework provides that collateral collected
as initial margin from a ``customer'' (defined as a ``buy-side
financial firm'') should be segregated from the initial margin
collector's proprietary assets. The initial margin collector also
should give the customer the option to individually segregate its
initial margin from other customers' margin. In very specific
circumstances, the initial margin collector may use margin provided by
the customer to hedge the risks associated with the customer's
positions with a third party. To the extent that the customer consents
to rehypothecation, it should be permitted only where applicable
insolvency law gives the customer protection from risk of loss of
initial margin in instances where either the initial margin collector
or the third party become insolvent, or they both do. Where a customer
has consented to rehypothecation and adequate legal safeguards are in
place, the margin collector and the third party to whom customer
collateral is rehypothecated should comply with additional restrictions
detailed in the 2013 international framework, including a prohibition
on any further rehypothecation of the customer's collateral by the
third party.
6. Requirements for Transactions Between Affiliates Are Left to the
National Supervisors
The 2013 international framework recommends that national
supervisors establish margin requirements for transactions between
affiliates as appropriate in a manner consistent with each
jurisdiction's legal and regulatory framework.
7. Requirements for Margining Non-Cleared Derivatives Should Be
Consistent and Non-Duplicative Across Jurisdictions
Under the 2013 international framework, home-country supervisors
may allow a covered entity to comply with a host-country's margin
regime if the host-country margin regime is consistent with the 2013
international framework. A branch may be subject to the margin
requirements of either the headquarters' jurisdiction or the host
country.
8. Margin Requirements Should Be Phased in Over an Appropriate Period
of Time
The 2013 international framework phases in margin requirements
between December 2015 and December 2019. Covered entities should begin
exchanging variation margin by December 1, 2015. The date on which a
covered entity should begin to exchange initial margin with a
counterparty depends on the notional amount of non-cleared derivatives
(including physically settled FX forwards and swaps) entered into both
by its consolidated corporate group and by the counterparty's
consolidated corporate group.
Currency denomination. The 2013 international framework generally
lays out a broad conceptual framework for margining requirements on
non-cleared derivatives. It also recommends specific quantitative
levels for several parameters such as the level of notional derivative
exposure that results in an entity being subject to the margin
requirements ([euro]8 billion), permitted initial margin thresholds
([euro]50 million), and minimum transfer amounts ([euro]500,000). In
the 2013 international framework, all such amounts are denominated in
Euros. In this proposal all such amounts are denominated in U.S.
dollars. The Agencies are aware that, over time, amounts that are
denominated in different currencies in different jurisdictions may
fluctuate relative to one another due to changes in exchange rates. The
Agencies seek comment on whether and how fluctuations resulting from
exchange rate movements should be addressed. In particular, should
these amounts be expressed in terms of a single currency in all
jurisdictions to prevent such fluctuations? Should the amounts be
adjusted over time if and when exchange rate movements necessitate
realignment? Are there other approaches to deal with fluctuations
resulting from significant exchange rate movements? Are there other
issues that should be considered in connection to the effects of
fluctuating exchange rates?
II. Overview of Proposed Rule
A. Margin Requirements
The Agencies have reviewed the comments received on the 2011
proposal and the 2013 international framework. The Agencies believe
that a number of changes to the 2011 proposal are warranted in order to
reflect certain comments received, as well as to achieve the 2013
international framework's goal of promoting global consistency and
reducing regulatory arbitrage opportunities. In light of the
significant differences from the 2011 proposal, the Agencies are
seeking comment on a revised proposed rule to implement section 4s of
the Commodity Exchange Act and section 15F of the Exchange Act (the
``proposal'' or the ``proposed rule'').
The Agencies are proposing to adopt a risk-based approach that
would establish initial and variation margin requirements for covered
swap entities. Consistent with the statutory requirement, the proposed
rule would help ensure the safety and soundness of the covered swap
entity and would be appropriate for the risk to the financial system
associated with non-cleared swaps held by covered swap entities. The
proposed rule takes into account the risk posed by a covered swap
entity's counterparties in establishing the minimum amount of initial
and variation margin that the covered swap entity must exchange with
its counterparties.
In implementing this risk-based approach, the proposed rule
distinguishes among four separate types of swap counterparties: (i)
Counterparties that are themselves swap entities; (ii) counterparties
that are financial end users with a material swaps exposure; (iii)
counterparties that are financial end users without a material swaps
exposure, and (iv) other
[[Page 57354]]
counterparties, including nonfinancial end users, sovereigns, and
multilateral development banks.\28\ These categories reflect the
Agencies' current belief that risk-based distinctions can be made
between these types of swap counterparties.
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\28\ See Sec. .2 of the proposed rule for the
various constituent definitions that identify these four types of
swap counterparties.
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The proposed rule's initial and variation margin requirements
generally apply to the posting, as well as the collection, of minimum
initial and variation margin amounts by a covered swap entity from and
to its counterparties. This proposal represents a refinement to the
Agencies' original collection-only approach to margin requirements
based on consideration of comments made on the 2011 proposal and the
2013 international framework. While the Agencies believe that imposing
requirements with respect to the minimum amount of initial and
variation margin to be collected is a critical aspect of offsetting the
greater risk to the covered swap entity and the financial system
arising from the covered swap entity's non-cleared swap exposure, the
Agencies also believe that requiring a covered swap entity to post
margin to other financial entities could forestall a build-up of
potentially destabilizing exposures in the financial system. The
proposed rule's approach therefore is designed to ensure that covered
swap entities transacting with other swap entities and with financial
end users in non-cleared swaps will be collecting and posting
appropriate minimum margin amounts with respect to those transactions.
For initial margin, the proposed rule would require a covered swap
entity to calculate its minimum initial margin requirement in one of
two ways. The covered swap entity may use a standardized margin
schedule, which is set out in Appendix A of the proposed rule. The
standardized margin schedule allows for certain types of netting and
offsetting of exposures. In the alternative, a covered swap entity may
use an internal margin model that satisfies certain criteria outlined
within Sec. .8 of the proposed rule and that has
been approved by the relevant prudential regulator.\29\
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\29\ See Sec. .8 and Appendix A of the
proposed rule for a complete description of the requirements for
initial margin models and standardized minimum initial margin
requirements.
---------------------------------------------------------------------------
Where a covered swap entity transacts with another swap entity
(regardless of whether the other swap entity meets the definition of a
``covered swap entity'' under the proposed rule), the covered swap
entity must collect at least the amount of initial margin required
under the proposed rule. Likewise, the swap entity counterparty also
will be required, under margin rules that are applicable to that swap
entity,\30\ to collect a minimum amount of initial margin from the
covered swap entity.\31\ Accordingly, covered swap entities will both
collect and post a minimum amount of initial margin when transacting
with another swap entity. A covered swap entity transacting with a
financial end user with a material swaps exposure as specified by this
proposed rule must collect at least the amount of initial margin
required by the proposed rule and must post at least the amount of
initial margin that the covered swap entity would be required by the
proposal to collect if the covered swap entity were in the place of the
counterparty. In addition, a covered swap entity must post or collect
initial margin on at least a daily basis as required under the proposed
rule in response to changes in the required initial margin amounts
stemming from changes in portfolio composition or any other factors
that result in a change in the required initial margin amounts.\32\
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\30\ All swap entities will be subject to a rule on minimum
margin for non-cleared swaps promulgated by one of the Agencies, the
SEC or the CFTC.
\31\ The counterparty may be a covered swap entity subject to
this proposed rule or a swap entity that is subject to the margin
rules of the CFTC or SEC. If the counterparty is a covered swap
entity, it must collect at least the amount of margin required under
this proposal. If the counterparty is a swap entity subject to the
margin rules of the CFTC or SEC, it must collect the amount of
margin required under the CFTC or SEC margin rules.
\32\ Under the proposed rule, when entering into a swap
transaction, the first collection and posting of initial margin may
be delayed for one day following the day the swap transaction is
executed. Thereafter, posting and collecting initial margin must be
made on at least a daily basis in response to changes in portfolio
composition or any other factors that would change the required
initial margin amounts.
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The proposed rule permits a covered swap entity to adopt a maximum
initial margin threshold amount of $65 million, below which it need not
collect or post initial margin from or to swap entities and financial
end users with material swaps exposures. The threshold would be applied
on a consolidated basis, and would apply both to the consolidated
covered swap entity as well as to the consolidated counterparty.\33\
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\33\ See Sec. Sec. .3 and
.8 of the proposed rule for a complete
description of the initial margin requirements.
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With respect to variation margin, the proposed rule generally
requires a covered swap entity to collect or post variation margin on
swaps with a swap entity or a financial end user (regardless of whether
the financial end user has a material swaps exposure) in an amount that
is at least equal to the increase or decrease in the value of the swap
since the counterparties' previous exchange of variation margin. The
proposed rule would not permit a covered swap entity to adopt a
threshold amount below which it need not collect or post variation
margin on swaps with swap entity and financial end user counterparties.
In addition, a covered swap entity must collect or post variation
margin with swap entities and financial end user counterparties under
the proposed rule on at least a daily basis.\34\
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\34\ See Sec. .4 of the proposed rule for a
complete description of the variation margin requirements.
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The proposed rule's margin provisions establish only minimum
requirements with respect to initial and variation margin. Nothing in
the proposed rule is intended to prevent or discourage a covered swap
entity from collecting or posting margin in amounts greater than is
required under the proposed rule.
Under the proposal, a covered swap entity's collection of margin
from ``other counterparties'' that are not swap entities or financial
end users (e.g., nonfinancial or ``commercial'' end users that
generally engage in swaps to hedge commercial risk, sovereigns, and
multilateral developments banks), is subject to the judgment of the
covered swap entity. That is, under the proposed rule, a covered swap
entity is not required to collect initial and variation margin from
these ``other counterparties'' as a matter of course. However, a
covered swap entity should continue with the current practice of
collecting initial or variation margin at such times and in such forms
and amounts (if any) as the covered swap entity determines in its
overall credit risk management of the swap entity's exposure to the
customer.
Although covered swap entities would be required to collect
variation margin from all financial end user counterparties under the
proposed rule, no minimum initial margin requirement would apply to
transactions with those financial end users that are not swap entities
and that do not have a material swaps exposure. Thus, for the purpose
of the initial margin requirements, financial end users that are not
swap entities and that do not have a material swaps exposure would be
treated in the same manner as entities characterized as ``other
counterparties.''
The Agencies believe that differential treatment of ``other
counterparties'' is consistent with the Dodd-Frank Act's
[[Page 57355]]
risk-based approach to establishing margin requirements. However, the
Agencies recognize that a covered swap entity may find it prudent from
a risk management perspective to collect margin from one or more of
these ``other counterparties.'' \35\
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\35\ See Sec. .3 and Sec.
.4 of the proposed rule for a complete description
of the initial and variation margin requirements that apply to
``other counterparties.''
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The proposed rule limits the types of collateral that are eligible
to be used to satisfy both the initial and variation margin
requirements. Eligible collateral is generally limited to high-quality,
liquid assets that are expected to remain liquid and retain their
value, after accounting for an appropriate risk-based ``haircut,''
during a severe economic downturn. Eligible collateral for variation
margin is limited to cash only. Eligible collateral for initial margin
includes cash, debt securities that are issued or guaranteed by the
U.S. Department of Treasury or by another U.S. government agency, the
Bank for International Settlements, the International Monetary Fund,
the European Central Bank, multilateral development banks, certain U.S.
Government-sponsored enterprises' (``GSEs'') debt securities, certain
foreign government debt securities, certain corporate debt securities,
certain listed equities, and gold.\36\ When determining the
collateral's value for purposes of satisfying the proposed rule's
margin requirements, non-cash collateral and cash collateral that is
not denominated in U.S. dollars or the currency in which payment
obligations under the swap are required to be settled would be subject
to an additional ``haircut'' as determined using Appendix B of the
proposed rule.\37\ The limits on eligible collateral and application of
a haircut would not apply to margin collected in excess of what is
required by the rule.
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\36\ An asset-backed security guaranteed by a U.S. Government-
sponsored enterprise is eligible collateral for purposes of initial
margin if the GSE is operating with capital support or another form
of direct financial assistance from the U.S. government (Sec.
.6(a)(2)(iii)).
\37\ See Sec. .6 and Appendix B of the
proposed rule for a complete description of the eligible collateral
requirements.
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Separate from the proposed rule's requirements with respect to the
collection and posting of initial and variation margin, the proposed
rule also would require a covered swap entity to require that any
collateral other than variation margin that it posts to its
counterparty (even collateral in excess of any required by the proposed
rule) be segregated at one or more custodians that are not affiliates
of the covered swap entity or the counterparty (``third-party
custodian''). The proposed rule would also require a covered swap
entity to place the initial margin it collects (in accordance with the
proposed rule) from a swap entity or a financial end user with material
swaps exposure at a third-party custodian.\38\ In both of the foregoing
cases, the proposed rule would require that the third-party custodian
be prohibited by agreement from certain actions with respect to any of
the funds or other property it holds as initial margin. First, the
custodial agreement must prohibit rehypothecating, repledging, reusing
or otherwise transferring, any of the funds or other property the
third-party custodian holds. Second, with respect to initial margin
required to be posted or collected, the custodial agreement must
prohibit substituting or reinvesting any funds or other property in any
asset that would not qualify as eligible collateral under the proposed
rule. Third, the custodial agreement must require that after such
substitution or reinvestment, the amount net of applicable discounts
described in Appendix B continue to be sufficient to meet the
requirements for initial margin under the proposal.\39\ Funds or other
property held by a third-party custodian but not required to be posted
or collected under the rule are not subject to any of these
restrictions on collateral substitution or reinvestment.
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\38\ The segregation requirement therefore applies only to the
minimum amount of initial margin that a covered swap entity is
required to collect by the rule from a swap entity or financial end
user with a material swaps exposure, but applies to all collateral
(other than variation margin) that the covered swap entity posts to
any counterparty.
\39\ See Sec. .7 of the proposed rule for a
complete description of the segregation requirements.
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Given the global nature of swaps markets and swap transactions,
margin requirements will be applied to transactions across different
jurisdictions. As required by the Dodd-Frank Act, the Agencies are
proposing a specific approach to address cross-border non-cleared swap
transactions. Under the proposal, foreign swaps of foreign covered swap
entities would not be subject to the margin requirements of the
proposed rule.\40\ In addition, certain covered swap entities that are
operating in a foreign jurisdiction and covered swap entities that are
organized as U.S. branches of foreign banks may choose to abide by the
swap margin requirements of the foreign jurisdiction if the Agencies
determine that the foreign regulator's swap margin requirements are
comparable to those of the proposed rule.\41\
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\40\ See Sec. .9 of the proposed rule.
\41\ See Sec. .9 of the proposed rule for a
complete description of the treatment of cross-border swap
transactions.
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B. Capital Requirements
Sections 731 and 764 of the Dodd-Frank Act also require each Agency
to issue, in addition to margin rules, joint rules on capital for
covered swap entities for which it is the prudential regulator.\42\ The
Board, FDIC, and OCC (each a ``banking agency'' and, collectively, the
``banking agencies'') have had risk-based capital rules in place for
banks to address over-the-counter (``OTC'') swaps since 1989 when the
banking agencies implemented their risk-based capital adequacy
standards (general banking risk-based capital rules) \43\ based on the
first Basel Accord.\44\ The general banking risk-based capital rules
have been amended and supplemented over time to take into account
developments in the swaps market. These supplements include the
addition of the market risk rule which requires banks and bank holding
companies meeting certain thresholds to calculate their capital
requirements for trading positions through models approved by their
primary Federal supervisor.\45\ In addition, certain large, complex
banks and bank holding companies are subject to the banking agencies'
advanced approaches risk-based capital rule (advanced approaches
rules), based on the advanced approaches of the Basel II Accord.\46\
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\42\ 7 U.S.C. 6s(e)(2); 15 U.S.C. 78o-10(e)(2).
\43\ See 54 FR 4186 (January 27, 1989). The general banking
risk-based capital rules are at 12 CFR part 3, Appendices A, B, and
C (national banks); 12 CFR part 167 (federal savings banks); 12 CFR
part 208, Appendices A, B, and E (state member banks); 12 CFR part
225, Appendices A, D, and E (bank holding companies); 12 CFR part
325, Appendices A, B, C, and D (state nonmember banks); 12 CFR part
390, subpart Z (state savings associations). The general risk-based
capital rules are supplemented by the market risk capital rules.
