[Federal Register Volume 79, Number 192 (Friday, October 3, 2014)]
[Proposed Rules]
[Pages 59898-59936]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-22962]



[[Page 59897]]

Vol. 79

Friday,

No. 192

October 3, 2014

Part II





Commodity Futures Trading Commission





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17 CFR Parts 23 and 140





Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap 
Participants; Proposed Rule

  Federal Register / Vol. 79 , No. 192 / Friday, October 3, 2014 / 
Proposed Rules  

[[Page 59898]]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 23 and 140

RIN 3038-AC97


Margin Requirements for Uncleared Swaps for Swap Dealers and 
Major Swap Participants

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rule; advance notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is proposing regulations to implement section 4s(e) of the 
Commodity Exchange Act (``CEA''), as added by section 731 of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank 
Act''). This provision requires the Commission to adopt initial and 
variation margin requirements for certain swap dealers (``SDs'') and 
major swap participants (``MSPs''). The proposed rules would establish 
initial and variation margin requirements for SDs and MSPs but would 
not require SDs and MSPs to collect margin from non-financial end 
users. In this release, the Commission is also issuing an Advance 
Notice of Proposed Rulemaking requesting public comment on the cross-
border application of such margin requirements. The Commission is not 
proposing rules on this topic at this time. It is seeking public 
comment on several potential alternative approaches.

DATES: Comments must be received on or before December 2, 2014.

ADDRESSES: You may submit comments, identified by RIN 3038-AC97 and 
Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap 
Participants, by any of the following methods:
     Agency Web site, via its Comments Online process at http://comments.cftc.gov. Follow the instructions for submitting comments 
through the Web site.
     Mail: Send to Christopher Kirkpatrick, Secretary of the 
Commission, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street NW., Washington, DC 20581.
     Hand Delivery/Courier: Same as Mail, above.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    Please submit your comments using only one of these methods.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
http://www.cftc.gov. You should submit only information that you wish 
to make available publicly. If you wish the Commission to consider 
information that may be exempt from disclosure under the Freedom of 
Information Act, a petition for confidential treatment of the exempt 
information may be submitted according to the established procedures in 
Sec.  145.9 of the Commission's regulations, 17 CFR 145.9.
    The Commission reserves the right, but shall have no obligation, to 
review, pre-screen, filter, redact, refuse or remove any or all of your 
submission from www.cftc.gov that it may deem to be inappropriate for 
publication, such as obscene language. All submissions that have been 
redacted, or removed that contain comments on the merits of the 
rulemaking will be retained in the public comment file and will be 
considered as required under the Administrative Procedure Act and other 
applicable laws, and may be accessible under the Freedom of Information 
Act.

FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director, 
Division of Clearing and Risk, 202-418-5480, [email protected]; Thomas 
J. Smith, Deputy Director, Division of Swap Dealer and Intermediary 
Oversight, 202-418-5495, [email protected]; Rafael Martinez, Financial 
Risk Analyst, Division of Swap Dealer and Intermediary Oversight, 202-
418-5462, [email protected]; Francis Kuo, Attorney, Division of Swap 
Dealer and Intermediary Oversight, 202-418-5695, [email protected]; or 
Stephen A. Kane, Research Economist, Office of Chief Economist, 202-
418-5911, [email protected]; Commodity Futures Trading Commission, 1155 
21st Street NW., Washington DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

A. Statutory Authority

    On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\ 
Title VII of the Dodd-Frank Act amended the CEA \2\ to establish a 
comprehensive regulatory framework designed to reduce risk, to increase 
transparency, and to promote market integrity within the financial 
system by, among other things: (1) Providing for the registration and 
regulation of SDs and MSPs; (2) imposing clearing and trade execution 
requirements on standardized derivative products; (3) creating 
recordkeeping and real-time reporting regimes; and (4) enhancing the 
Commission's rulemaking and enforcement authorities with respect to all 
registered entities and intermediaries subject to the Commission's 
oversight.
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    \1\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203, 124 Stat. 1376 (2010).
    \2\ 7 U.S.C. 1 et seq.
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    Section 731 of the Dodd-Frank Act added a new section 4s to the CEA 
setting forth various requirements for SDs and MSPs. Section 4s(e) 
mandates the adoption of rules establishing margin requirements for SDs 
and MSPs.\3\ Each SD and MSP for which there is a Prudential Regulator, 
as defined below, must meet margin requirements established by the 
applicable Prudential Regulator, and each SD and MSP for which there is 
no Prudential Regulator must comply with the Commission's regulations 
governing margin.
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    \3\ Section 4s(e) also directs the Commission to adopt capital 
requirements for SDs and MSPs. The Commission proposed capital rules 
in 2011. Capital Requirements for Swap Dealers and Major Swap 
Participants, 76 FR 27802 (May 12, 2011). The Commission will 
address capital requirements in a separate release.
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    The term Prudential Regulator is defined in section 1a(39) of the 
CEA, as amended by Section 721 of the Dodd-Frank Act. This definition 
includes the Federal Reserve Board (``FRB''); the Office of the 
Comptroller of the Currency (``OCC''); the Federal Deposit Insurance 
Corporation (``FDIC''); the Farm Credit Administration; and the Federal 
Housing Finance Agency.
    The definition specifies the entities for which these agencies act 
as Prudential Regulators. These consist generally of federally insured 
deposit institutions, farm credit banks, federal home loan banks, the 
Federal Home Loan Mortgage Corporation, and the Federal National 
Mortgage Association. The FRB is the Prudential Regulator under section 
4s not only for certain banks, but also for bank holding companies, 
certain foreign banks treated as bank holding companies, and certain 
subsidiaries of these bank holding companies and foreign banks. The FRB 
is not, however, the Prudential Regulator for nonbank subsidiaries of 
bank holding companies, some of which are required to be registered 
with the Commission as SDs or MSPs. In general, therefore, the 
Commission is required to establish margin requirements for all 
registered SDs and MSPs that are not subject to a Prudential Regulator. 
These include, among others, nonbank subsidiaries of bank holding 
companies, as well as certain foreign SDs and MSPs.
    Specifically, section 4s(e)(1)(B) of the CEA provides that each 
registered SD

[[Page 59899]]

and MSP for which there is not a Prudential Regulator shall meet such 
minimum capital requirements and minimum initial margin and variation 
margin requirements as the Commission shall by rule or regulation 
prescribe.
    Section 4s(e)(2)(B) provides that the Commission shall adopt rules 
for SDs and MSPs, with respect to their activities as an SD or an MSP, 
for which there is not a Prudential Regulator imposing (i) capital 
requirements and (ii) both initial and variation margin requirements on 
all swaps that are not cleared by a registered derivatives clearing 
organization (``DCO'').
    Section 4s(e)(3)(A) provides that to offset the greater risk to the 
SD or MSP and the financial system arising from the use of swaps that 
are not cleared, the requirements imposed under section 4s(e)(2) shall 
(i) help ensure the safety and soundness of the SD or MSP and (ii) be 
appropriate for the risk associated with the non-cleared swaps.
    Section 4s(e)(3)(C) provides, in pertinent part, that in 
prescribing margin requirements the Prudential Regulator and the 
Commission shall permit the use of noncash collateral the Prudential 
Regulator or the Commission determines to be consistent with (i) 
preserving the financial integrity of markets trading swaps and (ii) 
preserving the stability of the United States financial system.
    Section 4s(e)(3)(D)(i) provides that the Prudential Regulators, the 
Commission, and the Securities and Exchange Commission (``SEC'') shall 
periodically (but not less frequently than annually) consult on minimum 
capital requirements and minimum initial and variation margin 
requirements.
    Section 4s(e)(3)(D)(ii) provides that the Prudential Regulators, 
Commission and SEC shall, to the maximum extent practicable, establish 
and maintain comparable minimum capital and minimum initial and 
variation margin requirements, including the use of noncash collateral, 
for SDs and MSPs.