\44\ The Basel Committee on Banking Supervision developed the
first international banking capital framework in 1988, entitled,
International Convergence of Capital Measurement and Capital
Standards.
\45\ The banking agencies' market risk capital rules are
currently at 12 CFR part 3, Appendix B (OCC); 12 CFR parts 208 and
225, Appendix E (Board); and 12 CFR part 325, Appendix C (FDIC). The
rules apply to banks and bank holding companies with trading
activity (on a worldwide consolidated basis) that equals 10 percent
or more of the institution's total assets, or $1 billion or more.
\46\ See BCBS, International Convergence of Capital Measurement
and Capital Standards: A Revised Framework (2006). The banking
agencies implemented the advanced approaches of the Basel II Accord
in 2007. See 72 FR 69288 (December 7, 2010). The advanced approaches
rules are codified at 12 CFR part 3, Appendix C (OCC); 12 CFR part
208, Appendix F and 12 CFR part 225, Appendix G (Board); and 12 CFR
part 325, Appendix D (FDIC).
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[[Page 57356]]
In July 2013 the Board and the OCC issued a final rule (revised
capital framework) implementing regulatory capital reforms reflecting
agreements reached by the BCBS in ``Basel III: A Global Regulatory
Framework for More Resilient Banks and Banking Systems.'' \47\ The
revised capital framework includes the capital requirements for OTC
swaps described above. The FDIC adopted an interim final rule that was
substantively identical to the revised capital framework in July 2013
and later issued a final rule in April 2014 identical to the Board's
and the OCC's final rule.\48\
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\47\ See BCBS, Basel III: A Global Regulatory Framework For More
Resilient Banks and Banking Systems (2010), available at
www.bis.org/publ.bcbs189.htm.
\48\ 78 FR 62018 (October 11, 2013) (Board and OCC); 78 FR 20754
(April 14, 2014) (FDIC). These rules are codified at 12 CFR part 3
(national banks and federal savings associations), 12 CFR part 217
(state member banks, bank holding companies, and savings and loan
holding companies), and 12 CFR part 324 (state nonmember banks and
state savings associations).
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FHFA's predecessor agencies used a methodology similar to that
endorsed by the BCBS prior to the development of its recent revised and
enhanced framework to develop the risk-based capital rules applicable
to those entities now regulated by FHFA. Those rules still apply to all
FHFA-regulated entities.\49\ FHFA is in the process of revising and
updating these regulations for the Federal Home Loan Banks. The FCA's
risk-based capital regulations for Farm Credit System (``FCS'')
institutions, except for the Federal Agricultural Mortgage Corporation
(``Farmer Mac''), have been in place since 1988 and were last updated
in 2005.\50\ The FCA's risk-based capital regulations for Farmer Mac
have been in place since 2001 and were updated in 2011.\51\ On May 8,
2014, the FCA proposed revisions to its capital rules for all FCS
institutions, except Farmer Mac, that are comparable to the Basel III
framework.\52\
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\49\ For the duration of the conservatorships of Fannie Mae and
Freddie Mac (together, the ``Enterprises''), FHFA has directed that
its existing regulatory capital requirements would not be binding.
However, FHFA continues to closely monitor the Enterprises'
activities. Such monitoring, coupled with the unique financial
support available to the Enterprises from the U.S. Department of the
Treasury and the likelihood that FHFA will promulgate new risk-based
capital rules in due course to apply to the Enterprises (or their
successors) once the conservatorships have ended, lead to FHFA's
preliminary view that the reference to existing capital rules is
sufficient to address the risks discussed in the text above as to
the Enterprises.
\50\ See 53 FR 40033 (October 13, 1988); 70 FR 35336 (June 17,
2005); 12 CFR part 615, subpart H.
\51\ See 66 FR 19048 (April 12, 2001); 76 FR 23459 (April 27,
2011); 12 CFR part 652.
\52\ The FCA recently proposed revisions to its capital rules
for all FCS institutions, except Farmer Mac, that are comparable to
the Basel III Framework.
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As described below, the proposed rule requires a covered swap
entity to comply with regulatory capital rules already made applicable
to that covered swap entity as part of its prudential regulatory
regime. Given that these existing regulatory capital rules specifically
take into account and address the unique risks arising from swap
transactions and activities, the Agencies are proposing to rely on
these existing rules as appropriate and sufficient to offset the
greater risk to the covered swap entity and the financial system
arising from the use of swaps that are not cleared and to protect the
safety and soundness of the covered swap entity.
C. 2011 FCA and FHFA Special Section
In the 2011 proposal, FHFA and FCA (but not the other Agencies) had
proposed an additional provision, Sec. .11 of FHFA's
and FCA's proposed rules. Proposed Sec. .11 would
have required any entity that was regulated by FHFA or FCA, but was not
itself a covered swap entity, to collect initial margin and variation
margin from its swap entity counterparty when entering into a non-
cleared swap.\53\ Federal Home Loan Banks, Fannie Mae and its
affiliates, Freddie Mac and its affiliates, and all Farm Credit System
institutions including Farmer Mac (each a ``regulated entity'' and,
collectively, ``regulated entities'') would have been subject to this
provision. Regulated entities that were covered swap entities would
have been subject to Sec. Sec. 1 through 9 of the 2011 proposal with
respect to margin.
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\53\ See 76 FR 27564, 27582-83 (May 11, 2011). Section
.11 of the 2011 proposal would have required
regulated entities to collect initial and variation margin from
their swap entity counterparties on parallel terms to the
requirements governing collection by covered swap entities under
other sections of the 2011 proposal, including with respect to
initial margin calculation methods (via the use of a model or a
standardized ``lookup'' table), documentation standards and
segregation requirements. Section .11 of the 2011
proposal would not have applied to swaps entered into between
regulated entities and end users.
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FHFA and FCA proposed Sec. .11 to account for
the fact that the 2011 proposal only required covered swap entities to
collect initial and variation margin from, but did not require them to
post initial and variation margin to, their counterparties.\54\ The
approach that FHFA and FCA proposed in Sec. .11
recognized that a default by a swap counterparty to a regulated entity
could adversely affect the safe and sound operations of the regulated
entity. FHFA and FCA proposed Sec. .11 pursuant to
each Agency's role as safety and soundness regulator for its respective
regulated entities.
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\54\ Where a covered swap entity's counterparty was another
covered swap entity, the collection requirement would have applied
in both directions to make the requirement effectively bilateral.
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FHFA and FCA are not re-proposing as part of this proposal a
provision similar to that found in Sec. .11 of the
2011 proposal. Unlike the 2011 proposal, this proposal generally would
require two-way margining in swap transactions between covered swap
entities and FHFA- and FCA-regulated entities.\55\ This two-way
margining regime effectively reduces systemic risk by protecting both
the regulated entity and its covered swap entity counterparty from the
effects of a counterparty default, thereby eliminating the need for
FHFA and FCA to propose a separate provision similar to the earlier
proposed Sec. .11. However, should any changes
adopted as part of the final joint rule alter the current proposed two-
way margining regime in ways that raise safety and soundness concerns
for FHFA or FCA with regard to their respective regulated entities,
FHFA or FCA may decide to exercise its authority to adopt a provision
similar to Sec. .11 of the 2011 proposal to address
these concerns.\56\
[[Page 57357]]
Furthermore, FHFA and FCA each reserves the right and authority to
address its safety and soundness concerns through the Agencies' final
joint rulemaking or through a separate rulemaking or guidance
applicable only to its respective regulated entities.
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\55\ Two-way margining would not necessarily apply in all
circumstances. A regulated entity that is not itself a swap entity
would meet the proposed definition of financial end user. As a
result, if it engaged in swap activity above the threshold set in
the definition of material swaps exposure, then the rule would
require two-way margining as to both initial and variation margin,
with respect to its transactions with covered swap entities. If a
regulated entity does not have material swaps exposure, then a
covered swap entity and the regulated entity would be required to
exchange variation margin with each other but would only be required
to collect or post initial margin in such amounts as the parties
determine to be appropriate. In such circumstances, no specific
amount of initial margin would be required to be collected or posted
pursuant to this proposal.
\56\ Any final joint rule issued by the Agencies, once
effective, would address these safety and soundness concerns only in
circumstances where a regulated entity is transacting with a covered
swap entity regulated by a prudential regulator. Where a regulated
entity is instead engaged in a non-cleared swap with a swap entity
that is not subject to the oversight of one of the prudential
regulators, the applicable margin requirements would be those issued
by the regulator having jurisdiction over the swap entity, namely
the CFTC or the SEC. If one of those agencies were to diverge from
the two-way margining regime proposed here (and recommended by the
2013 international framework) in a manner that raises safety and
soundness concerns for FHFA or FCA with regard to their respective
regulated entities, FHFA or FCA also may exercise its authority to
adopt a special section to account for those situations as well,
either in the final joint rulemaking, or in a separate rulemaking or
guidance at a later date.
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D. The Proposed Rule and Community Banks
The Agencies expect that the proposed rule likely will have minimal
impact on community banks. The Agencies anticipate that community banks
will not engage in swap activity to the level necessary to meet the
definition of a swap dealer, major swap participant, security-based
swap dealer, or major security-based swap participant; and therefore,
are unlikely to fall within the proposed definition of a covered swap
entity. Because the proposed rule imposes requirements on covered swap
entities, no community bank will likely be directly subject to the
rule. Thus, a community bank that enters into non-cleared interest rate
swaps with its commercial customers would not be required to apply to
those swaps the proposed rule's requirements for initial margin or
variation margin.
When a community bank enters into a swap with a covered swap
entity, the covered swap entity would be required to post and collect
initial margin pursuant to the rule only if the community bank had a
material swaps exposure.\57\ The Agencies believe that the vast
majority of community banks do not engage in swaps at or near that
level of activity. Thus, for most, if not all community banks, the
proposed rule would only require a covered swap entity to collect
initial margin that it determines is appropriate to address the credit
risk posed by such a community bank. The Agencies believe covered swap
entities currently apply this approach as part of their credit risk
management practices.
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\57\ The proposed rule defines material swaps exposure as an
average daily aggregate notional amount of non-cleared swaps, non-
cleared security-based swaps, foreign exchange forwards and foreign
exchange swaps with all counterparties for June, July, and August of
the previous calendar year that exceeds $3 billion, where such
amount is calculated only for business days.
---------------------------------------------------------------------------
The proposed rule would require a covered swap entity to exchange
daily variation margin with a community bank, regardless of whether the
community bank had material swaps exposure. However, the covered swap
entity would only be required to collect variation margin from a
community bank when the amount of both initial margin and variation
margin required to be collected daily exceeded $650,000. The Agencies
expect that the vast majority of community banks will have a daily
margin requirement that is below this amount.
The Agencies seek comment on the potential impact that this
proposed rule might have on community banks.
E. The Proposed Rule and Farm Credit System Institutions
Similar to community banks, the proposed rule will have a minimal
impact on the Farm Credit System. Currently, no FCS institution,
including Farmer Mac, engage in swap activity at the level necessary to
meet the definition of a swap dealer, major swap participant, security-
based swap dealer, or a major security-based swap participant. For this
reason, no FCS institution, including Farmer Mac, would fall within the
proposed definition of a covered swap entity and, therefore, become
directly subject to this rule. Furthermore, an overwhelming majority of
FCS institutions do not currently engage in non-cleared swaps at or
near the level that they would have a material swaps exposure.
Therefore, a majority of FCS institutions would not be required by this
rule to exchange initial margin with a covered swap entity. For those
few FCS institutions that currently have a material swaps exposure,
initial margin exchange would be mandated only when non-cleared swap
transactions with an individual counterparty and its affiliates exceed
the $65 million threshold. All FCS institutions, including Farmer Mac,
are financial end users and, therefore, they must exchange variation
margin daily once the parties reach the $650,000 minimum transfer
amount.
The Agencies also seek specific comments on the potential impact of
this proposal on FCS institutions.
III. Section by Section Summary of Proposed Rule
A. Section .1: Authority, Purpose, Scope, and
Compliance Dates
Sections .1(a)-(c) of the proposal are agency-
specific. Section .1(a) sets out each Agency's
specific authority, and Sec. .1(b) describes the
purpose of the rule, including the specific entities covered by each
Agency's rule. Section .1(c) of the proposal
specifies the scope of the transactions to which the margin
requirements apply. It provides that the margin requirements apply to
all non-cleared swaps into which a covered swap entity enters. Each
prudential regulator is proposing rule text for its Agency-specific
version of Sec. .1(c) that specifies the entities to
which that prudential regulator's rule applies. Section
.1(c) further states that the margin requirements
apply only to swap and security-based swap transactions that are
entered into on or after the relevant compliance date set forth in
Sec. .1(d). This section also provides that nothing
in this proposal is intended to prevent, and nothing in this proposal
is intended to require, a covered swap entity from independently
collecting margin in amounts greater than are required under this
proposed rule.
1. Treatment of Swaps With Commercial End User Counterparties
Following passage of the Dodd-Frank Act, various parties expressed
concerns regarding whether sections 731 and 764 of the Dodd-Frank Act
authorize or require the CFTC, SEC, and Agencies to establish margin
requirements with respect to transactions between a covered swap entity
and a ``commercial end user'' (i.e., a nonfinancial counterparty that
is neither a swap entity nor a financial end user and engages in swaps
to hedge commercial risk).\58\ Pursuant to other provisions of the
Dodd-Frank Act, nonfinancial end users that engage in swaps to hedge
their commercial risks are exempt from the requirement that all swaps
designated for clearing by the CFTC or SEC be cleared by a CCP, and,
therefore they are exempt from the requirement to post initial margin
and variation margin to the CCP. Commenters to the 2011 proposal argued
that swaps with commercial end users should also be excluded from the
scope of margin requirements imposed for non-cleared swaps under
sections 731 and 764, asserting that commercial firms engaged in
hedging activities pose a reduced risk to their counterparties and the
stability of the U.S. financial system and that including these types
of counterparties in the scope of the proposal would undermine the
goals of excluding these firms from the clearing requirements.\59\
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\58\ Although the term ``commercial end user'' is not defined in
the Dodd-Frank Act, it is generally understood to mean a company
that is eligible for the exception to the mandatory clearing
requirement for swaps under section 2(h)(7) of the Commodity
Exchange Act and section 3C(g) of the Securities Exchange Act,
respectively. This exception is generally available to a person that
(i) is not a financial entity, (ii) is using the swap to hedge or
mitigate commercial risk, and (iii) has notified the CFTC or SEC how
it generally meets its financial obligations with respect to non-
cleared swaps or security-based swaps, respectively. See 7 U.S.C.
2(h)(7) and 15 U.S.C. 78c-3(g).
\59\ Statements in the legislative history of sections 731 and
764 suggest that at least some members of Congress did not intend,
in enacting these sections, to impose margin requirements on
nonfinancial end users engaged in hedging activities, even in cases
where they entered into swaps with swap entities. See, e.g., 156
Cong. Rec. S5904 (daily ed. July 15, 2010) (statement of Sen.
Lincoln).
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[[Page 57358]]
In formulating the proposed rule, the Agencies have carefully
considered these concerns and statements. The plain language of
sections 731 and 764 provides that the Agencies adopt rules for covered
swap entities imposing margin requirements on all non-cleared swaps.
Those sections do not, by their terms, exclude a swap with a
counterparty that is a commercial end user. Importantly, sections 731
and 764 also direct the Agencies to adopt margin requirements that (i)
help ensure the safety and soundness of the covered swap entity and
(ii) are appropriate for the risk associated with the non-cleared
swaps. Thus, the statute requires the Agencies to take a risk-based
approach to establishing margin requirements. Further, the Dodd-Frank
Act does not contain an express exemption for commercial end users from
the margin requirements of sections 731 and 764 of the Dodd-Frank Act.
The Agencies note that the application of margin requirements to non-
cleared swaps with nonfinancial end users could be viewed as lessening
the effectiveness of the clearing requirement exemption for these
nonfinancial end users.
The 2011 proposal permitted a covered swap entity to adopt, where
appropriate, initial and variation margin thresholds below which the
covered swap entity would not be required to collect initial or
variation margin from nonfinancial end users. The proposal noted the
lesser risk posed by these types of counterparties to covered swap
entities and financial stability with respect to exposures below these
thresholds. The Agencies received many comments on this aspect of the
2011 proposal. In particular, commenters requested that swap
transactions with nonfinancial end users and a number of other
counterparties, including sovereigns and multilateral development
banks, be explicitly excluded from the margin requirements.
The proposal takes a different approach to nonfinancial end users
than the 2011 proposal. Like the 2011 proposal, this proposal follows
the statutory framework and proposes a risk-based approach to imposing
margin requirements. Unlike the 2011 proposal, this proposal does not
require that the covered swap entity determine a specific, numerical
threshold for each nonfinancial end user counterparty. Rather, the
proposed rule does not require a covered swap entity to collect initial
margin and variation margin from nonfinancial end users and certain
other counterparties as a matter of course, but instead requires it to
collect initial and variation margin at such times and in such forms
and amounts (if any) as the covered swap entity determines would
appropriately address the credit risk posed by swaps entered into with
``other counterparties.'' \60\ The Agencies believe that this approach
is consistent with current market practice as well as with well-
established internal credit processes and standards of swap entities,
based on safety and soundness, that require covered swap entities to
use an integrated approach in evaluating the risk of their
counterparties in extending credit, including in the form of a swap,
and manage the overall credit exposure to the counterparty.
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\60\ In the case of a nonfinancial end user with a strong credit
profile, under current market practices, a swap dealer would likely
not require margin--in essence, it would extend unsecured credit to
the end user with respect to the underlying exposure. For
counterparties with a weak credit profile, a swap dealer would
likely make a different credit decision and require the counterparty
to post margin.
---------------------------------------------------------------------------
The proposal takes a similar approach to margin requirements for
transactions between covered swap entities and sovereign entities;
multilateral development banks; the Bank for International Settlements;
captive finance companies exempt from clearing pursuant to the Dodd-
Frank Act; and Treasury affiliates exempt from clearing pursuant to the
Dodd-Frank Act.\61\ The Agencies believe that this approach is
consistent with the statute, which requires the margin requirements to
be risk-based, and is appropriate in light of the lower risks that
these types of counterparties generally pose to the safety and
soundness of covered swap entities and U.S. financial stability.
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\61\ See 7 U.S.C. 2(h)(7)(C)(iii), 7 U.S.C. 2(h)(7)(D) and 15
U.S.C. 78c-3(g)(4).
---------------------------------------------------------------------------
2. Compliance Dates
Section .1(d) of the proposal includes a set of
compliance dates by which covered swap entities must comply with the
minimum margin requirements for non-cleared swaps. The compliance dates
of the proposal are consistent with the 2013 international framework.
The proposed rule would be effective with respect to any swap to which
a covered swap entity becomes a party on or after the relevant
compliance date and would continue to apply regardless of future
changes in the measured swaps exposure of the covered swap entity and
its affiliates or the counterparty and its affiliates.
For variation margin, the compliance date is December 1, 2015 for
all covered swap entities with respect to covered swaps with any
counterparty. The Agencies believe that the collection of daily
variation margin is currently a best practice and, as such, current
swaps business operations for covered swap entities of all sizes will
be able to achieve compliance with the proposed rule by December 1,
2015. Therefore, there is no phase-in for the variation margin
requirements.
As reflected in the table below, for initial margin, the compliance
dates range from December 1, 2015 to December 1, 2019 depending on the
average daily aggregate notional amount of non-cleared swaps, non-
cleared security-based swaps, foreign exchange forwards and foreign
exchange swaps (``covered swaps'') of the covered swap entity and its
counterparty for June, July and August of that year.\62\
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\62\ ``Foreign exchange forward and foreign exchange swap'' is
defined to mean any foreign exchange forward, as that term is
defined in section 1a(24) of the Commodity Exchange Act (7 U.S.C.
1a(24)), and foreign exchange swap, as that term is defined in
section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)).
Compliance Date Schedule for Initial Margin
------------------------------------------------------------------------
Compliance date Initial margin requirements
------------------------------------------------------------------------
December 1, 2015.................. Initial margin where both the
covered swap entity combined with
its affiliates and the counterparty
combined with its affiliates have
an average daily aggregate notional
amount of covered swaps for June,
July and August of 2015 that
exceeds $4 trillion.
December 1, 2016.................. Initial margin where both the
covered swap entity combined with
its affiliates and the counterparty
combined with its affiliates have
an average daily aggregate notional
amount of covered swaps for June,
July and August of 2016 that
exceeds $3 trillion.
December 1, 2017.................. Initial margin where both the
covered swap entity combined with
its affiliates and the counterparty
combined with its affiliates have
an average daily aggregate notional
amount of covered swaps for June,
July and August of 2017 that
exceeds $2 trillion.
[[Page 57359]]
December 1, 2018.................. Initial margin where both the
covered swap entity combined with
its affiliates and the counterparty
combined with its affiliates have
an average daily aggregate notional
amount of covered swaps for June,
July and August of 2018 that
exceeds $1 trillion.
December 1, 2019.................. Initial margin for any other covered
swap entity with respect to covered
swaps with any other counterparty.
------------------------------------------------------------------------
The Agencies expect that covered swap entities likely will need to
make a number of operational and legal changes to their current swaps
business operations in order to achieve compliance with the proposed
rule, including potential changes to internal risk management and other
systems, trading documentation, collateral arrangements, and
operational technology and infrastructure. In addition, the Agencies
expect that covered swap entities that wish to calculate initial margin
using an initial margin model will need sufficient time to develop such
models and obtain regulatory approval for their use. Accordingly, the
compliance dates have been structured to ensure that the largest and
most sophisticated covered swap entities and counterparties that
present the greatest potential risk to the financial system comply with
the requirements first. These swap market participants should be able
to make the required operational and legal changes more rapidly and
easily than smaller entities that engage in swaps less frequently and
pose less risk to the financial system.
Section .1(e) provides that once a covered swap
entity and its counterparty must comply with the margin requirements
for non-cleared swaps based on the compliance dates in Sec.
.1(d), the covered swap entity and its counterparty
shall remain subject to the margin requirements from that point
forward. As an example, December 1, 2016 is the relevant compliance
date where both the covered swap entity combined with its affiliates
and its counterparty combined with its affiliates have an average
aggregate daily notional amount of covered swaps that exceeds $3
trillion. If the notional amount of the swap activity for the covered
swap entity or the counterparty drops below that threshold amount of
covered swaps in subsequent years, their swaps would nonetheless remain
subject to the margin requirements. On December 1, 2019, any covered
swap entity that did not have an earlier compliance date becomes
subject to the margin requirements with respect to non-cleared swaps
entered into with any counterparty.
3. Treatment of Swaps Executed Prior to the Applicable Compliance Date
under a Netting Agreement
The Agencies note that a covered swap entity may enter into swaps
on or after the proposed rule's compliance date pursuant to the same
master netting agreement that governs existing swaps entered into with
a counterparty prior to the compliance date. As discussed below, the
proposed rule permits a covered swap entity to (i) calculate initial
margin requirements for swaps under an eligible master netting
agreement (``EMNA'') with the counterparty on a portfolio basis in
certain circumstances, if it does so using an initial margin model; and
(ii) calculate variation margin requirements under the proposed rule on
an aggregate, net basis under an EMNA with the counterparty. Applying
the proposed rule in such a way would, in some cases, have the effect
of applying it retroactively to swaps entered into prior to the
compliance date under the EMNA. The Agencies expect that the covered
swap entity will comply with the margin requirements with respect to
all swaps governed by an EMNA, regardless of the date on which they
were entered into, consistent with current industry practice.\63\ A
covered swap entity would need to enter into a separate master netting
agreement for swaps entered into after the proposed rule's compliance
date in order to exclude swaps entered into with a counterparty prior
to the compliance date.
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\63\ See proposed rule Sec. Sec. .4(d) and
.8(b).
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4. Non-Cleared Swaps Between Covered Swap Entities and Their Affiliates
The proposed rule prescribes margin requirements on all non-cleared
swaps between a covered swap entity and its counterparties. In
particular, the proposal generally would cover swaps between banks that
are covered swap entities and their affiliates that are financial end
users, including affiliates that are subsidiaries of a bank, such as
operating subsidiaries, Edge Act subsidiaries, agreement corporation
subsidiaries, financial subsidiaries, and lower-tier subsidiaries of
such subsidiaries. The Agencies note that other applicable laws require
transactions between banks and their affiliates to be on an arm's
length basis. In particular, section 23B of the Federal Reserve Act
provides that many transactions between a bank and its affiliates must
be on terms and under circumstances, including credit standards, that
are substantially the same or at least as favorable to the bank as
those prevailing at the time for comparable transactions with or
involving nonaffiliated companies.\64\ The requirements of section 23B
generally would mean that a bank engaging in a swap with an affiliate
should do so on the same terms (including the posting and collecting of
margin) that would prevail in a swap between the bank and a
nonaffiliated company. Since the proposed rule will apply to a swap
between a bank and a nonaffiliated company, it will also apply to a
swap between a bank and an affiliate.
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\64\ 12 U.S.C. 371c-1(a).
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While section 23B applies to transactions between a bank and its
financial subsidiary, it does not apply to transactions between a bank
and other subsidiaries, such as an operating subsidiary, an Edge Act
subsidiary, or an agreement corporation subsidiary. The proposed rule
does not exempt a bank's swaps with these affiliates and would
therefore impose margin requirements on all swaps between a bank and a
subsidiary, including a subsidiary that is not covered by section 23B.
B. Section .2: Definitions
Section .2 of the 2011 proposal defined its key
terms. In particular, the 2011 proposal defined the four types of swap
counterparties that formed the basis of the 2011 proposal's risk-based
approach to margin requirements. Section .2
also provided other key operative terms needed to calculate the amount
of initial and variation margin required under other sections of the
2011 proposal.
[[Page 57360]]
1. Overview of 2011 Proposal and Comments on Swap Counterparty
Definitions
The four types of counterparties defined in the 2011 proposal were
(in order of highest to lowest risk): (i) Swap entities; (ii) high-risk
financial end users; (iii) low-risk financial end users; and (iv)
nonfinancial end users. The 2011 proposal defined ``swap entity'' as
any entity that is required to register as a swap dealer, major swap
participant, security-based swap dealer or major security-based swap
participant.\65\
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\65\ See 2011 proposal Sec. .2(y) (2011).
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Section .2 of the 2011 proposal defined a
financial end user largely based on the definition of a ``financial
entity'' that is ineligible for the exemption from the mandatory
clearing requirements of sections 723 and 763 of the Dodd-Frank Act,
and also included foreign governments.\66\ As noted above, the 2011
proposal also distinguished between margin requirements for high-risk
and low-risk financial end users. Section .2 of the
2011 proposal defined a financial end user counterparty as a low-risk
financial end user only if (i) its swaps fall below a specified
``significant swaps exposure'' threshold; (ii) it predominantly uses
swaps to hedge or mitigate the risks of its business activities; and
(iii) it is subject to capital requirements established by a prudential
regulator or state insurance regulator. The 2011 proposal defined a
nonfinancial end user as any counterparty that is an end user but is
not a financial end user.\67\
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\66\ See 7 U.S.C. 2(h)(7); 15 U.S.C. 78c-3(g).
\67\ See 2011 proposal Sec. .2(r) (2011).
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The Agencies requested comment on whether the 2011 proposal's
categorization of various types of counterparties by risk, and the key
definitions used to implement this risk-based approach, were
appropriate, or whether alternative approaches or definitions would
better reflect the purposes of sections 731 and 764 of the Dodd-Frank
Act. As discussed above, many commenters argued that nonfinancial end
users should not be subject to the margin requirements and urged that
the language and intent of the statute did not require the imposition
of margin on nonfinancial end users.
Many commenters also argued that particular types of entities
should either be excluded from the term financial end user or be
classified as a low-risk financial end user instead of a high-risk
financial end user.\68\ In particular, commenters argued that the
following entities should be excluded from the definition of financial
end user: (i) Foreign sovereigns; (ii) states and municipalities; (iii)
multilateral development banks; (iv) captive finance companies; (v)
Treasury affiliates; (vi) cooperatives exempt from clearing; (vii)
pension plans; (viii) payment card networks; and (ix) special purpose
vehicles. A few commenters contended that small financial end users
should be treated as nonfinancial end users because these entities use
swaps mostly to hedge risk.
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\68\ As described further below, the proposal does not
distinguish between high-risk and low-risk financial end users in
this manner.
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2. 2014 Proposal for Swap Counterparty Definitions
Section .2 of the proposal defines key terms used
in the proposed rule, including the types of counterparties that form
the basis of the proposal's risk-based approach to margin requirements
and other key terms needed to calculate the required amount of initial
margin and variation margin.\69\ As noted above, this proposal
distinguishes among four separate types of counterparties: \70\ (i)
Counterparties that are themselves swap entities; (ii) counterparties
that are financial end users with a material swaps exposure; (iii)
counterparties that are financial end users without a material swaps
exposure; and (iv) other counterparties, including nonfinancial end
users, sovereigns, and multilateral development banks. Below is a
general description of the significant terms defined in Sec.
.2.\71\
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\69\ Initial margin means the collateral as calculated in
accordance with Sec. .8 that is posted or
collected in connection with a non-cleared swap. See proposed rule
Sec. .2; see also proposed rule Sec.
.3 (describing initial margin requirements).
Variation margin means a payment by one party to its counterparty to
meet performance of its obligations under one or more non-cleared
swaps between the parties as a result of a change in value of such
obligations since the last time such payment was made. See proposed
rule Sec. .2; see also proposed rule Sec.
.4 (describing variation margin requirements).
\70\ Counterparty is defined to mean, with respect to any non-
cleared swap or non-cleared security-based swap to which a covered
swap entity is a party, each other party to such non-cleared swap or
non-cleared security-based swap. Non-cleared swap means a swap that
is not a cleared swap, as that term is defined in section 1a(7) of
the Commodity Exchange Act (7 U.S.C. 1a(7)) and non-cleared
security-based swap means a security-based swap that is not,
directly or indirectly, submitted to and cleared by a clearing
agency registered with the SEC. Clearing agency is defined to have
the meaning specified in section 3(a)(2) of the Securities Exchange
Act (15 U.S.C. 78c(a)(23)) and derivatives clearing organization is
defined to have the meaning specified in section 1a(15) of the
Commodity Exchange Act (7 U.S.C. 1a(15)). See proposed rule Sec.
.2.
\71\ The term ``nonfinancial end user'' is not used in the
proposal. Nonfinancial end users would be treated as ``other
counterparties'' in the proposal. See proposed rule Sec.
.3(d) & .4(c).
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a. Swap Entity
Similar to the 2011 proposal, this proposal defines ``swap entity''
by reference to the Securities Exchange Act and the Commodity Exchange
Act to mean a security-based swap dealer, a major security-based swap
participant, a swap dealer, or a major swap participant.
b. Financial End User
The proposal's definition of financial end user takes a different
approach than the 2011 proposal, which, as noted above, was based on
the definition of a ``financial entity'' that is ineligible for the
exemption from mandatory clearing requirements of sections 723 and 763
of the Dodd-Frank Act. In order to provide certainty and clarity to
counterparties as to whether they would be financial end users for
purposes of this proposal, the financial end user definition provides a
list of entities that would be financial end users as well as a list of
entities excluded from the definition. This approach would mean that
covered swap entities would not need to make a determination regarding
whether their counterparties are predominantly engaged in activities
that are financial in nature, as defined in section 4(k) of the Bank
Holding Company Act of 1956, as amended (the ``BHC Act'').\72\ In
contrast to the 2011 proposal, the Agencies now are proposing to rely,
to the greatest extent possible, on the counterparty's legal status as
a regulated financial entity.
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\72\ The financial entity definition in the 2011 proposal
includes a person predominantly engaged in activities that are in
the business of banking, or in activities that are financial in
nature, as defined in section 4(k) of the BHC Act. See 7 U.S.C.