B. Previous Proposal

    Following extensive consultation and coordination with the 
Prudential Regulators, the Commission published proposed rules for 
public comment in 2011.\4\ The Prudential Regulators published 
substantially similar rules two weeks later.\5\
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    \4\ Margin Requirements for Uncleared Swaps for Swap Dealers and 
Major Swap Participants, 76 FR 23732 (April 28, 2011).
    \5\ Margin and Capital Requirements for Covered Swap Entities, 
76 FR 27564 (May 11, 2011).
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    The Commission received 102 comment letters. The Prudential 
Regulators received a comparable number. The commenters included 
financial services industry associations, agricultural industry 
associations, energy industry associations, insurance industry 
associations, banks, brokerage firms, investment managers, insurance 
companies, pension funds, commercial end users, law firms, public 
interest organizations, and other members of the public. The commenters 
addressed numerous topics including applicability of the rules to 
certain products, applicability to certain market participants, margin 
calculation methodologies, two-way vs. one-way margin, margin 
thresholds, permissible collateral, use of independent custodians, 
rehypothecation of collateral, and harmonization with other regulators.
    The Commission has taken the comments it received into 
consideration in developing the further proposal contained herein. This 
proposal differs in a number of material ways from the previous 
proposal \6\ and the Commission has determined that it is appropriate 
to issue a new request for comment. The Prudential Regulators have also 
decided to issue a new request for comment. The public is invited to 
comment on any aspect of the current proposal.
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    \6\ These include, among others, the definition of financial end 
user, the definition of material swaps exposure, the requirement for 
two-way margin between SDs and financial end users, and the list of 
eligible collateral for initial margin.
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C. International Standards

    While the comments on the 2011 proposal were being reviewed, 
regulatory authorities around the world determined that global 
harmonization of margin standards was an important goal. The CFTC and 
the Prudential Regulators decided to hold their rulemakings in abeyance 
pending completion of the international efforts.
    In October 2011, the Basel Committee on Banking Supervision 
(``BCBS'') and the International Organization of Securities Commissions 
(``IOSCO''), in consultation with the Committee on Payment and 
Settlement Systems (``CPSS'') and the Committee on Global Financial 
Systems (``CGFS''), formed a working group to develop international 
standards for margin requirements for uncleared swaps. Representatives 
of more than 20 regulatory authorities participated. From the United 
States, the CFTC, the FDIC, the FRB, the OCC, the Federal Reserve Bank 
of New York, and the SEC were represented.
    In July 2012, the working group published a proposal for public 
comment.\7\ In addition, the group conducted a Quantitative Impact 
Study (``QIS'') to assess the potential liquidity and other 
quantitative impacts associated with margin requirements.\8\
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    \7\ BCBS/IOSCO, Consultative Document, Margin requirements for 
non-centrally cleared derivatives (July 2012).
    \8\ BCBS/IOSCO, Quantitative Impact Study, Margin requirements 
for non-centrally cleared derivatives (November 2012).
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    After consideration of the comments on the proposal and the results 
of the QIS, the group published a near-final proposal in February 2013 
and requested comment on several specific issues.\9\ The group 
considered the additional comments in finalizing the recommendations 
set out in the report.
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    \9\ BCBS/IOSCO, Consultative Document, Margin requirements for 
non-centrally cleared derivatives (February 2013).
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    The final report was issued in September 2013.\10\ This report (the 
``2013 international framework'') articulates eight key principles for 
non-cleared derivatives margin rules, which are described below. These 
principles represent the minimum standards approved by BCBS and IOSCO 
and recommended to the regulatory authorities in member jurisdictions 
of these organizations.
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    \10\ BCBS/IOSCO, Margin requirements for non-centrally cleared 
derivatives (September 2013) (``BCBS/IOSCO Report'').
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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 central counterparties (``CCPs''). 
The 2013 international framework does not include a margin requirement 
for physically settled foreign exchange (``FX'') forwards and swaps. 
The framework also would not apply initial margin requirements to the 
fixed physically-settled FX component of cross-currency swaps.
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 non-financial entities. 
Sovereigns, central banks, certain multilateral development banks, the 
Bank for International

[[Page 59900]]

Settlements (BIS), and non-systemic, non-financial 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 a level of 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 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 or both of the initial margin 
collector and the third party become insolvent. Where a customer has 
consented to rehypothecation and adequate legal safeguards are in 
place, the margin collector and the third party to which 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 recommends 
specific quantitative levels for several requirements 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 Commission is 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.

[[Page 59901]]

    The Commission seeks 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. Proposed Margin Regulations