2(h)(7); 15 U.S.C. 78c-3(g). The Agencies requested comment on how
covered swap entities should make this determination, and whether
they should use an approach similar to that developed by the Board
for purposes of Title I of the Dodd-Frank Act. See 68 FR 20756
(April 5, 2013). Section 4(k) of the BHC Act includes conditions
that do not define whether an activity is itself financial but were
imposed on bank holding companies to ensure that the activity is
conducted by bank holding companies in a safe and sound manner or to
comply with another provision of law. Staff of the Agencies
recognize that by simply choosing not to comply with the conditions
imposed on the manner in which those activities must be conducted by
bank holding companies, a firm could avoid being considered to be
engaged in activities that are financial in nature.
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Under the proposal, financial end user includes a counterparty that
is not a swap entity but is:
A bank holding company or an affiliate thereof; a savings
and loan holding company; a nonbank financial institution supervised by
the Board of Governors of the Federal Reserve System under Title I of
the Dodd-Frank
[[Page 57361]]
Wall Street Reform and Consumer Protection Act (12 U.S.C. 5323);
A depository institution; a foreign bank; a Federal credit
union, State credit union as defined in section 2 of the Federal Credit
Union Act (12 U.S.C. 1752(1) & (6)); an institution that functions
solely in a trust or fiduciary capacity as described in section
2(c)(2)(D) of the Bank Holding Company Act (12 U.S.C. 1841(c)(2)(D));
an industrial loan company, an industrial bank, or other similar
institution described in section 2(c)(2)(H) of the Bank Holding Company
Act (12 U.S.C. 1841(c)(2)(H));
An entity that is state-licensed or registered as a credit
or lending entity, including a finance company; money lender;
installment lender; consumer lender or lending company; mortgage
lender, broker, or bank; motor vehicle title pledge lender; payday or
deferred deposit lender; premium finance company; commercial finance or
lending company; or commercial mortgage company; but excluding entities
registered or licensed solely on account of financing the entity's
direct sales of goods or services to customers;
A money services business, including a check casher; money
transmitter; currency dealer or exchange; or money order or traveler's
check issuer;
A regulated entity as defined in section 1303(20) of the
Federal Housing Enterprises Financial Safety and Soundness Act of 1992
(12 U.S.C. 4502(20)) and any entity for which the Federal Housing
Finance Agency or its successor is the primary federal regulator;
Any institution chartered and regulated by the Farm Credit
Administration in accordance with the Farm Credit Act of 1971, as
amended, 12 U.S.C. 2001 et seq.;
A securities holding company; a broker or dealer; an
investment adviser as defined in section 202(a) of the Investment
Advisers Act of 1940 (15 U.S.C. 80b-2(a)); an investment company
registered with the SEC under the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.); or a company that has elected to be regulated as
a business development company pursuant to section 54(a) of the
Investment Company (15 U.S.C. 80a-53);
A private fund as defined in section 202(a) of the
Investment Advisers Act of 1940 (15 U.S.C. 80-b-2(a)); an entity that
would be an investment company under section 3 of the Investment
Company Act of 1940 (15 U.S.C. 80a-3) but for section 3(c)(5)(C); or an
entity that is deemed not to be an investment company under section 3
of the Investment Company Act of 1940 pursuant to Investment Company
Act Rule 3a-7 of the Securities and Exchange Commission (17 CFR 270.3a-
7);
A commodity pool, a commodity pool operator, or a
commodity trading advisor as defined in, respectively, sections 1a(10),
1a(11), and 1a(12) of the Commodity Exchange Act (7 U.S.C. 1a(10), 7
U.S.C. 1a(11), 7 U.S.C. 1a(12)); or a futures commission merchant;
An employee benefit plan as defined in paragraphs (3) and
(32) of section 3 of the Employee Retirement Income and Security Act of
1974 (29 U.S.C. 1002);
An entity that is organized as an insurance company,
primarily engaged in writing insurance or reinsuring risks underwritten
by insurance companies, or is subject to supervision as such by a State
insurance regulator or foreign insurance regulator;
An entity that is, or holds itself out as being, an entity
or arrangement that raises money from investors primarily for the
purpose of investing in loans, securities, swaps, funds or other assets
for resale or other disposition or otherwise trading in loans,
securities, swaps, funds or other assets;
An entity that would be a financial end user as described
above or a swap entity, if it were organized under the laws of the
United States or any State thereof; or
Notwithstanding the specified exclusions described below,
any other entity that [Agency] has determined should be treated as a
financial end user.
In developing this definition of financial end user, the Agencies
sought to provide certainty and clarity to covered swap entities and
their counterparties regarding whether particular counterparties would
qualify as financial end users and be subject to the margin
requirements of the proposed rule. The Agencies tried to strike a
balance between the desire to capture all financial counterparties,
without being overly broad and capturing commercial firms and
sovereigns. Financial firms present a higher level of risk than other
types of counterparties because the profitability and viability of
financial firms is more tightly linked to the health of the financial
system than other types of counterparties. Because financial
counterparties are more likely to default during a period of financial
stress, they pose greater systemic risk and risk to the safety and
soundness of the covered swap entity. In case the list of financial end
users in the proposal does not capture a particular entity, the last
part of this definition would allow an Agency to require a covered swap
entity to treat a counterparty as a financial end user for margin
purposes, where appropriate for safety and soundness purposes or to
address systemic risk.
In developing the list of financial entities, the Agencies sought
to include entities subject to Federal statutes that impose
registration or chartering requirements on entities that engage in
specified financial activities, such as deposit taking and lending,
securities and swaps dealing, or investment advisory activities; as
well as asset management and securitization entities. For example,
certain securities investment funds as well as securitization vehicles
are covered, to the extent those entities would qualify as private
funds defined in section 202(a) of the Investment Advisers Act of 1940,
as amended (the ``Advisers Act''). In addition, certain real estate
investment companies would be included as financial end users as
entities that would be investment companies under section 3 of the
Investment Company Act of 1940, as amended (the ``Investment Company
Act''), but for section 3(c)(5)(C), and certain other securitization
vehicles would be included as entities deemed not to be investment
companies pursuant to Rule 3a-7 of the Investment Company Act.
Because Federal law largely looks to the States for the regulation
of the business of insurance, the proposed definition broadly includes
entities organized as insurance companies or supervised as such by a
State insurance regulator. This element of the proposed definition
would extend to reinsurance and monoline insurance firms, as well as
insurance firms supervised by a foreign insurance regulator.
The Agencies are also proposing to cover, as financial end users,
the broad variety and number of nonbank lending and retail payment
firms that operate in the market. To this end, the Agencies are
proposing to include State-licensed or registered credit or lending
entities and money services businesses, under proposed regulatory
language incorporating an inclusive list of the types of firms subject
to State law.\73\ However, the Agencies recognize that the licensing of
nonbank lenders in some states extends to commercial firms
[[Page 57362]]
that provide credit to the firm's customers in the ordinary course of
business. Accordingly, the Agencies are proposing to exclude an entity
registered or licensed solely on account of financing the entity's
direct sales of goods or services to customers. The Agencies request
comment on whether this aspect of the proposed rule adequately
maintains a distinction between financial end users and commercial end
users.
---------------------------------------------------------------------------
\73\ The Agencies expect that state-chartered financial
cooperatives that provide financial services to their members, such
as lending to their members and entering into swaps in connection
with those loans, would be treated as financial end users, pursuant
to this aspect of the proposed rule's coverage of credit or lending
entities.
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Under the proposed rule, those cooperatives that are financial
institutions, such as credit unions, FCS banks and associations, and
other financial cooperatives \74\ are financial end users because their
sole business is lending and providing other financial services to
their members, including engaging in swaps in connection with such
loans.\75\ Cooperatives that are financial end users may qualify for an
exemption from clearing,\76\ and therefore, they may enter into non-
cleared swaps with covered swap entities that are subject to the
proposed rule.
---------------------------------------------------------------------------
\74\ The National Rural Utility Cooperative Finance Cooperation
is an example of another financial cooperative.
\75\ Most cooperatives are producer, consumer, or supply
cooperatives and, therefore, they are not financial end users.
However, many of these cooperatives have financing subsidiaries and
affiliates. These financing subsidiaries and affiliates would not be
financial end users under this proposal if they qualify for an
exemption under sections 2(h)(7)(C)(iii) or 2(h)(7)(D) of the
Commodity Exchange Act or section 3C(g)(4) of the Securities
Exchange Act of 1934.
\76\ Section 2(h)(7)(c)(ii) of the Commodity Exchange Act and
section 3C(g)(4) of the Securities Exchange Act of 1934 authorize
the CFTC and the SEC, respectively, to exempt small depository
institutions, small Farm Credit System institutions, and small
credit unions with total assets of $10 billion or less from the
mandatory clearing requirements for swaps and security-based swaps.
See 7 U.S.C. 2(h)(7) and 15 U.S.C. 78c-3(g). Additionally, the CFTC,
pursuant to its authority under section 2(h)(1)(A) of the Commodity
Exchange Act, enacted 17 CFR part 50, subpart C, section 50.51,
which allows cooperative financial entities, including those with
total assets in excess of $10 billion, to elect an exemption from
mandatory clearing of swaps that: (1) They enter into in connection
with originating loans for their members; or (2) hedge or mitigate
commercial risk related to loans or swaps with their members.
---------------------------------------------------------------------------
The Agencies remain concerned, however, that now or in the future,
one or more types of financial entities might escape classification
under the specific Federal or State regulatory regimes included in the
proposed definition of a financial end user. The Agencies have
accordingly included two additional prongs in the definition. First,
the Agencies have included language that would cover an entity that is,
or holds itself out as being, an entity or arrangement that raises
money from investors primarily for the purpose of investing in loans,
securities, swaps, funds or other assets for resale or other
disposition or otherwise trading in loans, securities, swaps, funds or
other assets. The Agencies request comment on the extent to which there
are (or may be in the future) pooled investment vehicles that are not
captured by the other prongs of the definition (such as the provisions
covering private funds under the Advisers Act or commodity pools under
the Commodity Exchange Act). The Agencies also request comment on
whether this aspect of the definition of financial end user provides
sufficiently clear guidance to covered swap entities and market
participants as to its intended scope, and whether it adequately
maintains a distinction between financial end users and commercial end
users.
Second, as previously explained, the proposed rule would allow an
Agency to require a covered swap entity to treat an entity as a
financial end user for margin purposes, as appropriate for safety and
soundness purposes, or to mitigate systemic risks. In such case,
consistent with the Agency's supervisory procedures, the Agency that is
the covered swap entity's prudential regulator would notify the covered
swap entity in writing of the regulator's intention to require
treatment of the counterparty as a financial end user, and the date by
which such treatment is to be implemented.\77\
---------------------------------------------------------------------------
\77\ The Agencies' procedures would generally provide an
adequate opportunity for the covered swap entity to raise objections
to the Agency's proposed action and for the Agency to respond.
---------------------------------------------------------------------------
To address the classification of foreign entities as financial end
users, the Agencies are proposing to require the covered swap entity to
determine whether a foreign counterparty would fall within another
prong of the financial end user definition if the foreign entity was
organized under the laws of the United States or any State. The
Agencies recognize that this approach would impose upon covered swap
entities the difficulties associated with analyzing a foreign
counterparty's business activities in light of a broad array of U.S.
regulatory requirements. The alternative, however, would require
covered swap entities to gather a foreign counterparty's financial
reporting data and determine the relative amount of enumerated
financial activities in which the counterparty is engaged over a
rolling period.\78\ The Agencies request comment on whether some other
method or approach would adequately assure that the rule's objectives
with respect to covered swap entity safety and soundness and reductions
of systemic risk can be achieved, in a fashion that can be more readily
operationalized by covered swap entities.
---------------------------------------------------------------------------
\78\ See, e.g., 68 FR 20756 (April 5, 2013).
---------------------------------------------------------------------------
Unlike the 2011 proposal, the proposal excludes certain types of
counterparties from the definition of financial end user. In
particular, the proposal states that the term ``financial end user''
does not generally include any counterparty that is:
A sovereign entity; \79\
---------------------------------------------------------------------------
\79\ Sovereign entity is defined to mean a central government
(including the U.S. government) or an agency, department, or central
bank of a central government. See proposed rule Sec. .2. A
sovereign entity would include the European Central Bank for
purposes of this exclusion.
---------------------------------------------------------------------------
A multilateral development bank; \80\
---------------------------------------------------------------------------
\80\ Multilateral development bank is defined to mean the
International Bank for Reconstruction and Development, the
Multilateral Investment Guarantee Agency, the International Finance
Corporation, the Inter-American Development Bank, the Asian
Development Bank, the African Development Bank, the European Bank
for Reconstruction and Development, the European Investment Bank,
the European Investment Fund, the Nordic Investment Bank, the
Caribbean Development Bank, the Islamic Development Bank, the
Council of Europe Development Bank, and any other entity that
provides financing for national or regional development in which the
U.S. government is a shareholder or contributing member or which the
[AGENCY] determines poses comparable credit risk. See proposed rule
Sec. .2.
---------------------------------------------------------------------------
The Bank for International Settlements;
A captive finance company that qualifies for the exemption
from clearing under section 2(h)(7)(C)(iii) of the Commodity Exchange
Act and implementing regulations; or
A person that qualifies for the affiliate exemption from
clearing pursuant to section 2(h)(7)(D) of the Commodity Exchange Act
or section 3C(g)(4) of the Securities Exchange Act and implementing
regulations.
The Agencies note the exclusion for sovereign entities,
multilateral development banks and the Bank for International
Settlements is generally consistent with the 2013 international
framework which recommended that margin requirements not apply to
sovereigns, central banks, multilateral development banks or the Bank
for International Settlements. The last two categories that are
excluded from the financial end user definition were excluded by Title
VII of the Dodd-Frank Act from the definition of financial entity
subject to mandatory clearing. The Agencies also believe that this
approach is appropriate as these entities generally pose less systemic
risk to the financial system in addition to posing less counterparty
risk to a swap entity. Thus, the Agencies believe that application of
the margin requirements
[[Page 57363]]
to swaps with these counterparties is not necessary to achieve the
objectives of this rule.
The Agencies note that States would not be excluded from the
definition of financial end user, as the term ``sovereign entity''
includes only central governments. The categorization of a State or
particular part of a State as a financial end user depends on whether
that part of the State is otherwise captured by the definition of
financial end user. For example, a State entity that is a
``governmental plan'' under the Employment Retirement Income Security
Act of 1974, as amended, would meet the definition of financial end
user.
The Agencies believe that the proposal addresses many of the
commenters' concerns about the definition of ``financial end user''
contained in the 2011 proposal. Entities that are neither financial end
users nor swap entities are treated as ``other counterparties'' in this
proposal.\81\ The Agencies seek comment on all aspects of the financial
end user definition including whether the definition has succeeded in
capturing all entities that should be treated as financial end users.
The Agencies request comment on whether there are additional entities
that should be included as financial end users and, if so, how those
entities should be defined. Further, the Agencies also request comment
on whether there are additional entities that should be excluded from
the definition of financial end user and why those particular entities
should be excluded. The Agencies also request comment on whether
another approach to defining financial end user (e.g., basing the
financial end user definition on the financial entity definition as in
the 2011 proposal) would provide more appropriate coverage and clarity,
and whether covered swap entities could operationalize such an approach
as part of their regular procedures for taking on new counterparties.
---------------------------------------------------------------------------
\81\ As is further discussed below, these entities excluded from
the definition of ``financial end users,'' as well as nonfinancial
counterparties, are treated as ``other counterparties'' with respect
to the proposed variation margin requirements. With respect to the
proposed initial margin requirements, the ``other counterparties''
category also includes financial end users that do not have a
material swaps exposure.