A. Introduction

    During the financial crisis of 2008-2009, DCOs met all their 
obligations without any financial support from the government. By 
contrast, significant sums were expended by governmental entities as 
the result of losses incurred in connection with uncleared swaps. For 
example, a unit of American International Group (``AIG'') entered into 
many credit default swaps and did not post initial margin or regularly 
pay variation margin on these positions.\11\ AIG was unable to meet its 
obligations and the Federal Reserve and the Department of the Treasury 
expended large sums of money to meet these obligations.\12\
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    \11\ See The Financial Crisis Inquiry Commission, The Financial 
Crisis Inquiry Report: Final Report of the National Commission on 
the Causes of the Financial and Economic Crisis in the United States 
(Official Government Edition) at 265-268 (2011), available at http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf.
    \12\ Id. at 344-352, 350. See also United States Department of 
the Treasury, Office of Financial Stability, Troubled Asset Relief 
Program, Four Year Retrospective: An Update on the Wind Down of 
TARP, pp. 3, 18-19. Treasury and the Federal Reserve committed $182 
billion to stabilize AIG. Ultimately all of this was recovered plus 
a return of $22.7 billion.
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    A key reason for this difference in the performance of cleared and 
uncleared swaps is that DCOs use variation margin and initial margin as 
the centerpiece of their risk management programs while these tools 
often were not universally used in connection with uncleared swaps. 
Consequently, in designing the proposed margin rules for uncleared 
swaps, the Commission has built upon the sound practices for risk 
management employed by central counterparties for decades.
    Variation margin serves as a mechanism for periodically recognizing 
changes in the value of open positions and reducing unrealized losses 
to zero. Open positions are marked to their current market value each 
day and funds are transferred between the parties to reflect any change 
in value since the previous time the positions were marked. This 
process prevents losses from accumulating over time and thereby reduces 
both the chance of default and the size of any default should one 
occur.
    Initial margin serves as a performance bond against potential 
future losses. If a party fails to meet its obligation to pay variation 
margin, resulting in a default, the other party may use initial margin 
to cover some or all of any loss. Because the payment of variation 
margin prevents losses from compounding over an extended period of 
time, initial margin only needs to cover any additional losses that 
might accrue between the previous time that variation margin was paid 
and the time that the position is liquidated.
    Well-designed margin systems protect both parties to a trade as 
well as the overall financial system. They serve both as a check on 
risk-taking that might exceed a party's financial capacity and as a 
resource that can limit losses when there is a failure by a party to 
meet its obligations.
    The statutory provisions cited above reflect Congressional 
recognition that (i) margin is an essential risk-management tool and 
(ii) uncleared swaps pose greater risks than cleared swaps. As 
discussed further below, many commenters expressed concern that the 
imposition of margin requirements on uncleared swaps will be very 
costly for SDs and MSPs.\13\ However, margin has been, and will 
continue to be, required for all cleared products. Given the 
Congressional reference to the ``greater risk'' of uncleared swaps and 
the requirement that margin for such swaps ``be appropriate for the 
risk,'' the Commission believes that establishing margin requirements 
for uncleared swaps that are at least as stringent as those for cleared 
swaps is necessary to fulfill the statutory mandate. Within these 
statutory bounds the Commission has endeavored to limit costs 
appropriately, as detailed further below.
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    \13\ For purposes of this proposal, the term ``SD'' means any 
swap dealer registered with the Commission. Similarly, the term 
``MSP'' means any major swap participant registered with the 
Commission.
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    The discussion below addresses: (i) The products covered by the 
proposed rules; (ii) the market participants covered by the proposed 
rules; (iii); the nature and timing of the margin obligations; (iv) the 
methods of calculating initial margin; (v) the methods of calculating 
variation margin; (vi) permissible forms of margin; (vii) custodial 
arrangements; (viii) documentation requirements; (ix) the 
implementation schedule; and (x) advance notice of proposed rulemaking 
on the cross-border application of the rules.
    In developing the proposed rules, the Commission staff worked 
closely with the staff of the Prudential Regulators.\14\ In most 
respects, the proposed rules would establish a similar framework for 
margin requirements as the Prudential Regulators' proposal. Key 
differences are noted in the discussion below.
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    \14\ As required by section 4s of the CEA, the Commission staff 
also has consulted with the SEC staff.
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    The proposed rules are consistent with the 2013 international 
framework. In some instances, as contemplated in the framework, the 
proposed rules provide more detail than the framework. In a few other 
instances, the proposed rules are stricter than the framework. Any such 
variations from the framework are noted in the discussion below.

B. Products

    As noted above, section 4s(e)(2)(B)(ii) of the CEA directs the 
Commission to establish both initial and variation margin requirements 
for SDs and MSPs ``on all swaps that are not cleared.'' The scope 
provision of the proposed rules \15\ states that the proposal would 
cover swaps that are uncleared swaps \16\ and that are executed after 
the applicable compliance date.\17\
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    \15\ Proposed Regulation Sec.  23.150.
    \16\ The term uncleared swap is defined in proposed Regulation 
Sec.  23.151.
    \17\ A schedule of compliance dates is set forth in proposed 
Regulation Sec.  23.160.
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    The term ``cleared swap'' is defined in section 1a(7) of the CEA to 
include any swap that is cleared by a DCO registered with the 
Commission. The Commission notes, however, that SDs and MSPs also clear 
swaps through foreign clearing organizations that are not registered 
with the Commission. The Commission believes that a clearing 
organization that is not a registered DCO must meet certain basic 
standards in order to avoid creating a mechanism for evasion of the 
uncleared margin requirements. Accordingly, the Commission is proposing 
to include in the definition of cleared swaps certain swaps that have 
been accepted for clearing by an entity that has received a no-action 
letter from the Commission staff or exemptive relief from the 
Commission permitting it to clear such swaps for U.S. persons without 
being registered as a DCO.\18\
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    \18\ See CFTC Ltr. No. 14-107 (August 18, 2014) (granting no-
action relief to Clearing Corporation of India Ltd.); CFTC Ltr. No. 
14-87 (June 26, 2014) (granting no-action relief to Korea Exchange, 
Inc.); CFTC Ltr. No. 14-68 (May 7, 2014) (granting no-action relief 
to OTC Clearing Hong Kong Limited and certain of its clearing 
members); CFTC Ltr. No. 14-27 (Mar. 20, 2014) (extending previous 
grant of no-action relief to Eurex Clearing AG and certain of its 
clearing members); CFTC Ltr. No. 14-07 (Feb. 6, 2014) (granting no-
action relief to ASX Clear (Futures) Pty Limited); and CFTC Ltr. No. 
13-73 (Dec. 19, 2013) (extending previous grant of no-action relief 
to Japan Securities Clearing Corporation and certain of its clearing 
members).

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[[Page 59902]]

    The Commission requests comment on whether it is appropriate to 
exclude swaps that are cleared by an entity that is not a registered 
DCO. If so, the Commission further requests comment on whether the 
proposed rule captures the proper clearing organizations. For example, 
should the Commission require that the clearing organizations be 
qualifying central counterparties (``QCCPs'') \19\ or be subject to 
regulation and supervision that is consistent with the CPSS-IOSCO 
Principles for Financial Market Infrastructures (``PFMIs'')?
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    \19\ A QCCP is a clearing organization that meets the standards 
to be designated as such set forth by the Basel Committee for 
Banking Supervision in the report ``Capital requirements for bank 
exposures to central counterparties'' (April 2014).
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    Because the pricing of swaps reflects the credit arrangements under 
which they were executed, it could be unfair to the parties and 
disruptive to the markets to require that the rules apply to positions 
executed before the applicable compliance dates. The rules, however, 
would permit SDs and MSPs voluntarily to include swaps executed before 
the applicable compliance date in portfolios margined pursuant to the 
proposed rules.\20\ Many market participants might do so to take 
advantage of netting effects across transactions.
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    \20\ See proposed Regulation Sec.  23.154(b)(2) for initial 
margin and proposed Regulation Sec.  23.153(c) for variation margin.
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    As a result of the determination by the Secretary of the Treasury 
to exempt foreign exchange swaps and foreign exchange forwards from the 
definition of swap,\21\ the following transactions would not be subject 
to the requirements: (i) Foreign exchange swaps; (ii) foreign exchange 
forwards; and (iii) the fixed, physically settled foreign exchange 
transactions associated with the exchange of principal in cross-
currency swaps.
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    \21\ Determination of Foreign Exchange Swaps and Foreign 
Exchange Forwards Under the Commodity Exchange Act, 77 FR 69694 
(Nov. 20, 2012).
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    In a cross-currency swap, the parties exchange principal and 
interest rate payments in one currency for principal and interest rate 
payments in another currency. The exchange of principal occurs upon the 
inception of the swap, with a reversal of the exchange of principal at 
a later date that is agreed upon at the inception of the swap. The 
foreign exchange transactions associated with the fixed exchange of 
principal in a cross-currency swap are closely related to the exchange 
of principal that occurs in the context of a foreign exchange forward 
or swap. Accordingly, the Commission is proposing to treat that portion 
of a cross-currency swap that is a fixed exchange of principal in a 
manner that is consistent with the treatment of foreign exchange 
forwards and swaps. This treatment of cross-currency swaps is limited 
to cross-currency swaps and does not extend to any other swaps such as 
non-deliverable currency forwards.
    The Commission requests comment on the proposed treatment of 
products. In particular, commenters are invited to discuss the costs 
and benefits of the proposed approach. Commenters are urged to quantify 
the costs and benefits, if practicable. Commenters also may suggest 
alternatives to the proposed approach where the commenters believe that 
the alternatives would be appropriate under the CEA.

C. Market Participants

1. SDs and MSPs
    As noted above, section 4s(e)(2)(B) of the CEA directs the 
Commission to impose margin requirements on SDs and MSPs for which 
there is no Prudential Regulator (``covered swap entities'' or 
``CSEs'').\22\ This provision further states that the requirement shall 
apply to ``all swaps that are not cleared.'' Section 4s(e)(3)(A)(2) 
states that the requirements must be ``appropriate to the risks 
associated with'' the swaps.
---------------------------------------------------------------------------

    \22\ This term is defined in proposed Regulation Sec.  23.151.
---------------------------------------------------------------------------

    Because different types of counterparties can pose different levels 
of risk, the Commission's proposed requirements would differ depending 
on the category of counterparty. The proposed rules would establish 
three categories of counterparty: (i) SDs and MSPs, (ii) financial end 
users,\23\ and (iii) non-financial end users.\24\ As discussed below, 
the nature of an SD/MSP's obligations under the rules would differ 
depending on whether the counterparty was a covered counterparty or a 
non-financial end user.
---------------------------------------------------------------------------

    \23\ This term is defined in proposed Regulation Sec.  23.151.
    \24\ This term is defined in proposed Regulation Sec.  23.151 to 
include entities that are not SDs, MSPs, or financial entities.
---------------------------------------------------------------------------

2. Financial End Users
    a. Definition
    Financial end users would include any entity that (i) is specified 
in the definition, and (ii) is not an SD or MSP. The definition lists 
numerous entities whose business is financial in nature. The proposed 
rule also would permit the Commission to designate additional entities 
as financial end users if it identified additional entities whose 
activities and risk profile would warrant inclusion. As contemplated by 
the 2013 international framework, the CFTC proposal, which is the same 
as the Prudential Regulator's proposal, contains greater detail in 
defining financial end users than the international standards.\25\
---------------------------------------------------------------------------

    \25\ ``The precise definition of financial firms, non-financial 
firms, and systemically important non-financial firms will be 
determined by appropriate national regulation.'' See BCBS/IOSCO 
Report at 9.
---------------------------------------------------------------------------

    In developing the definition, the Commission and the Prudential 
Regulators sought to provide clarity about whether particular 
counterparties would be subject to the margin requirements of the 
proposed rule. The definition is an attempt to strike a balance between 
the need to capture all financial counterparties that pose significant 
risk to the financial system and the danger of being overly inclusive.
    The Commission believes that financial firms generally 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 CSE.
    The list of financial entities is based to a significant extent on 
Federal statutes that impose registration or chartering requirements on 
entities that engage in specified financial activities. Such activities 
include deposit taking and lending, securities and swaps dealing, 
investment advisory activities, and asset management.
    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 proposal also would cover a broad variety and number of nonbank 
lending and retail payment firms that operate in the market. To this 
end, the proposal would include State-licensed or registered credit or 
lending entities

[[Page 59903]]

and money services businesses, under proposed regulatory language 
incorporating an inclusive list of the types of firms subject to State 
law.\26\ However, the Commission recognizes that the licensing of 
nonbank lenders in some states extends to commercial firms that provide 
credit to the firm's customers in the ordinary course of business. 
Accordingly, the Commission is proposing to exclude an entity 
registered or licensed solely because it finances the entity's direct 
sales of goods or services to customers. The Commission requests 
comment on whether this aspect of the proposed rule adequately 
maintains a distinction between financial end users and commercial end 
users.
---------------------------------------------------------------------------

    \26\ The Commission expects that 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.
---------------------------------------------------------------------------

    In addition, real estate investment companies would be financial 
end users, as they are entities that would be investment companies 
under section 3 of the Investment Company Act but for section 
3(c)(5)(C). Furthermore, other securitization vehicles would be 
financial end users in cases where those vehicles are entities that are 
deemed not to be investment companies under section 3 of the Investment 
Company Act pursuant to Rule 3a-7. The Commission also notes that the 
category of investment companies registered with the SEC under the 
Investment Company Act would include registered investment companies as 
well as business development companies.
    Under the proposed rule, those cooperatives that are financial 
institutions, such as credit unions, Farm Credit System banks and 
associations, and the National Rural Utilities Cooperative Finance 
Corporation would be 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.\27\ 
Cooperatives that are financial end users may qualify for an exemption 
from clearing,\28\ and therefore, they may enter into non-cleared swaps 
with covered swap entities that are subject to the proposed rule.
---------------------------------------------------------------------------

    \27\ Under the proposed rule, the financing subsidiaries or 
affiliates of producer or consumer cooperatives would be non-
financial end users.
    \28\ Section 2(h)(7)(c)(ii) of the CEA 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. Additionally, the 
CFTC, pursuant to its authority under section 2(h)(1)(A) of the CEA, 
enacted 17 CFR 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 Commission remains concerned, however, that 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. Accordingly, the definition includes two 
additional prongs. First, the definition 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 Commission requests 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 Investment Advisers Act or 
commodity pools under the CEA). The Commission also requests 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, the proposal would allow the Commission to require a swap 
dealer and major swap participant (``covered swap entity'') to treat an 
entity as a financial end user for margin purposes, even if the person 
is not specifically listed within the definition of ``financial end 
user'' or if the entity is excluded from the definition of financial 
end user as described below. This provision was included out of an 
abundance of caution to act as a safety mechanism in the event that an 
entity didn't fall squarely within one of the listed categories but was 
effectively acting as a financial end user.
    To address the classification of foreign entities as financial end 
users, the proposal would 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 Commission recognizes 
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.\29\ The 
Commission requests comment on whether some other method or approach 
would adequately assure that the rule's objectives with respect to 
dealer safety and soundness and reductions of systemic risk can be 
achieved, in a fashion that can be more readily operationalized by 
covered swap entities. For example, would it be appropriate to have 
foreign counterparties certify to CSEs whether they are financial end 
users or not? This could be operationally simpler for the CSEs and 
would avoid the circumstance where one CSE, in good faith, deemed a 
foreign counterparty to be a financial end user and another CSE, in 
good faith, did not.
---------------------------------------------------------------------------