---------------------------------------------------------------------------
c. Material Swaps Exposure
The proposal differs from the 2011 proposal by distinguishing
between swaps with financial end user counterparties that have a
material swaps exposure and swaps with financial end user
counterparties that do not have a material swaps exposure. ``Material
swaps exposure'' for an entity is defined to mean that the entity and
its affiliates have an average daily aggregate notional amount of non-
cleared swaps, non-cleared security-based swaps, foreign exchange
forwards and foreign exchange swaps with all counterparties for June,
July and August of the previous year that exceeds $3 billion, where
such amount is calculated only for business days. The Agencies believe
that using the average daily aggregate notional amount during June,
July, and August of the previous year, instead of a single as-of date,
is appropriate to gather a more comprehensive assessment of the
financial end user's participation in the swaps market, and address the
possibility that a market participant might ``window dress'' its
exposure on an as-of date such as year-end, in order to avoid the
Agencies' margin requirements. Material swaps exposure would be
calculated based on the previous year. For example, on January 1, 2015,
an entity would determine whether it had a material swaps exposure in
June, July and August of 2014 that exceeded $3 billion.\82\
---------------------------------------------------------------------------
\82\ As a specific example of the calculation for material swaps
exposure, consider a financial end user (together with its
affiliates) with a portfolio consisting of two non-cleared swaps
(e.g., an equity swap, an interest rate swap) and one non-cleared
security-based credit swap. Suppose that the notional value of each
swap is exactly $10 billion on each business day of June, July, and
August of 2015. Furthermore, suppose that a foreign exchange forward
is added to the entity's portfolio at the end of the day on July 31,
2015, and that its notional value is $10 billion on every business
day of August 2015. On each business day of June and July 2015, the
aggregate notional amount of non-cleared swaps, security-based swaps
and foreign exchange forwards and swaps is $30 billion. Beginning on
August 1, 2015 the aggregate notional amount of non-cleared swaps,
security-based swaps and foreign exchange forwards and swaps is $40
billion. The daily average aggregate notional value for June, July
and August of 2015 is then (22 x $30 billion +23 x $30 billion + 21
x $40 billion)/(22 + 23 + 21) = $33.18 billion, in which case this
entity would be considered to have a material swaps exposure for
every date in 2016.
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d. Other Definitions
The proposal also defines a number of other terms that were not
defined in the 2011 proposal. The Agencies believe that these
definitions will help provide additional clarity regarding the
application of the margin requirements contained in the proposed rule.
i. Affiliate
The proposal defines ``affiliate'' to mean any company that
controls, is controlled by, or is under common control with another
company. This definition of affiliate is the same as that in the BHC
Act and consequently should be familiar to market participants.\83\ The
proposal also defines subsidiary to mean a company that is controlled
by another company, which is similar to the definition in the BHC Act
and the Board's Regulation Y.\84\
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\83\ See section 2(k) of the Bank Holding Company Act, 12 U.S.C.
1841(k).
\84\ See section 2(d) of the Bank Holding Company Act, 12 U.S.C.
1841(d); 12 CFR 225.2(o).
---------------------------------------------------------------------------
The term affiliate is used in the definition of initial margin
threshold amount which means a credit exposure of $65 million that is
applicable to non-cleared swaps between a covered swap entity and its
affiliates with a counterparty and its affiliates. The inclusion of
affiliates in this definition is meant to make clear that the initial
margin threshold amount applies to an entity and its affiliates.
Similarly, the term ``affiliate'' is also used in the definition of
``material swaps exposure,'' as material swaps exposure takes into
account the exposures of an entity and its affiliates.
ii. Control
The definitions of ``affiliate'' and ``subsidiary'' use the term
``control,'' which is also a defined term in the proposal.\85\ The
proposal provides that control of another company means: (i) Ownership,
control, or power to vote 25 percent or more of a class of voting
securities of the company, directly or indirectly or acting through one
or more other persons; (ii) ownership or control of 25 percent or more
of the total equity of the company, directly or indirectly or acting
through one or more other persons; or (iii) control in any manner of
the election of a majority of the directors or trustees of the company.
This definition of control is similar to the definition under the BHC
Act and consequently should be familiar to many market
participants.\86\
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\85\ The term subsidiary is used in Sec. .9
to describe certain entities that are eligible for substituted
compliance.
\86\ See, e.g., section 2(a)(2) of the Bank Holding Company Act,
12 U.S.C. 1841(a)(2).
---------------------------------------------------------------------------
The Agencies seek comment on the definition of control in this
proposal. In particular, the Agencies request comment on this
definition of control as it relates to advised and sponsored funds and
sponsored securitization vehicles. The Agencies believe that advised
and sponsored funds and sponsored securitization vehicles would not be
affiliates of the investment adviser or sponsor unless the adviser or
sponsor meets the definition of control (e.g., owning 25 percent or
more of the voting securities or total equity or controlling the
election of the majority
[[Page 57364]]
of the directors or trustees). The 2013 international framework states
that investment funds that are managed by an investment adviser are
considered distinct entities that are treated separately when applying
the threshold as long as the funds are distinct legal entities that are
not collateralized by or otherwise guaranteed or supported by other
investment funds or the investment adviser in the event of fund
insolvency or bankruptcy. The intent of the Agencies is to follow the
approach of the 2013 international framework for investment funds and
securitization vehicles, including with respect to guarantees and other
collateral support arrangements. The Agencies request comment on
whether the proposal's definition of control would allow investment
funds and securitization vehicles to be treated separately in the
manner described in the 2013 international framework.
iii. Cross-Currency Swap
The proposal defines a cross-currency swap as a swap in which one
party exchanges with another party principal and interest rate payments
in one currency for principal and interest rate payments in another
currency, and the exchange of principal occurs upon the inception of
the swap, with a reversal of the exchange at a later date that is
agreed upon at the inception of the swap. As explained in greater
detail below, the proposal provides that the proposed initial margin
requirements for cross-currency swaps do not apply to the portion of
the swap that is the fixed exchange of principal. This treatment of
cross-currency swaps is consistent with the treatment recommended in
the 2013 international framework. This treatment of cross-currency
swaps also aligns with the determination by the Secretary of the
Treasury to exempt foreign exchange swaps from the definition of swap
as explained further below. Non-deliverable forwards would not be
treated as cross-currency swaps for purposes of the proposal, and thus
would be subject to the margin requirements set forth under the
proposed rule.
iv. Major Currencies
Major currencies is defined to mean: (i) United States Dollar
(USD); (ii) Canadian Dollar (CAD); (iii) Euro (EUR); (iv) United
Kingdom Pound (GBP); (v) Japanese Yen (JPY); (vi) Swiss Franc (CHF);
(vii) New Zealand Dollar (NZD); (viii) Australian Dollar (AUD); (ix)
Swedish Kronor (SEK); (x) Danish Kroner (DKK); (xi) Norwegian Krone
(NOK); and (xii) any other currency as determined by the relevant
Agency.\87\ Major currencies are eligible collateral for initial margin
as described further in Sec. .6.
---------------------------------------------------------------------------
\87\ See the CFTC's regulation of Off-Exchange Retail Foreign
Exchange Transactions and Intermediaries for this list of major
currencies, 75 FR 55410 at 55412 (September 10, 2010).
---------------------------------------------------------------------------
v. Prudential Regulator
The proposal defines prudential regulator to have the meaning
specified in section 1a(39) of the Commodity Exchange Act.\88\ Section
1a(39) of the Commodity Exchange Act defines the term ``prudential
regulator'' for purposes of the capital and margin requirements
applicable to swap dealers, major swap participants, security-based
swap dealers and major security-based swap participants. The entities
for which each of the Agencies is the prudential regulator is set out
in Sec. .1 of each Agency's rule text.
---------------------------------------------------------------------------
\88\ See 7 U.S.C. 1a(39).
---------------------------------------------------------------------------
vi. Eligible Master Netting Agreement
Qualifying master netting agreement (``QMNA'') was defined in the
2011 proposal, based on the definition of the term in the Federal
banking agencies' risk-based capital rules applicable to derivatives
positions held by insured depository institutions and bank holding
companies.\89\ A few commenters expressed concern with the 2011
proposal's definition of QMNA. These commenters argued that a
requirement providing that any exercise of rights under the agreement
will not be stayed or avoided under applicable law and would not allow
for rights to be stayed as required under certain bankruptcy,
receivership or liquidation regimes.
---------------------------------------------------------------------------
\89\ See 76 FR 27564 at 27576 (May 11, 2011).
---------------------------------------------------------------------------
Since the 2011 proposal, the Federal banking agencies have modified
the definition of QMNA used in their risk-based capital rules.\90\ The
proposal contains a revised definition based on the new QMNA definition
in the risk-based capital rules. However, the proposal uses the term
``eligible master netting agreement'' (``EMNA'') to avoid confusion
with and distinguish from the term used under the capital rules. The
Agencies believe that the modifications to the definition address the
concerns raised by commenters.
---------------------------------------------------------------------------
\90\ See 12 CFR part 3.2, 12 CFR part 217.2, and 12 CFR part
324.2.
---------------------------------------------------------------------------
The proposal defines EMNA as any written, legally enforceable
netting agreement that creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default (including receivership, insolvency, liquidation, or similar
proceeding) provided that certain conditions are met. These conditions
include requirements with respect to the covered swap entity's right to
terminate the contract and liquidate collateral and certain standards
with respect to legal review of the agreement to ensure it meets the
criteria in the definition. The legal review must be sufficient so that
the covered swap entity may conclude with a well-founded basis that,
among other things, the contract would be found legal, binding, and
enforceable under the law of the relevant jurisdiction and that the
contract meets the other requirements of the definition.
The Agencies believe that the revised EMNA definition addresses
commenters' concerns regarding certain insolvency regimes where rights
can be stayed. In particular, the second criteria has been modified to
provide that any exercise of rights under the agreement will not be
stayed or avoided under applicable law in the relevant jurisdictions,
other than (i) in receivership, conservatorship, or resolution by an
Agency exercising its statutory authority, or similar laws in foreign
jurisdictions that provide for limited stays to facilitate the orderly
resolution of financial institutions, or (ii) in a contractual
agreement subject by its terms to any of the foregoing laws.\91\
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\91\ See proposed rule Sec. .2.
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The Agencies request comment on whether the proposed definition of
EMNA provides sufficient clarity regarding the laws of foreign
jurisdictions that provide for limited stays to facilitate the orderly
resolution of financial institutions or whether additional specificity
should be provided regarding additional factors required in order for a
foreign law to qualify under the EMNA definition. For example, should
the definition include a limitation of the duration of the limited
stay? If so, what should such limitation be (e.g., one or two-business
days)? The Agencies also seek comment regarding whether the provision
for a contractual agreement made subject by its terms to limited stays
under resolution regimes adequately encompasses potential contractual
agreements of this nature or whether this provision needs to be
broadened, limited, clarified or modified in some manner.
vii. State
State is defined in the proposal to mean any State, commonwealth,
territory, or possession of the United States, the District of
Columbia, the Commonwealth of Puerto Rico, the Commonwealth of the
Northern Mariana
[[Page 57365]]
Islands, American Samoa, Guam, or the United States Virgin Islands. The
purpose of this definition is to make clear these regions would be
included as States for purposes of Sec. .9 that
addresses the cross-border application of margin requirements.
viii. U.S. Government-Sponsored Enterprises
The 2011 proposal did not specifically define U.S. Government-
sponsored enterprises, although it allowed the securities of these
entities to be pledged as eligible collateral. Under the 2014 proposal,
U.S. Government-sponsored enterprise means an entity established or
chartered by the U.S. government to serve public purposes specified by
Federal statute, but whose debt obligations are not explicitly
guaranteed by the full faith and credit of the United States. U.S.
Government-sponsored enterprises currently include Farm Credit System
banks, associations, and service corporations, Farmer Mac, the Federal
Home Loan Banks, Fannie Mae, Freddie Mac, the Financing Corporation,
and the Resolution Funding Corporation. In the future, Congress may
create new U.S Government-sponsored enterprises, or terminate the
status of existing U.S. Government-sponsored entities. This term is
used in the definition of eligible collateral as described further in
Sec. .6.
ix. Entity Definitions
The Agencies are including a number of other definitions including
``bank holding company,'' ``broker,'' ``dealer,'' ``depository
institution,'' ``foreign bank,'' ``futures commission merchant,''
``savings and loan holding company,'' and ``securities holding
company'' that are defined by cross-reference to the relevant statute.
Many of these terms are also used in the definition of ``financial end
user'' or ``market intermediary,'' which is defined to mean a
securities holding company, a broker, a dealer, a futures commission
merchant, a swap dealer, or a security-based swap dealer.
C. Section .3: Initial Margin
1. Overview of 2011 Proposal and Public Comments
Section .3 of the 2011 proposal set out the
initial margin amounts for a covered swap entity to collect from its
counterparty for its non-cleared swaps. The 2011 proposal specified,
among other things, the manner in which a covered swap entity must
calculate the initial margin requirements applicable to its non-cleared
swaps. These initial margin requirements applied only to the amount of
initial margin that a covered swap entity would be required to collect
from its counterparties. In general, these requirements did not address
whether, or in what amounts, a covered swap entity must post initial
margin to a counterparty.\92\
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\92\ As previously discussed, Sec. .11 of the
FHFA and FCA versions of the 2011 proposal required all institutions
supervised by FHFA and the FCA to collect initial and variation
margin from their swap entity counterparties.
---------------------------------------------------------------------------
The 2011 proposal requested comment on whether the rule should
incorporate two-way margining. A number of commenters stated that the
Agencies should require covered swap entities to post margin.
Commenters raised a number of concerns regarding the lack of any
requirement for covered swap entities to post both initial margin and
variation margin to their counterparties. For example, one commenter
argued that covered swap entities that do not post collateral present a
risk to the system in the event that such covered swap entities
experience financial distress. Commenters also said that by requiring
two-way margining, overall leverage exposure would be reduced to an
appropriate level.
Under the 2011 proposal, a covered swap entity would have been
permitted to select from two alternatives to calculate its initial
margin requirements. A covered swap entity could calculate its initial
margin requirements using a standardized ``look-up'' table that
specified the minimum initial margin that was required to be collected.
Alternatively, a covered swap entity could calculate its minimum
initial margin requirements using an internal margin model that met
certain criteria and that had been approved by the relevant prudential
regulator.
In the 2011 proposal, the Agencies proposed initial margin
threshold amounts, which varied based on the relative risk posed by the
counterparty; high-risk financial end users were subject to lower
threshold amounts than low-risk financial end users; and nonfinancial
end users were subject to thresholds that were set according to the
covered swap entity's internal credit policies. Commenters expressed
varying views on the proposed thresholds. For example, one commenter
stated that establishing thresholds by counterparty type was too broad
and did not appropriately reflect risk. Another commenter suggested
that low-risk financial end users should not be subject to a threshold,
while a third commenter stated that dollar threshold amounts were
arbitrary and should be eliminated altogether.
Under the 2011 proposal, a covered swap entity was required to
collect initial margin on or before the date it entered into a swap.
Some commenters indicated that this requirement was operationally
infeasible due to timing cutoffs and time differences between time
zones, and for this reason, commenters requested that the Agencies
permit covered swap entities to collect initial margin one to three
days after entering into the transaction.
2. 2014 Proposal
a. Collecting and Posting Initial Margin
Consistent with the 2013 international framework and comments
received relating to the 2011 proposal, the Agencies are proposing that
swap entities that are transacting in non-cleared swaps with one
another or with financial end users with material swaps exposure
collect and post initial margin with respect to those non-cleared
swaps. Assuming all swap entities will be subject to an Agency, CFTC,
or SEC margin rule that requires collection of initial margin, the
proposed rule will result in a collect-and-post system for all non-
cleared swaps between swap entities. Under this proposal, a covered
swap entity transacting with a financial end user with material swaps
exposure must (i) calculate its initial margin collection amount using
an approved internal model or the standardized look-up table, (ii)
collect an amount of initial margin that is at least as large as the
initial margin collection amount less any permitted initial margin
threshold amount (which is discussed in more detail below), and (iii)
post at least as much initial margin to the financial end user with
material swaps exposure as the covered swap entity would be required to
collect if it were in the place of the financial end user with material
swaps exposure.
b. Calculation Alternatives
Similar to the 2011 proposal, the proposed rule permits a covered
swap entity to select from two methods (the standardized look-up table
or the internal margin model) for calculating its initial margin
requirements. In all cases, the initial margin amount required under
the proposed rule is a minimum requirement; covered swap entities are
not precluded from collecting additional initial margin (whether by
contract or subsequent agreement with the counterparty) in such forms
and amounts as the covered swap entity believes is appropriate. These
methods are discussed further below under Appendix A and Sec.
.8,
[[Page 57366]]
respectively. Section .8 also addresses the use of
EMNAs for initial margin.
c. Initial Margin Thresholds
As part of the proposed rule's initial margin requirements and
consistent with the 2013 international framework, a covered swap entity
using either calculation method may adopt an initial margin threshold
amount of up to $65 million, below which the covered swap entity need
not collect or post initial margin from and to a swap entity or
financial end user with a material swaps exposure.\93\ This feature of
the proposed threshold serves two purposes. First, covered swap
entities would be able to make greater use of their own internal credit
assessments when making a threshold determination as to the credit and
other risks presented by a specific counterparty. Covered swap entities
dealing with counterparties that are judged to be of high credit
quality may determine a counterparty-specific threshold (of up to $65
million) so credit extensions made by covered swap entities can be more
flexible and better informed by granular, internal credit
determinations. Second, allowing the use of initial margin thresholds,
to the extent prudently applied by covered swap entities, may reduce
the potential liquidity burden of the proposed margin requirements. A
number of commenters on the 2011 proposal indicated that the liquidity
costs of the proposed requirements were inappropriately high. Unlike
the 2011 proposal, the current proposal requires both collection and
posting of initial margin. Moreover, the Agencies anticipate that
allowing for the use of initial margin thresholds of up to $65 million
will provide relief to smaller and less systemically risky
counterparties while ensuring that initial margin is collected from
those counterparties that pose the greatest systemic risk to the
financial system.
---------------------------------------------------------------------------
\93\ This credit exposure limit is defined in the proposed rule
as the initial margin threshold amount. See proposed rule Sec. Sec.
.2, .3(a). A covered swap entity
that has established an initial margin threshold amount for a
counterparty need only collect initial margin if the required amount
exceeds the initial margin threshold amount, and in such cases is
only required to collect the excess amount.
---------------------------------------------------------------------------
The proposed initial margin threshold of $65 million would be
applied on a consolidated entity level, and therefore, would apply
across all non-cleared swaps between a covered swap entity and its
affiliates and the counterparty and its affiliates. For example,
suppose that a firm engages in separate swap transactions, executed
under separate legally enforceable EMNAs, with three counterparties,
all belonging to the same larger consolidated group, such as a bank
holding company. Suppose further that the initial margin requirement is
$100 million for each of the firm's netting sets with each of the three
counterparties. The firm dealing with these three affiliates must
collect at least $235 million (235 = $100 + $100 + $100 - $65) from the
consolidated group. Exactly how the firm allocates the $65 million
threshold among the three netting sets is subject to agreement between
the firm and its counterparties. The firm may not extend the $65
million threshold to each netting set so that the total amount of
initial margin collected is only $105 million (105 = 100 - 65 + 100 -
65 + 100 - 65). The requirement to apply the threshold on a fully
consolidated basis applies to both the counterparty to which the
threshold is being extended and the counterparty that is extending the
threshold.\94\ Applying this threshold on a consolidated entity level
precludes the possibility that covered swap entities and their
counterparties would create legal entities and netting sets that have
no economic basis and are constructed solely for the purpose of
applying additional thresholds to evade margin requirements.
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\94\ Suppose that in the example set out above, the firm is
organized into three subsidiaries (A, B, and C) and each of these
subsidiaries engages in non-centrally cleared swaps with the
counterparties. In this case, the extension of the $65 million
threshold by the firm to the counterparties is considered across the
entirety of the firm, including the affiliates A, B and C, so that
all affiliates of the firm extend in the aggregate no more than $65
million in an initial margin threshold to all of the counterparties.
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The Agencies' preliminary view is that the proposed initial margin
threshold of $65 million is appropriate and reflects a risk-based
approach to the margin requirements. However, the Agencies seek comment
on the use of such a threshold in the margin requirements and the
proposed size of $65 million. Importantly, the Agencies recognize that
allowing for a significant initial margin threshold subjects covered
swap entities and their counterparties to credit risk that may
materialize quickly in the event of a significant period of financial
stress. Is the proposed use of an initial margin threshold appropriate
in light of the risks associated with its use? Does the proposed level
of the threshold appropriately balance the need to limit the liquidity
impact of the requirements with the need to limit credit exposures in
non-cleared swaps markets? Are there other approaches that could be
taken in this regard that would be more effective than the proposed
initial margin threshold approach?
d. Material Swaps Exposure
Under the proposed rule and consistent with the 2013 international
framework, covered swap entities are required to collect and post
initial margin only with financial end user counterparties that have a
material swaps exposure. The Agencies do not propose to require the
exchange of initial margin with financial end users with small
exposures, as it is assumed that these entities, in most circumstances,
would have an initial margin requirement that is significantly less
than the proposed $65 million threshold amount.\95\ Requiring covered
swap entities to subject financial end users with exposures that would
generally result in initial margin requirements substantially below $65
million could create significant operational burdens, as the initial
margin collection amounts would need to be calculated on a daily basis
even though no initial margin would be expected to be collected given
that these amounts would be below the permitted initial margin
threshold of $65 million.
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\95\ To be consistent, both ``initial margin threshold'' and
``material swaps exposure'' are defined to include the counterparty
and its affiliates.
---------------------------------------------------------------------------
Under the proposed rule and consistent with the 2013 international
framework, the Agencies have adopted a simple and transparent approach
to defining material swaps exposure that depends on a counterparty's
gross notional derivative exposure for non-cleared swaps. The Agencies'
preliminary view is that this approach is appropriate as gross notional
derivative exposure is broadly related to a counterparty's overall size
and risk exposure and provides for a simple and transparent measurement
of exposure that presents only a modest operational burden. Under the
proposed rule, a covered swap entity would not be required to collect
or post initial margin to or from a financial end user counterparty
without a material swaps exposure, that is, if its average daily
aggregate notional amount of covered swaps over a defined period
exceeds $3 billion.\96\ This amount differs from that set forth in the
2013 international framework, which defines smaller financial end users
as those counterparties that have a gross aggregate amount of covered
swaps below [euro]8 billion, which, at current exchange rates, is
approximately equal to $11 billion.
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\96\ The definition of ``material swaps exposure'' can be found
in Sec. .2 of the proposed rule.
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The Agencies' preliminary view is that defining material swaps
exposure
[[Page 57367]]
as a gross notional exposure of $3 billion, rather than $11 billion, is
appropriate because it reduces systemic risk without imposing undue
burdens on covered swap entities, and therefore, is consistent with the
objectives of the Dodd-Frank Act. This view is based on data and
analyses that have been conducted since the publication of the 2013
international framework.
Specifically, the Agencies have reviewed actual initial margin
requirements for a sample of cleared swaps. These analyses indicate
that there are a significant number of cases in which a financial end
user counterparty would have a material swaps exposure level below $11
billion but would have a swap portfolio with an initial margin
collection amount that significantly exceeds the proposed permitted
initial margin threshold amount of $65 million. The intent of both the
Agencies and the 2013 international framework is that the initial
margin threshold provide smaller counterparties with relief from the
operational burden of measuring and tracking initial margin collection
amounts that are expected to be below $65 million. Setting the material
swaps exposure threshold at $11 billion appears to be inconsistent with
this intent, based on the recent analyses.
The table below summarizes actual initial margin requirements for
4,686 counterparties engaged in cleared interest rate swaps. Each
counterparty represents a particular portfolio of cleared interest rate
swaps. Each counterparty had a swap portfolio with a total gross
notional amount less than $11 billion and each is a customer of a CCP's
clearing member (no customer is itself a CCP clearing member). Column
(1) displays the initial margin amount as a percentage of the gross
notional amount. Column (2) reports the initial margin, in millions of
dollars that would be required on a portfolio with a gross notional
amount of $11 billion.
Initial Margin Amounts on 4,686 Cleared Interest Rate Swap Portfolios
------------------------------------------------------------------------
Column (2) Initial
Column (1) Initial margin amount on an
margin amount as $11 billion gross
percentage of gross notional portfolio
notional amount (%) ($MM)
------------------------------------------------------------------------
Average..................... 2.1 231
25th Percentile............. 0.6 66
50th Percentile............. 1.4 154
75th Percentile............. 2.7 297
------------------------------------------------------------------------
As shown in the table above, the average initial margin rate across
all 4,686 counterparties, reported in Column (1), is 2.1 percent, which
would equate to an initial margin collection amount, reported in Column
(2), of $231 million on an interest rate swap portfolio with a gross
notional amount of $11 billion. This average initial margin collection
amount significantly exceeds the proposed permitted threshold amount of
$65 million. Seventy-five percent of the 4,686 cleared interest rate
swap portfolios exhibit an initial margin rate in excess of 0.6
percent, which equates to an initial margin amount on a cleared
interest rate swap portfolio of $66 million (approximately equal to the
proposed permitted threshold amount).
The data above represent actual margin requirements on a sample of
interest rate swap portfolios that are cleared by a single CCP. Some
CCPs also provide information on the initial margin requirements on
specific and representative swaps that they clear. The Chicago
Mercantile Exchange (``CME''), for example, provides information on the
initial margin requirements for cleared interest rate swaps and credit
default swaps that it clears. This information does not represent
actual margin requirements on actual swap portfolios that are cleared
by the CME but does represent the initial margin that would be required
on specific swaps if they were cleared at the CME. The table below
presents the initial margin requirements for two swaps that are cleared
by the CME.
Initial Margin Amounts on CME Cleared Interest Rate and Credit Default
Swaps
------------------------------------------------------------------------
Column (2) Initial
Column (1) Initial margin amount on an
margin amount as $11 billion gross
percentage of gross notional portfolio
notional amount (%) ($MM)
------------------------------------------------------------------------
5 year, receive fixed and 2.0 216
pay floating rate interest
rate swap..................
5 year, sold CDS protection 1.9 213
on the CDX IG Series 20
Version 22 Index...........
------------------------------------------------------------------------
According to the CME, the initial margin requirement on the
interest rate swap and the credit default swap are both roughly two
percent of the gross notional amount. This initial margin rate
translates to an initial margin amount of roughly $216 million on a
swap portfolio with a gross notional amount of $11 billion.
Accordingly, this data also indicates that the initial margin
collection amount on a swap portfolio with a gross notional size of $11
billion could be significantly larger than the proposed permitted
initial margin threshold of $65 million.
In addition to the information provided in the tables above, the
Agencies' preliminary view is that additional considerations suggest
that the initial margin collection amounts associated with non-cleared
swaps could be even greater than those reported in the tables above.
The tables above represent initial margin requirements on cleared
interest rate and credit default index swaps. Non-cleared swaps in
other asset classes, such as single name equity or single name credit
default swaps, are likely to be riskier and hence would require even
more initial margin. In addition, non-cleared swaps often contain
complex features, such as nonlinearities, that
[[Page 57368]]
make them even riskier and would hence require more initial margin.
Finally, non-cleared swaps are generally expected to be less liquid
than cleared swaps and must be margined, under the proposed rule,
according to a ten-day close-out period rather than the five-day period
required for cleared swaps. The data presented above pertains to
cleared swaps that are margined according to a five-day and not a ten-
day close-out period. The requirement to use a ten-day close-out period
would further increase the initial margin requirements of non-cleared
versus cleared swaps.
In light of the data and considerations noted above, the Agencies'
preliminary view is that it is appropriate and consistent with the
intent of the 2013 international framework to identify a material swaps
exposure with a gross notional amount of $3 billion rather than $11
billion ([euro]8 billion) as is suggested by the 2013 international
framework. Identifying a material swaps exposure with a gross notional
amount of $3 billion is more likely to result in an outcome in which
entities with a gross notional exposure below the material swaps
exposure amount would be likely to have an initial margin collection
amount below the proposed permitted initial margin threshold of $65
million. The Agencies do recognize, however, that even at the lower
amount of $3 billion, there are likely to be some cases in which the
initial margin collection amount of a portfolio that is below the
material swaps exposure amount will exceed the proposed permitted
initial margin threshold amount of $65 million. The Agencies'
preliminary view is that such instances should be relatively rare and
that the operational benefits of using a simple and transparent gross
notional measure to define the material swaps exposure amount are
substantial.
The Agencies seek comment on the use and definition of material
swaps exposure. In particular, is the proposed $3 billion level of the
material swaps exposure appropriate? Should the amount be higher or
lower and if so, why? Are there alternative measurement methodologies
that do not rely on gross notional amounts that should be used? Does
the proposed rule's use and definition of the material swaps exposure
raise any competitive equity issues that should be considered? Are
there any other aspects of the material swaps exposure that should be
considered by the Agencies?
d. Timing
The proposed rule establishes the timing under which a covered swap
entity must comply with the initial margin requirements set out in
Sec. Sec. .3(a) and (b). Under the proposed rule, a
covered swap entity, with respect to any non-cleared swap to which it
is a party, must, on a daily basis, comply with the initial margin
requirements for a period beginning on or before the business day
following the day it enters into the transaction and ending on the date
the non-cleared swap is terminated or expires. This requirement will
cause covered swap entities to recalculate their initial margin
requirements per their internal margin models or the standardized look-
up table each business day. As a result, covered swap entities may need
to adjust the amount of initial margin they collect or post on a daily
basis.
Under the 2011 proposal, a covered swap entity was required to
collect initial margin on or before the date it entered into a non-
cleared swap. In the proposed rule, the Agencies have changed the
timing provision in Sec. .3 to require a covered swap entity
to comply with the initial margin requirements beginning on or before
the business day following the day it enters into the swap. Providing
an additional day is intended to address the operational concerns
raised by the commenters to the 2011 proposal.
e. Other Counterparties
Under the proposed rule, a covered swap entity is not required as a
matter of course to collect initial margin with respect to any non-
cleared swap with a counterparty other than a financial end user with
material swaps exposure or a swap entity, but shall collect initial
margin at such times and in such forms and amounts (if any) that the
covered swap entity determines appropriately address the credit risk
posed by the counterparty and the risks of such swaps. Thus, the
specific provisions of the Agencies' rules on initial margin
requirements, documentation, and eligible collateral would not apply to
non-cleared swaps between covered swap entities and these ``other
counterparties.'' These ``other counterparties'' would include
nonfinancial end users, entities that are excluded from the definition
of financial end user, and financial end users without material swaps
exposure. The Agencies' preliminary view is that this treatment of
``other counterparties'' is consistent with the Dodd-Frank Act's risk-
based approach to establishing margin requirements. In particular, the
Agencies intend for the proposed requirements with respect to ``other
counterparties'' to be consistent with current market practice and
understand that in many cases a covered swap entity would exchange
little or no margin with these counterparty types. There may be
circumstances, however, in which a covered swap entity finds it prudent
to collect initial margin from these counterparty types, for example,
if a covered swap entity chose to incorporate margin to mitigate the
safety and soundness effects of its credit exposures to these
counterparty types.
D. Section .4: Variation Margin
1. Overview of 2011 Proposal and Public Comments
Section .4 of the 2011 proposal specified the variation
margin requirements applicable to non-cleared swaps. Consistent with
the treatment of initial margin in the 2011 proposal, the variation
margin requirements applied only to the collection of variation margin
by covered swap entities from their counterparties, and not to the
posting of variation margin to their counterparties. Under the 2011
proposal, covered swap entities and their counterparties were free to
negotiate the extent to which a covered swap entity could have been
required to post variation margin to a counterparty (other than a swap
entity that is itself subject to margin requirements). In the 2011
proposal, the Agencies requested comment on whether the margin rules
should impose a separate, additional requirement that a covered swap
entity post variation margin to financial end users and nonfinancial
end users. Consistent with the comments received relating to initial
margin, many commenters recommended two-way posting of variation margin
for transactions between covered swap entities and financial end users.
Specifically, commenters argued that the bilateral exchange of
variation margin would reduce systemic risk, increase transparency, and
facilitate central clearing.
The 2011 proposal also established a minimum amount of variation
margin that must be collected, leaving covered swap entities free to
collect larger amounts if they elected to do so. Under the 2011
proposal, a covered swap entity would have been permitted to establish,
for certain counterparties that are end users, a credit exposure limit
that acts as a threshold below which the covered swap entity need not
collect variation margin. Specifically, the variation margin threshold
amount that a covered swap entity could establish for a low-risk
financial end user counterparty could be calculated in the same way as
the proposed initial margin threshold amounts for such counterparties.