    \29\ See e.g., Definitions of ``Predominantly Engaged In 
Financial Activities'' and ``Significant Nonbank Financial Company 
and Bank Holding Company'', 68 FR 20756 (April 5, 2013).
---------------------------------------------------------------------------

    The definition of financial entities \30\ would exclude the 
government of any country, central banks, multilateral development 
banks, the Bank for International Settlements, captive finance 
companies,\31\ and agent affiliates.\32\ The exclusion for sovereign 
entities, multilateral development banks and the Bank for International 
Settlements is consistent with the 2013 international framework and the 
proposal of the Prudential Regulators.

[[Page 59904]]

Captive finance companies and agent affiliates were excluded by the 
Dodd-Frank Act from the definition of financial entity subject to 
mandatory clearing.
---------------------------------------------------------------------------

    \30\ Proposed Regulation Sec.  23.151.
    \31\ A captive finance company is an entity that is excluded 
from the definition of financial entity under section 
2(h)(7)(c)(iii) of the CEA for purposes of the requirement to submit 
certain swaps for clearing. That section describes it as ``an entity 
whose primary business is providing financing, and uses derivatives 
for the purpose of hedging underlying commercial risks related to 
interest rate and foreign currency exposures, 90 percent or more of 
which arise from financing that facilitates the purchase or lease of 
products, 90 percent or more of which are manufactured by the parent 
company or another subsidiary of the parent company.''
    \32\ An agent affiliate is an entity that is an affiliate of a 
person that qualifies for an exception from the requirement to 
submit certain trades for clearing. Under section 2(h)(7)(D) of the 
CEA, ``an affiliate of a person that qualifies for an exception 
under subparagraph (A) (including affiliate entities predominantly 
engaged in providing financing for the purchase of the merchandise 
or manufactured goods of the person) may qualify for the exception 
only if the affiliate, acting on behalf of the person and as an 
agent, uses the swap to hedge or mitigate the commercial risk of the 
person or other affiliate of the person that is not a financial 
entity.''
---------------------------------------------------------------------------

    The Commission notes 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 ERISA would meet the definition of 
financial end user.
    For a foreign entity that was not a central government, a foreign 
regulator could request a determination whether the entity was a 
financial end user. Such a determination could extend to other 
similarly situated entities in that jurisdiction.
    The Commission seeks comment on all aspects of the financial end 
user definition, including whether the definition has succeeded in 
capturing all entities that should be included. The Commission requests 
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 Commission also requests 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 Commission also requests 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.
    The Commission requests comment on the costs and benefits of the 
proposed definition of financial end user. Commenters are urged to 
quantify the costs and benefits, if practicable. Commenters also may 
suggest alternatives to the proposed approach where the commenters 
believe that the alternatives would be appropriate under the CEA.
b. Small Banks
    As noted above, banks would be financial end users under the 
proposal. They would be subject to initial margin requirements if they 
entered into uncleared swaps with CSEs and, as discussed below, had 
material swaps exposure. Staff of the Prudential Regulators have 
indicated that they expect that the proposed rule likely will have 
minimal impact on small banks.
    Staff of the Prudential Regulators believe that the vast majority 
of small banks do not engage in swaps at or near that level of activity 
that would meet the material swaps exposure threshold. If, however, a 
small bank did exceed the threshold level, the Prudential Regulators 
believe it would be appropriate for the protection of both the CSE and 
the small bank for two-way initial margin to be posted. The Commission 
notes that, as discussed in more detail below, initial margin would 
only need to be posted to the extent it exceeded $65 million.
    The proposed rule would require a CSE to exchange daily variation 
margin with a small bank, regardless of whether the institution had 
material swap exposure. However, the covered swap entity would only be 
required to collect variation margin from a small bank when the amount 
of both initial margin and variation margin required to be collected 
exceeded $650,000. The Prudential Regulators have indicated that they 
expect that the vast majority of small banks will have a daily margin 
requirement that is below this amount.
    The Commission requests comment on all aspects of the proposed 
treatment of small banks. In particular, the Commission requests 
comment on the interaction of this proposal with clearing exemptions 
that have been granted.\33\
---------------------------------------------------------------------------

    \33\ See Commission Regulations Sec. Sec.  50.50(d)(small 
banks), 50.51 (cooperatives), 50.52 (inter-affiliate trades), and 
CFTC Ltr. No. 13-22 (June 4, 2013) (treasury affiliates).
---------------------------------------------------------------------------

c. Affiliates of CSEs
    The proposal generally would cover swaps between CSEs and their 
affiliates that are financial end users. The Commission notes that 
other applicable laws require transactions between banks and their 
affiliates to be on an arm's length basis. For example, 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.\34\ Consistent 
with that treatment, the Prudential Regulators and the Commission are 
proposing to apply the margin requirements to swaps between CSEs and 
their affiliates.
---------------------------------------------------------------------------

    \34\ 12 U.S.C. 371c-1(a).
---------------------------------------------------------------------------

    The Commission requests comment on all aspects of the proposed 
treatment of transactions with affiliates. In particular, the 
Commission requests comment on the interaction of this proposal with 
clearing exemptions that have been granted.
d. Multilateral Development Banks
    The proposed definition of the term ``multilateral development 
bank,'' includes a provision encompassing ``[a]ny 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 
Commission determines poses comparable credit risk.'' The Commission 
seeks comment regarding this definition. In particular, is the 
criterion of comparability of credit risk appropriate for this 
definition? Should the Commission look to other characteristics of the 
entity in determining whether it should be within the definition of 
``multilateral development bank''?
e. Material Swaps Exposure
    A CSE would not be required to exchange initial margin with a 
financial end user if the financial end user did not have ``material 
swaps exposure.'' \35\ Material swaps exposure would be computed using 
the average daily aggregate notional amount of uncleared swaps, 
security-based swaps, foreign exchange forwards, and foreign exchange 
swaps\36\ with all counterparties for June, July, and August of the 
previous calendar year. Essentially, a financial end user would have 
material swaps exposure if it held an aggregate gross notional amount 
of these products of more than $3 billion.\37\
---------------------------------------------------------------------------