The 2011 proposal
[[Page 57369]]
would not have allowed a variation margin threshold amount for swap
entity or high-risk financial end user counterparties. The 2011
proposal permitted a covered swap entity to calculate variation margin
requirements on an aggregate basis across all non-cleared swaps with a
counterparty that were executed under the same QMNA. The Agencies
requested comment regarding whether permitting the aggregate
calculation of variation margin requirements was appropriate and, if
so, whether the 2011 proposal's definition of ``QMNA'' raised practical
or implementation difficulties or was inconsistent with market
practices. Commenters generally supported netting and argued that
netting diversification should be allowed across asset classes.
The 2011 proposal also specified that covered swap entities
calculate and collect variation margin from counterparties that were
themselves swap entities or financial end users at least once per
business day, and from counterparties that are nonfinancial end users
at least once per week once the relevant credit threshold was exceeded.
2. 2014 Proposal
a. Collecting and Paying Variation Margin
Consistent with the initial margin requirements of this proposal,
the Agencies are proposing that swap entities transacting with one
another and with financial end users be required to collect and pay
variation margin with respect to non-cleared swaps. As with initial
margin, the Agencies believe that requiring covered swap entities both
to collect and pay margin with these counterparties effectively reduces
systemic risk by protecting both the covered swap entity and its
counterparty from the effects of a counterparty default.
In response to the comments received and consistent with the 2013
international framework, the proposed rule would require a covered swap
entity to collect variation margin from all swap entities and from
financial end users regardless of whether the financial end user has a
material swaps exposure. The proposed rule generally requires a covered
swap entity to collect and pay variation margin on non-cleared swaps in
an amount that is at least equal to the increase or decrease (as
applicable) in the value of such swaps since the previous exchange of
variation margin. Unlike the 2011 proposal, and the initial margin
requirements set out in Sec. Sec. .3(a) and (b) of this
proposal, a covered swap entity may not adopt a threshold amount below
which it need not collect or pay variation margin on swaps with a swap
entity or financial end user counterparty (although transfers below a
minimum transfer amount would not be required, as discussed in Sec.
.5, below).
The terms ``pay'' and ``paid'' are used when referring to variation
margin. This terminology is being proposed based on a preliminary
understanding that market participants view the economic substance of
variation margin as settling the daily exposure of non-cleared swaps
between counterparties. This perception is reinforced by the current
market practice among swap participants of requiring that variation
margin, where required under the parties' negotiated agreements, be
provided in cash. As noted below, Sec. .6 of the proposed
rule would limit eligible collateral for variation margin to cash.
The market perception that variation margin essentially settles the
current exposure may not always align with the underlying legal
requirement or with contracts that document the parties' rights and
obligations with respect to swaps. On the one hand, for cleared swaps,
derivatives clearing organizations are required by law to settle the
exposure with counterparties at least daily, and thus the legal
requirement is aligned with market participants' perceptions about the
underlying economic substance of such transfers.\97\ On the other hand,
for non-cleared swaps, there is currently no statutory requirement that
counterparties settle their exposures daily, leaving parties to
negotiate such settlement.
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\97\ Section 5b(c)(2)(E) of the Commodity Exchange Act requires
derivatives clearing organizations to ``complete money settlements
on a timely basis (but not less frequently than once each business
day).'' CFTC regulations define ``settlement'' as, among other
things, ``payment and receipt of variation margin for futures,
options, and swaps.'' 17 CFR 39.14(a)(1). Further, CFTC regulations
require that ``except as otherwise provided by Commission order,
derivatives clearing organizations shall effect a settlement with
each clearing member at least once each business day.'' 17 CFR
39.14(b).
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It is the Agencies' understanding that standard swap documentation
may treat variation margin differently depending on the underlying
legal structure. For example, swap agreements under New York law might
refer to variation margin as being ``posted'' pursuant to a security
interest. Swap documentation referencing English law, however, may be
aligned with a title transfer regime under which variation margin is
not furnished pursuant to a security interest.
By proposing to use ``pay'' and ``paid'' terminology with respect
to variation margin, the Agencies do not intend to propose to mandate,
as a legal matter, to alter current practices under which variation
margin is characterized as being ``posted'' pursuant to an agreement
that establishes a security interest. Also, the Agencies, by proposing
``pay'' and ``paid'' terminology, do not intend to alter the
characterization of such transfer of variation margin funds for
accounting, tax, or other purposes. The Agencies invite comment on the
appropriateness of the proposed terminology and whether other
terminology may better address the underlying purpose of the legal
requirements for the Agencies to establish requirements related
variation margin requirements.
b. Frequency
Section .4(b) of the proposed rule establishes the
frequency at which a covered swap entity must comply with the variation
margin requirements set out in Sec. .4(a). Under the proposed
rule, a covered swap entity must collect or pay variation margin with
swap entities and financial end user counterparties no less frequently
than once per business day.
c. Other Counterparties
Like the proposed initial margin requirements set out in Sec.
.3, the proposed rule permits a covered swap entity to collect
variation margin from counterparties other than swap entities and
financial end users at such times and in such forms and amounts (if
any) that the covered swap entity determines appropriately address the
credit risk posed by the counterparty and the risks of such non-cleared
swaps. The specific provisions of the Agencies' rules on variation
margin requirements, documentation, eligible collateral, segregation,
and rehypothecation would not apply to swaps between covered swap
entities and these ``other counterparties.'' As with initial margin,
the Agencies intend for the proposed requirements to be consistent with
current market practice and understand that, in many cases, a covered
swap entity would exchange little or no margin with these counterparty
types.
An important difference between the treatment of ``other
counterparties'' in the cases of initial margin and of variation margin
is that the scope of ``other counterparties'' for variation margin
requirements is narrower than for the initial margin requirements.
Specifically, under the proposed rule, financial end users without
material swaps exposures are treated similarly as ``other
counterparties'' in the context of the initial margin requirements but
not the variation margin requirements.
[[Page 57370]]
In other words, all financial end user counterparties are subject
to the variation margin requirements, while only financial end user
counterparties with material swaps exposure are subject to initial
margin requirements. The different composition of ``other
counterparties'' between the proposed initial and variation margin
requirements reflects the Agencies' view that variation margin is an
important risk mitigant that (i) reduces the build-up of risk that may
ultimately pose systemic risk; (ii) imposes a lesser liquidity burden
than does initial margin; and (iii) reflects current market practice
and a risk management best practice by providing for the regular
exchange of variation margin between covered swap entities and
financial end users.
e. Netting Arrangements
Similar to the 2011 proposal, the proposed rule permits a covered
swap entity to calculate variation margin requirements on an aggregate
net basis across all non-cleared swap transactions with a counterparty
that are executed under a single EMNA. If an EMNA covers non-cleared
swaps that were entered into before the applicable compliance date,
those swaps must be included in the aggregate for purposes of
calculating the required variation margin. As discussed previously,
under the proposed rule, the margin requirements would not be applied
retroactively, and therefore, no new initial margin or variation margin
requirements would be imposed on non-cleared swaps entered into prior
to the relevant compliance date until those transactions are rolled-
over or renewed. The only requirements that would apply to a pre-
compliance date transaction would be the initial margin and variation
margin requirements to which the parties to the transaction had
previously agreed by contract. However, if non-cleared swaps that were
entered into prior to the applicable compliance date were included in
the EMNA, those swaps would be subject to the proposed variation margin
requirements. A covered swap entity would need to establish a new EMNA
to cover only swaps entered into after the compliance date in order to
not include pre-compliance date swaps. Like the 2011 proposal, the
proposed rule defines an EMNA as a legally enforceable agreement to
offset positive and negative mark-to-market values of one or more swaps
that meet a number of specific criteria designed to ensure that these
offset rights are fully enforceable, documented and monitored by the
covered swap entity.\98\
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\98\ EMNAs are discussed in more detail in Sec. .2 of
the proposed rule.
---------------------------------------------------------------------------
E. Section .5: Minimum Transfer Amount and Satisfaction of
Collecting and Posting Requirements
1. Minimum Transfer Amount
The 2011 proposal included a minimum transfer amount for the
collection of initial and variation margin by covered swap entities.
Under the 2011 proposal, a covered swap entity was not required to
collect margin from any individual counterparty otherwise required
under the rule until the required cumulative amount was $100,000 or
more.
The proposed rule also provides for a minimum transfer amount for
the collection and posting of margin by covered swap entities. Under
the proposal, a covered swap entity need not collect or post initial or
variation margin from or to any individual counterparty otherwise
required unless and until the required cumulative amount of initial and
variation margin is greater than $650,000.\99\ This minimum transfer
amount is consistent with the 2013 international framework and
addresses a number of comments received on the 2011 proposal indicating
that the $100,000 minimum transfer amount was too low and inconsistent
with market practice. The Agencies' preliminary view is that the higher
minimum transfer amount is consistent with the mandate to mitigate risk
to swap entities and to the financial system.
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\99\ See proposed rule Sec. .5(a). The minimum
transfer amount only affects the timing of margin collection; it
does not change the amount of margin that must be collected once the
$650,000 threshold is crossed. For example, if the margin
requirement were to increase from $500,000 to $800,000, the covered
swap entity would be required to collect the entire $800,000
(subject to application of any applicable initial margin threshold
amount).
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2. Satisfaction of Collecting and Posting Requirements
The 2011 proposal addressed the situation where a counterparty
refused or otherwise failed to make variation margin payments to a
covered swap entity. The 2011 proposal provided that the covered swap
entity would not be in violation of the rule in this situation so long
as it took certain steps to collect the margin or commenced termination
of the swap.
This proposal includes similar provisions with respect to both
initial and variation margin. Specifically, under Sec. .5(b),
a covered swap entity shall not be deemed to have violated its
obligation to collect or post initial or variation margin from or to a
counterparty if: (1) The counterparty has refused or otherwise failed
to provide or accept the required margin to or from the covered swap
entity; and (2) the covered swap entity has (i) made the necessary
efforts to collect or post the required margin, or has otherwise
demonstrated upon request to the satisfaction of the appropriate Agency
that it has made appropriate efforts to collect the required margin, or
(ii) commenced termination of the non-cleared swap with the
counterparty promptly following the applicable cure period and
notification requirements.
F. Section .6: Eligible Collateral
1. Overview of 2011 Proposal and Public Comments
The 2011 proposal placed strict limits on the collateral that
covered swap entities could collect to meet their minimum margin
requirements. For minimum variation margin requirements, the Agencies
proposed to recognize only immediately available cash (denominated
either in U.S. dollars or in the currency in which payment obligations
under the swap contract would be settled) and obligations issued by or
fully guaranteed by the U.S. government. For minimum initial margin
requirements, the Agencies proposed to recognize the aforementioned
assets plus senior debt obligations issued by Fannie Mae, Freddie Mac,
the Federal Home Loan Banks, or Farmer Mac, and ``insured obligations''
of the Farm Credit Banks.\100\
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\100\ ``Insured obligations'' of FCS banks are consolidated and
System-wide obligations issued by FCS banks. These obligations are
insured by the Farm Credit System Insurance Corporation out of funds
in the Farm Credit Insurance Fund. Should the Farm Credit Insurance
Fund ever be exhausted, Farm Credit System banks are jointly and
severally liable for payment on insured obligations. See 12 U.S.C.
2277a-3.
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Most commenters that addressed the eligible collateral section of
the 2011 proposal, including industry groups and members of Congress,
stated that the Agencies should expand the list of eligible collateral
to include a broader range of high-quality, liquid and readily
marketable assets. These commenters stated that a more expansive list
of eligible collateral would be consistent with market practice,
legislative intent, and international standards. Many commenters
suggested that the minimum margin requirements included in the 2011
proposal could disrupt financial markets by significantly increasing
the demand for certain liquid assets, inadvertently
[[Page 57371]]
restrict liquidity and, in turn, slow economic growth. Additionally,
commenters suggested that increased demand for ``eligible'' assets
could inappropriately distort the market for those assets relative to
other high-quality, liquid, and readily marketable assets.
2. 2014 Proposal
a. Variation Margin Collateral
Under the proposal, the Agencies are proposing to require the
collection or payment of immediately available cash funds to satisfy
the minimum variation margin requirements. Such payment must be
denominated either in U.S. dollars or in the currency in which payment
obligations under the swap are required to be settled. When determining
the currency in which payment obligations under the swap are required
to be settled, a covered swap entity must consider the entirety of the
contractual obligation. As an example, in cases where a number of
swaps, each potentially denominated in a different currency, are
subject to a single master agreement that requires all swap cash flows
to be settled in a single currency, such as the Euro, then that
currency (Euro) may be considered the currency in which payment
obligations are required to be settled. The Agencies request comment on
whether there are current market practices that would raise
difficulties or concerns about identifying the appropriate settlement
currency in applying this aspect of the proposed rule, from a
contractual or other operational standpoint.
Limiting variation margin to cash should sharply reduce the
potential for disputes over the value of variation margin collateral.
Additionally, this proposed change is consistent with regulatory and
industry initiatives to improve standardization and efficiency in the
OTC swaps market. For example, in June 2013, ISDA published the 2013
Standard Credit Support Annex (SCSA), which provides for the sole use
of cash for variation margin. Additionally, the Agencies note that
central counterparties generally require variation margin to be paid in
cash.
Under this proposed rule, the value of cash paid to satisfy
variation margin requirements is not subject to a haircut. Variation
margin payments reflect gains and losses on a swap transaction, and
payment or receipt of variation margin generally represents a transfer
of ownership in the collateral. Therefore, haircuts are not a necessary
component of the regulatory requirements for cash variation margin.
The Agencies seek comment on the appropriateness of limiting
variation margin to cash, and on any other revisions that commenters
believe would be appropriate to better align the variation margin
requirements applicable with arrangements that are currently observed
in the OTC swap market.
b. Initial Margin Collateral
The Agencies are proposing to expand the list of eligible
collateral with respect to the collection and posting of initial
margin. The standards for eligible initial margin collateral in the
2014 proposal pertain to collateral collected or posted in connection
with the proposed minimum requirements. This proposal in no way
restricts the types of collateral that may be collected or posted to
satisfy margin terms that are bilaterally negotiated and not required
under the proposal. For example, under the proposal a covered swap
entity may extend an initial margin threshold of up to $65 million on
an aggregate basis to each swap entity or financial end user
counterparty and its affiliates. If a covered swap entity extended such
an initial margin threshold to a counterparty and the resulting minimum
initial margin requirement was zero, but the covered swap entity
decided to collect initial margin collateral to protect itself against
counterparty credit risk, then the covered swap entity could choose to
collect that initial margin in any form of collateral, including forms
other than the types of collateral specified in the rule.
Relatedly, under the 2014 proposal, covered swap entities need to
collect initial margin for non-cleared swaps with certain entities
(``other counterparties'') in such forms and amounts (if any) and at
such times that the covered swap entity determines appropriately
address the credit risk posed by the counterparty and the risks of such
transactions. For such a transaction, a covered swap entity is
responsible for determining the amount, the form, and the time for the
margin to be collected. Accordingly, margin collected by a covered swap
entity in connection with a non-cleared swap with an ``other
counterparty'' can be in any form of collateral, including in forms
other than the types of collateral specified in the rule.
Although the list of eligible collateral in the 2014 proposal for
initial margin is more expansive than the 2011 proposal, the Agencies
continue to believe that it is necessary to impose limits on the types
of assets eligible to satisfy the minimum margin requirements.
Therefore, the Agencies are limiting the recognition of collateral to
certain assets deemed to be highly liquid, particularly during a period
of financial stress as suggested by the 2013 international framework.
To support this approach, the Agencies note that to protect a covered
swap entity during periods of financial stress, collateral eligible to
satisfy the proposed minimum margin requirements should not have
excessive exposures to credit, market, or foreign exchange risk.