    \35\ Proposed Regulation Sec.  23.152 applies to ``covered 
counterparties.'' Proposed Regulation Sec.  23.151 defines that term 
to include financial entities with material swaps exposure.
    \36\ The 2013 international framework states that all uncleared 
derivatives, ``including physically settled FX forwards and swaps'' 
should be included in determining whether a covered entity should be 
subject to margin requirements. BCBS/IOSCO Report Paragraph 8.8. 
Although these products would not themselves be subject to margin 
requirements, they are uncleared derivatives that pose risks. It was 
the judgment of BCBS/IOSCO that they should be included in 
identifying significant market participants in the uncleared space. 
Consistent with international standards and with the Prudential 
Regulators' proposal, the Commission is proposing to include them 
for purposes of this calculation.
    \37\ Proposed Regulation Sec.  23.151.
---------------------------------------------------------------------------

    This provision recognizes that a financial end user that has 
relatively smaller positions does not pose the same risks as a 
financial end user with

[[Page 59905]]

larger positions. By reducing the number of market participants subject 
to certain margin requirements, it also addresses the concerns that 
have been expressed about the availability of sufficient collateral to 
meet these requirements.
    While adoption of a material swaps exposure threshold is consistent 
with the 2013 international framework,\38\ the Commission and the 
Prudential Regulators, are proposing to set the materiality standard 
lower than the international standard. However, the lower standard was 
chosen in order to be consistent with the intent of the international 
standards, which was to require collection of margin only when the 
amount exceeds $65 million, as explained below.
---------------------------------------------------------------------------

    \38\ BCBS/IOSCO Report at 9.
---------------------------------------------------------------------------

    The 2013 international framework 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. The preliminary view of the 
Commission and the Prudential Regulators is that defining material 
swaps exposure 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 Commission and the Prudential Regulators 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 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 Commission 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. 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 (1) initial       Column (2) initial
                                                                    margin amount as     margin amount on an $11
                                                                  percentage of gross     billion gross notional
                                                                  notional amount (%)         portfolio ($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 (1) initial       Column (2) initial
                                                                    margin amount as     margin amount on an $11
                                                                  percentage of gross     billion gross notional
                                                                  notional amount (%)         portfolio ($MM)
----------------------------------------------------------------------------------------------------------------
5 year, receive fixed and pay floating rate interest rate swap                      2.0                      216
5 year, sold CDS protection on the CDX IG Series 20 Version 22                      1.9                      213
 Index........................................................
----------------------------------------------------------------------------------------------------------------


[[Page 59906]]

    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 
Commission's preliminary view is that additional considerations suggest 
that the initial margin collection amounts associated with uncleared 
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. Uncleared 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, uncleared swaps often contain complex 
features, such as nonlinearities, that make them even riskier and would 
hence require more initial margin. Finally, uncleared 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 uncleared versus cleared swaps.
    In light of the data and considerations noted above, the 
Commission's 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 Commission does 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 
Commission's 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 Commission notes that under the implementation schedule set out 
below, this requirement would not take effect until January 1, 
2019.\39\ Parties with gross notional exposures around this amount 
would have several years notice before the requirements took effect.
---------------------------------------------------------------------------

    \39\ Proposed Regulation Sec.  23.160.
---------------------------------------------------------------------------

    The Commission requests comment on all aspects of the material 
swaps exposure provision. In particular, the Commission requests 
comment on the proposal to establish a level that is lower than the 
level set forth in the 2013 international framework. 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 Commission?
    The Commission requests comment on the costs and benefits of the 
proposed definition of material swaps exposure. Commenters are urged to 
quantify the costs and benefits, if practicable. Commenters also may 
suggest alternatives to the proposed approach where the commenters 
believe that the alternatives would be appropriate under the CEA.
3. Non-Financial End Users
    Non-financial end users would include any entity that was not an 
SD, an MSP, or a financial end user. The proposal would not require 
CSEs to exchange margin with non-financial end users. The Commission 
believes that such entities, which generally are using swaps to hedge 
commercial risk, pose less risk to CSEs than financial entities. 
Therefore, under section 4s(e)(3)(A)(ii) of the CEA, applying a 
different standard to trades by CSEs with non-financial entities than 
to trades by CSEs with covered counterparties would be ``appropriate to 
the risk.''
    This approach is consistent with Congressional intent. Senior 
Congressional leaders have stated that they do not believe that non-
financial end users should be required to post margin for uncleared 
swaps.\40\ In addition, the Dodd-Frank Act generally exempted non-
financial end users from the requirement that they submit trades to 
clearing.\41\ If the Commission required them to post margin for 
uncleared trades, the clearing exemption could be weakened because the 
costs of clearing are likely to be less than the costs of margining an 
uncleared position. This approach is also consistent with international 
standards.\42\
---------------------------------------------------------------------------

    \40\ Letter from Chairman Debbie Stabenow, Committee on 
Agriculture, Nutrition and Forestry, U.S. Senate, Chairman Frank D. 
Lucas, Committee on Agriculture, United States House of 
Representatives, Chairman Tim Johnson, Committee on Banking, 
Housing, and Urban Affairs, U.S. Senate, and Chairman Spencer 
Bachus, Committee on Financial Services, United States House of 
Representatives to Secretary Timothy Geithner, Department of 
Treasury, Chairman Gary Gensler, U.S. Commodity Futures Trading 
Commission, Chairman Ben Bernanke, Federal Reserve Board, and 
Chairman Mary Shapiro, U.S. Securities and Exchange Commission 
(April 6, 2011); Letter from Chairman Christopher Dodd, Committee on 
Banking, Housing, and Urban Affairs, U.S. Senate, and Chairman 
Blanche Lincoln, Committee on Agriculture, Nutrition, and Forestry, 
U.S. Senate, to Chairman Barney Frank, Financial Services Committee, 
United States House of Representatives, and Chairman Collin 
Peterson, Committee on Agriculture, United States House of 
Representatives (June 30, 2010); see also 156 Cong. Rec. S5904 
(daily ed. July 15, 2010) (statement of Sen. Lincoln).
    \41\ See section 2(h)(7) of the CEA.
    \42\ BCBS/IOSCO Report at pp. 7-8.
---------------------------------------------------------------------------

    The Commission's proposal is generally consistent with the proposal 
of the Prudential Regulators but differs in some particulars. The 
Prudential Regulators' proposal contains the following provision:


    A covered swap entity is not required to collect initial margin 
with respect to any non-cleared swap or non-cleared security-based 
swap with a counterparty that is neither a financial end user with 
material swaps exposure nor a swap entity but shall collect initial 
margin at such times and in such forms (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 and non-
cleared security-based swaps.

    The Commission's proposal does not contain this provision.
    The Commission's proposal contains other provisions designed to 
address the mandate under section 4s(e)(3)(A)(i) that Commission rules 
``help ensure the safety and soundness'' of SDs and MSPs. First, as 
discussed further below, the rules would require CSEs to enter into 
certain documentation with all counterparties, including non-financial 
entities, to provide clarity about the parties' respective rights and 
obligations.\43\ CSEs and non-financial

[[Page 59907]]

entities would be free to set initial margin and variation margin 
requirements, if any, in their discretion and any thresholds agreed 
upon by the parties would be permitted.
---------------------------------------------------------------------------

    \43\ Proposed Regulation Sec.  23.158.
---------------------------------------------------------------------------

    Second, the proposal would require each CSE to calculate 
hypothetical initial and variation margin amounts each day for 
positions held by non-financial entities that have material swaps 
exposure to the covered counterparty.\44\ That is, the CSE must 
calculate what the margin amounts would be if the counterparty were 
another SD or MSP and compare them to any actual margin requirements 
for the positions.\45\ These calculations would serve as risk 
management tools to assist the CSE in measuring its exposure and to 
assist the Commission in conducting oversight of the CSE.
---------------------------------------------------------------------------

    \44\ Proposed Regulations Sec. Sec.  23.154(a)(6) and 
23.155(a)(3).
    \45\ This is consistent with the requirement set forth in 
section 4s(h)(3)(B)(iii)(II) of the CEA that SDs and MSPs must 
disclose to counterparties who are not SDs or MSPs a daily mark for 
uncleared swaps.
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D. Nature and Timing of Margin Requirements

1. Initial Margin
    Subject to thresholds discussed below, the proposal would require 
each CSE to collect initial margin from, and to post initial margin 
with, each covered counterparty on or before the business day after 
execution \46\ for every swap with that counterparty.\47\ The proposal 
would require the CSEs to continue to post and to collect initial 
margin until the swap is terminated or expires.\48\
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    \46\ Commission Regulation Sec.  23.200(e) defines execution to 
mean, ``an agreement by the counterparties (whether orally, in 
writing, electronically, or otherwise) to the terms of the swap 
transaction that legally binds the counterparties to such terms 
under applicable law.'' 17 CFR 23.200(e).
    \47\ Proposed Regulation Sec.  23.152(a).
    \48\ Proposed Regulation Sec.  23.152(b).
---------------------------------------------------------------------------

    Recognizing that SDs and MSPs pose greater risk to the markets and 
the financial system than other swap market participants, Congress 
established a comprehensive regulatory scheme for them including 
registration, recordkeeping, reporting, margin, capital, and business 
conduct requirements. Accordingly, under the mandate of section 
4s(e)(3)(C) to preserve the financial integrity of markets trading 
swaps and to preserve the stability of the United States financial 
system, the Commission is proposing to require SDs and MSPs to collect 
initial margin from, and to post initial margin with, one another.
    Similarly, as discussed above, the Commission believes that 
financial end users with material swaps exposure potentially pose 
greater risk to CSEs and to the financial system than non-financial end 
users or financial end users with smaller aggregate exposures. 
Accordingly, under the mandate of section 4s(e)(3)(A) to help ensure 
the safety and soundness of SDs and MSPs, the Commission is proposing 
to require SDs and MSPs to collect initial margin from, and to post 
initial margin with, financial end users.
    Notably, the proposal would require both collecting and posting of 
initial margin by CSEs (``two-way margin''). Two-way margin helps to 
ensure the safety and soundness of CSEs. Daily collection of initial 
margin increases the safety and soundness of the CSE by providing 
collateral to cover potential future exposure from each counterparty. 
That is, if a counterparty fails to meet an obligation, the CSE can 
liquidate the initial margin that it holds to cover some or all of the 
loss. But daily posting of initial margin also helps to ensure the 
safety and soundness of a CSE by making it more difficult for the CSE 
to build up exposures that it cannot fulfill. That is, the requirement 
that a CSE post initial margin acts as a discipline on its risk taking. 
The requirement also would make it more difficult for a rogue trader to 
hide his positions.
    In the wake of clearing mandates, uncleared swaps are likely to be 
more customized and consequently trade in a less liquid market than 
cleared swaps. As a result, uncleared swaps potentially might take a 
longer time and require a greater price premium to be liquidated than 
cleared swaps, particularly in distressed market conditions. Initial 
margin is designed to address these risks.
    The proposal contains a provision stating that a CSE would not be 
deemed to have violated its obligation to collect initial margin if it 
took certain steps.\49\ Specifically, if a counterparty failed to pay 
the required initial margin to the CSE, the CSE would be required to 
make the necessary efforts to attempt to collect the initial margin, 
including the timely initiation and continued pursuit of formal dispute 
resolution mechanisms,\50\ or otherwise demonstrate upon request to the 
satisfaction of the Commission that it has made appropriate efforts to 
collect the required initial margin or commenced termination of the 
swap.
---------------------------------------------------------------------------

    \49\ Proposed Regulation Sec.  23.152(c).
    \50\ See Commission Regulation Sec.  23.504(b)(4).
---------------------------------------------------------------------------

    The Commission requests comment on all aspects of the proposal 
relating to the nature and timing of initial margin. In particular, the 
Commission requests comment on two-way initial margin.
    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.
2. Variation Margin
    Subject to a minimum transfer amount discussed below, the proposal 
would require each CSE to collect variation margin from, and to pay 
variation margin to, each counterparty that is a swap entity or a 
financial end user, on or before the end of the business day after 
execution for each swap with that counterparty.\51\ The proposed rule 
would require the CSEs to continue to pay or collect variation margin 
each business day until the swap is terminated or expires.\52\
---------------------------------------------------------------------------

    \51\ Proposed Regulation Sec.  23.153(a).
    \52\ Proposed Regulation Sec.  23.153(b).
---------------------------------------------------------------------------

    Two-way variation margin would protect the safety and soundness of 
CSEs for the same reasons discussed above in connection with initial 
margin. Two-way variation margin has been a keystone of the ability of 
DCOs to manage risk. Each day, starting on the day after execution, 
current exposure is removed from the market through the payment and 
collection of variation margin.
    If two-way variation margin were not required for uncleared swaps 
between CSEs and counterparties that are swap entities or financial end 
users, current exposures might accumulate beyond the financial capacity 
of a counterparty. In contrast to initial margin, which is designed to 
cover potential future exposures, variation margin addresses actual 
current exposures, that is, losses that have already occurred. 
Unchecked accumulation of such exposures was one of the characteristics 
of the financial crisis which, in turn, led to the enactment of the 
Dodd-Frank Act.\53\ As with initial margin, the Commission believes 
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

[[Page 59908]]

counterparty from the effects of a default.
---------------------------------------------------------------------------

    \53\ See The Financial Crisis Inquiry Commission, The Financial 
Crisis Inquiry Report: Final Report of the National Commission on 
the Causes of the Financial and Economic Crisis in the United States 
(Official Government Edition) at 265-268 (2011), available at http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf.
---------------------------------------------------------------------------