The Agencies are proposing to permit a broader range of collateral
to be pledged to satisfy the minimum initial margin requirements, which
includes cash collateral (subject to the same requirements applicable
to variation margin) and any of the following:
(1) A security that is issued by, or unconditionally guaranteed as
to the timely payment of principal and interest by, the U.S. Department
of the Treasury;
(2) A security that is issued by, or unconditionally guaranteed as
to the timely payment of principal and interest by, a U.S. government
agency (other than the U.S. Department of the Treasury) whose
obligations are fully guaranteed by the full faith and credit of the
United States government;
(3) A publicly traded debt security issued by, or an asset-backed
security fully guaranteed as to the timely payment of principal and
interest by, a U.S. Government-sponsored enterprise that is operating
with capital support or another form of direct financial assistance
received from the U.S. government that enables the repayments of the
U.S. Government-sponsored enterprise's eligible securities;
(4) Any major currency, regardless of whether it is the currency in
which payment obligations under the swap are required to be settled;
(5) A security that is issued by the European Central Bank or by a
sovereign entity that receives no higher than a 20 percent risk weight
under subpart D of the Federal banking agencies' risk-based capital
rules; \101\
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\101\ See 12 CFR part 3, subpart D, 12 CFR part 217, subpart D,
and 12 CFR part 324, subpart D.
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(6) A security that is issued by or unconditionally guaranteed as
to the timely payment of principal and interest by the Bank for
International Settlements, the International Monetary Fund, or a
multilateral development bank;
(7) A publicly traded debt security for which the issuer has
adequate capacity to meet financial commitments (as defined by the
appropriate Federal
[[Page 57372]]
agency),\102\ including such a security issued by a U.S. Government-
sponsored enterprise not covered in (3), above;
---------------------------------------------------------------------------
\102\ The FCA is proposing a new definition of ``investment
grade'' only for FCS institutions in Sec. .2 that is
identical to 12 CFR 1.2(d).
---------------------------------------------------------------------------
(8) A publicly traded common equity security that is included in
the Standard and Poor's Composite 1500 Index, an index that a covered
swap entity's supervisor in a foreign jurisdiction recognizes for the
purposes of including publicly traded common equity as initial margin,
or any other index for which the covered swap entity can demonstrate
that the equities represented are as liquid and readily marketable as
those included in the Standard and Poor's Composite 1500 Index; and
(9) Gold.
Notably, any debt security issued by a U.S. Government-sponsored
enterprise that is not operating with capital support or another form
of direct financial assistance from the U.S. government would be
eligible collateral only if the security met the requirements for debt
securities discussed above. The Agencies seek comment on how the
likelihood of financial assistance from the United States not
authorized under current law (that is, the perceived ``implicit
guarantee'') influences the determination that a U.S. Government-
sponsored enterprise has ``adequate capacity to meet financial
commitments'' when its debt securities are considered for acceptance as
collateral for initial margin. The Agencies also request comment on
whether the final rule should state that debt securities of a U.S.
Government-sponsored enterprise that is not operating with capital
support or other financial assistance from the U.S. government are
eligible collateral for initial margin only if: (1) The U.S.
Government-sponsored enterprise has adequate capacity to meet financial
commitments (as defined in each agency's rule) and (2) the
determination of ``adequate capacity'' is not reliant on financial
assistance from the U.S. Government.
In the context of corporate securities, initial margin collateral
is further restricted to exclude any corporate securities (equity or
debt) issued by the counterparty or any of its affiliates, a bank
holding company, a savings and loan holding company, a foreign bank, a
depository institution, a market intermediary, or any company that
would be one of the foregoing if it were organized under the laws of
the United States or any State, or an affiliate of one of the foregoing
institutions. These restrictions reflect the Agencies' view that
securities issued by the foregoing entities are very likely to come
under significant pressure during a period of financial stress when a
covered swap entity may be resolving a counterparty's defaulted swap
position and present a general source of wrong-way risk. Accordingly,
the Agencies believe that it is prudent to restrict initial margin
collateral in this manner and that these restrictions will not unduly
reduce the scope of collateral that is eligible to satisfy the minimum
initial margin requirements.
The Agencies request comment on the securities subject to this
restriction, and, in particular, on whether securities issued by other
entities, such as non-bank systemically important financial
institutions designated by the Financial Stability Oversight Council,
also should be excluded from the list of eligible collateral.
For the purpose of the initial margin requirements, the recognized
value of assets posted as initial margin collateral, except U.S.
dollars and the currency in which the payment obligations of the swap
is required, is subject to haircuts. These collateral haircuts reduce
the value of the initial margin to an amount that is equal to the
market value of the initial margin collateral multiplied by one minus
the specific collateral haircut. Collateral haircuts guard against the
possibility that the value of initial margin collateral could decline
during the period that a defaulted swap position has to be closed out
by a covered swap entity. The proposed collateral haircuts, which
appear in Appendix B, have been calibrated to be broadly consistent
with valuation changes observed during periods of financial stress.
The Agencies request comment on whether the proposed rule's list of
eligible collateral for minimum initial and variation margin
requirements, and the haircuts applied to initial margin, are
appropriate.
The approach taken to initial margin collateral in the proposal,
which is consistent with the 2013 international framework, recognizes a
broad array of financial collateral ranging from high quality sovereign
bonds to corporate securities and commodities. The Agencies believe
that broadening the scope of eligible collateral addresses concerns
about collateral availability and market impact without exposing
covered swap entities to undue risk. In particular, the Agencies
believe that this proposal appropriately restricts eligible collateral
to liquid and high-quality assets with limited market and credit risk.
In addition, initial margin collateral is subject to robust collateral
haircuts that will further reduce risk.
Because the value of collateral may change, a covered swap entity
must monitor the value and quality of collateral previously collected
to satisfy minimum initial margin requirements. If the value of such
collateral has decreased, or if the quality of the collateral has
deteriorated so that it no longer qualifies as eligible collateral, the
covered swap entity must collect additional collateral of sufficient
value and quality to ensure that all applicable minimum margin
requirements remain satisfied on a daily basis.
The proposal does not allow a covered swap entity to fulfill the
minimum margin requirements with any forms of non-cash collateral not
included in the list of liquid and readily marketable assets described
above. The use of alternative types of collateral to fulfill regulatory
margin requirements is complicated by pro-cyclical considerations (for
example, the changes in the liquidity, price volatility, or wrong-way
risk of collateral during a period of financial stress could exacerbate
that stress) and the need to ensure that the collateral is subject to
low credit, market, and liquidity risk. Therefore, this proposed rule
limits the recognition of collateral to the aforementioned list of
assets.
However, counterparties that wish to rely on assets that do not
qualify as eligible collateral under the proposed rule still would be
able to pledge those assets with a lender in a separate arrangement,
using the cash or other eligible collateral received from that separate
arrangement to meet the minimum margin requirements.
G. Section .7: Segregation of Collateral
1. 2011 Proposal and Public Comment
The 2011 proposal established minimum safekeeping standards for
collateral posted by covered swap entities to assure that collateral is
available to support the swaps and not housed in a jurisdiction where
it is not available if defaults occur. The 2011 proposal required the
covered swap entity to require a counterparty that is a swap entity to
hold funds or other property posted as initial margin at an independent
third-party custodian. The 2011 proposal also required that the
independent third-party custodian be prohibited by contract from: (i)
Rehypothecating or otherwise transferring any initial margin it holds
for the covered swap entity; and (ii) reinvesting any initial margin
held by the custodian in any asset that would
[[Page 57373]]
not qualify as eligible collateral for initial margin under the 2011
proposal. Further, the 2011 proposal required that the custodian be
located in a jurisdiction that applies the same insolvency regime to
the custodian as would apply to the covered swap entity. These
custodian and related requirements applied only to initial margin, not
variation margin, and did not apply to transactions with a counterparty
that was not a swap entity. Collateral collected from counterparties
that were not swap entities could be segregated at the discretion of
the counterparties.
The third-party custodian requirement in the 2011 proposal was
based on a preliminary view by the Agencies that requiring a covered
swap entity's initial margin to be segregated at a third-party
custodian was necessary to offset the greater risk to the covered swap
entity and the financial system arising from the use of non-cleared
swaps, and protect the safety and soundness of the covered swap entity.
Commenters generally supported the protections described in the
2011 proposal as reasonable to protect the pledged or transferred
collateral but several commenters noted that these types of protections
would be costly and have large liquidity impacts and may increase
systemic risk, given that much of the collateral would likely be held
by a relatively few large custodians. In addition, concerns were
expressed by some commenters with the ability of custodians to meet the
requirement that the jurisdiction of insolvency of the custodian be the
same as the covered swap entity.
2. 2014 Proposal
The proposal retains and expands on most of the collateral
safekeeping requirements of the 2011 proposal and revises requirements
related to the custodial agreement.
Section .7(a) of the proposal addresses
requirements for when a covered swap entity posts any collateral other
than variation margin. Posting collateral to a counterparty exposes a
covered swap entity to risks in recovering such collateral in the event
of its counterparty's insolvency. To address this risk and to protect
the safety and soundness of the covered swap entity, Sec.
.7(a) requires a covered swap entity that posts any
collateral other than variation margin with respect to a non-cleared
swap to require that such collateral be held by one or more custodians
that are not affiliates of the covered swap entity or the counterparty.
This requirement would apply to initial margin posted by a covered swap
entity pursuant to Sec. .3(b), as well as initial
margin that is not required by this rule but is posted by a covered
swap entity as a result of negotiations with its counterparty, such as
initial margin posted to a financial end user that does not have
material swaps exposure or initial margin posted to another covered
swap entity even though the amount was less than the $65 million
initial margin threshold amount.
Section .7(b) of the proposal addresses
requirements for when a covered swap entity collects initial margin
required by Sec. .3(a). Under Sec.
.7(b), the covered swap entity shall require that
initial margin collateral collected pursuant to Sec.
.3(a) be held at one or more custodians that are not
affiliates of either party. Because the collection of initial margin
does not expose the covered swap entity to the same risk of
counterparty default as is created when a covered swap entity posts
collateral, the scope of the requirements for initial margin that a
covered swap entity collects is narrower than the scope for
requirements for posting collateral. As a result, Sec.
.7(b) applies only to initial margin that a covered
swap entity collects as required by Sec. .3(a),
rather than all collateral collected.
For collateral subject to Sec. .7(a) or Sec.
.7(b), Sec. .7(c) requires the custodian to act
pursuant to a custodial agreement that is legal, valid, binding, and
enforceable under the laws of all relevant jurisdictions including in
the event of bankruptcy, insolvency, or similar proceedings. Such a
custodian agreement must prohibit the custodian from rehypothecating,
repledging, reusing or otherwise transferring (through securities
lending, repurchase agreement, reverse repurchase agreement, or other
means) the funds or other property held by the custodian. Section
.7(d) provides that, notwithstanding this prohibition on
rehypothecating, repledging, reusing or otherwise transferring the
funds or property held by the custodian, the posting party may
substitute or direct any reinvestment of collateral, including, under
certain conditions, collateral collected pursuant to Sec.
.3(a) or posted pursuant to Sec.
.3(b).
In particular, for initial margin collected pursuant to Sec.
.3(a) or posted pursuant to Sec. .3(b), the posting
party may substitute only funds or other property that meet the
requirements for initial margin under Sec. .6 and where the
amount net of applicable discounts described in Appendix B would be
sufficient to meet the requirements of Sec. .3. The
posting party also may direct the custodian to reinvest funds only in
assets that would qualify as eligible collateral under Sec.
.6 and ensure that the amount net of applicable
discounts described in Appendix B would be sufficient to meet the
requirements of Sec. .3. In the cases of both
substitution and reinvestment, the proposed rule requires the posting
party to ensure that the value of eligible collateral net of haircuts
remains equal to or above the minimum requirements contained in Sec.
.3. In addition, the restrictions on the substitution
of collateral described above do not apply to cases where a covered
swap entity has posted or collected more initial margin than is
required under Sec. .3. In such cases the initial
margin that has been posted or collected in satisfaction of Sec.
.3 is subject to the restrictions on collateral
substitution but any additional collateral that has been posted is not
subject to the restrictions on collateral substitution and, as noted
above, any additional collateral that has been collected by the covered
swap entity is not subject to any of the requirements of Sec.
.7.
The segregation limits on rehypothecation, repledge, or reuse
contained in Sec. .7 apply only with respect to the
initial margin requirement and not with respect to variation
margin.\103\ The Agencies' preliminary view is that requiring covered
swap entities to segregate and limit the rehypothecation, repledge, or
reuse of funds and other property held in satisfaction of the initial
margin requirement is necessary to (i) offset the greater risk to the
covered swap entity and the financial system arising from the use of
swaps that are not cleared and (ii) protect the safety and soundness of
the covered swap entity. In developing this proposal, the Agencies have
considered that the failure of a covered swap entity could pose
significant systemic risks to the financial system, and losses borne by
the financial system in such a failure could have significant
consequences. The consequences could be magnified if funds or other
property received by the failing covered swap entity to satisfy the
initial margin requirement cannot be quickly recovered by nondefaulting
counterparties during a period of financial stress. To the extent that
initial margin requirements are intended to constrain risk-taking, a
lack of
[[Page 57374]]
restrictions on rehypothecation, repledging, and reusing initial margin
and a lack of segregation at an unaffiliated custodian will weaken
their effect.
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\103\ The proposed rule does not apply the segregation
requirement to variation margin because variation margin is
generally used to offset the current exposure arising from actual
changes in the market value of derivative swap transaction rather
than to secure potential exposure arising from future changes in the
market value of the swap transaction during the closeout of the
exposure.
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The Agencies are concerned that not requiring funds or other
property held to satisfy the initial margin requirement to be held at
an unaffiliated custodian and limiting its rehypothecation, repledging,
or reuse at the outset may cause an entity that incurs a severe loss,
due to credit or market events, to face liquidity challenges during
periods of stress. Requiring the protection of pledged initial margin
bilaterally between the counterparties provides assurance that the
pledging counterparty is much less likely to face additional losses
(due to the loss of its transferred or pledged initial margin) above
the replacement cost of the non-cleared swaps portfolio. During a
period of stress, the custodian will provide assurance that the
counterparties' initial margin is indeed only available to meet
incremental losses during the closeout of the defaulting counterparty's
non-cleared swaps and has not been used to secure other obligations. As
such, this reduces the incentive for the nondefaulting counterparty to
become concerned with meeting its obligations to other nondefaulting
counterparties, reducing the interconnected risk associated with non-
cleared swaps.
As discussed above, the limitations on rehypothecation, repledging,
or reusing pledged collateral will likely increase funding costs for
some market participants required to post initial margin, including
some covered swap entities. Moreover, when a covered swap entity
intermediates non-cleared swaps between two financial end users with
material swaps exposure the proposed rule would require that the
covered swap entity post initial margin to each financial end user and
that the covered swap entity collect initial margin from each financial
end user and that these funds or other property be held at a third-
party custodian that will not rehypothecate, repledge, or reuse such
assets. These proposed requirements will result in a significant amount
of initial margin collateral that will be held and segregated to guard
against the risk of counterparty default.
The 2013 international framework sets out parameters for member
countries to permit a limited degree of rehypothecation, repledging,
and reuse of initial margin collateral when a covered swap entity is
dealing with a financial end user if certain safeguards for protecting
the financial end user's rights in such collateral are available under
applicable law. If such protections exist, under the 2013 international
framework, a member country may allow a swap entity to rehypothecate,
repledge, or reuse initial margin provided by a non-dealer financial
end user one time to hedge the covered swap entities exposure to the
financial end user.\104\ The Agencies seek comment on the circumstances
under which one-time rehypothecation, repledge, or reuse of initial
margin posted by a non-dealer financial end user would be permitted
under the 2013 international framework and whether this would be a
commercially viable option for market participants.
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\104\ The prudential regulators note that on April 14, 2014, the
European Supervisory Authorities (``ESA'') issued for comment a
proposal to implement the 2013 international framework. Like the
prudential regulators, the ESA did not propose to allow the
rehypothecation, repledge, or reuse of initial margin. See ``Draft
Regulatory Technical Standards on Risk-mitigation Techniques for
OTC-derivative Contracts Not Cleared by a CCP under Article 11(15)
of Regulation (EU) No. 648/2012'', pp 11, 42-43 (April 14, 2014),
https://www.eba.europa.eu/documents/10180/655149/JC+CP+2014+03+%28CP+on+risk+mitigation+for+OTC+derivatives%29.pdf.
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H. Section .8: Initial Margin Models and Standardized
Amounts
1. Overview of 2011 Proposal and Public Comments
Section