    In contrast to the initial margin requirement, which would only 
apply to financial end users with material swaps exposure, the proposed 
variation margin requirement would apply to all financial end users 
regardless of whether the entity had material swaps exposure. This is 
consistent with international standards.\54\ It reflects the 
Commission's view that variation margin is an important risk mitigant 
that (i) reduces the build-up of risk that may ultimately pose systemic 
risk and (ii) imposes a lesser liquidity burden than does initial 
margin. Moreover, this approach is consistent with current market 
practice.
---------------------------------------------------------------------------

    \54\ BCBS/IOSCO Report at 9.
---------------------------------------------------------------------------

    The proposal would permit netting of variation margin across 
swaps.\55\ Any netting would have to be done pursuant to an eligible 
master netting agreement.\56\ The agreement would create a single legal 
obligation for all individual transactions covered by the agreement 
upon an event of default. It would specify the rights and obligations 
of the parties under various circumstances.\57\
---------------------------------------------------------------------------

    \55\ Proposed Regulation Sec.  23.153(c).
    \56\ Proposed Regulation Sec.  23.151, definition of ``eligible 
master netting agreement.''
    \57\ Id.
---------------------------------------------------------------------------

    As is the case for initial margin, the proposal contains a 
provision stating that a CSE would not be deemed to have violated its 
obligation to collect variation margin if it took certain steps.\58\ 
Specifically, if a counterparty failed to pay the required variation 
margin to the CSE, the CSE would be required to make the necessary 
efforts to attempt to collect the variation margin, including the 
timely initiation and continued pursuit of formal dispute resolution 
mechanisms, including pursuant to Commission Regulation 23.504(b)(4), 
if applicable, or otherwise demonstrate upon request to the 
satisfaction of the Commission that it has made appropriate efforts to 
collect the required variation margin or commenced termination of the 
swap.
---------------------------------------------------------------------------

    \58\ Proposed Regulation Sec.  23.153(d).
---------------------------------------------------------------------------

    The Commission requests comment on all aspects of the proposal 
relating to the nature and timing of variation margin.
    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.

E. Calculation of Initial Margin

1. Overview
    Under the proposed rules, a CSE could calculate initial margin 
using either a model-based method or a standardized table-based 
method.\59\ The required amount of initial margin would be the amount 
computed pursuant to the model or the table minus a threshold amount of 
$65 million.\60\ This amount could not be less than zero.\61\ The 
initial margin specified under the rule would be a minimum requirement, 
and the parties would be free to require more initial margin.
---------------------------------------------------------------------------

    \59\ Proposed Regulation Sec.  23.154.
    \60\ Proposed Regulation Sec.  23.151, definition of ``initial 
margin threshold amount.''
    \61\ Proposed Regulation Sec.  23.154(a)(4).
---------------------------------------------------------------------------

    When a CSE entered into a swap with a counterparty that was either 
another CSE or an SD/MSP subject to a Prudential Regulator, each party 
would bear the responsibility for calculating the amount that it would 
collect.\62\ Thus, for such trades, the amount a party posted could 
differ from the amount it collected either because of differences in 
their respective methodologies or because the product has asymmetric 
risk. As a practical matter, the Commission understands that the 
industry is working to develop common standards that would minimize 
this for methodologies.
---------------------------------------------------------------------------

    \62\ Proposed Regulation Sec.  23.152(a).
---------------------------------------------------------------------------

    When, however, a CSE entered into a swap with a financial entity, 
the CSE would have responsibility for calculating both the amount it 
collected and the amount it posted.\63\ This is because the statute 
does not directly impose margin requirements on financial entities. 
They only come within the scope of section 4s when they trade with SDs 
or MSPs.
---------------------------------------------------------------------------

    \63\ Proposed Regulation Sec.  23.154(b).
---------------------------------------------------------------------------

    As noted, the rules would permit CSEs and their covered 
counterparties to establish margin thresholds of up to $65 million. 
This means that the parties could agree not to post and/or to collect 
any margin amount falling below this threshold level. For covered 
entities that were part of a consolidated group, a single threshold 
would be applied across the consolidated group, not individually to 
each entity.\64\ This threshold is consistent with the 50 million Euro 
threshold set forth in the international standards as is the 
consolidated group requirement.\65\ The Prudential Regulators proposed 
the same treatment in this regard.
---------------------------------------------------------------------------

    \64\ Proposed Regulation Sec.  23.151, definition of ``initial 
margin threshold amount.''
    \65\ BCBS/IOSCO Report at 9.
---------------------------------------------------------------------------

    Concern has been expressed by some in the industry about the 
potential expense of two-way margin. The $65 million threshold is 
designed to mitigate that expense while continuing to protect the 
financial integrity of CSEs and the financial system. Smaller exposures 
would be permitted to go uncollateralized, but a significant percentage 
of all large exposures would be supported by collateral.
    For example, if the initial margin calculated for a particular 
trade were $55 million, the CSE would not be required to post or to 
collect initial margin because the amount would be below the $65 
million threshold. If the margin amount were $75 million, the CSE would 
only be required to post and to collect $10 million, the amount the 
margin calculation exceeded the $65 million threshold.
    In order to reduce transaction costs, the proposal would establish 
a ``minimum transfer amount'' of $650,000.\66\ Initial and variation 
margin payments would not be required to be made if the payment were 
below that amount. This amount is consistent with international 
standards.\67\ It represents an amount sufficiently small that the 
level of risk reduction might not be worth the transaction costs of 
transferring the money. It would affect only the timing of collection; 
it would not change the amount of margin that must be collected once 
the $650,000 level was exceeded.
---------------------------------------------------------------------------

    \66\ Proposed Regulation Sec.  23.154(a)(3).
    \67\ BCBS/IOSCO Report at 9.
---------------------------------------------------------------------------

    For example, if a party posted $80 million as initial margin on 
Monday and the requirement increased to $80,400,000 on Tuesday, the 
party would not be required to post additional funds on Tuesday because 
the $400,000 increase would be less than the minimum transfer amount. 
If, however, on Wednesday, the requirement increased by another 
$400,000 to $80,800,000, the party would be required to post the entire 
$800,000 additional amount.
    The Commission requests comment on the $65 million threshold and 
the $650,000 minimum transfer amount. The Commission requests comment 
on the costs and benefits of the proposed approach. Commenters are 
urged to quantify the costs and benefits, if practicable. Commenters 
also may suggest alternatives to the proposed approach where the 
commenters believe that the alternatives would be appropriate under the 
CEA.

[[Page 59909]]

2. Models
a. Commission Approval
    Consistent with international standards, the proposal would require 
CSEs to obtain the written approval of the Commission before using a 
model to calculate initial margin.\68\ Further, the CSE would have to 
demonstrate that the model satisfied all of the requirements of this 
section on an ongoing basis.\69\ In addition, a CSE would have to 
notify the Commission in writing before extending the use of a model 
that has been approved to an additional product type, making any change 
to any initial margin model that has been approved that would result in 
a material change in the CSE's assessment of initial margin 
requirements; or making any material change to assumptions used in the 
model.\70\ The Commission could rescind its approval of a model if the 
Commission determined that the model no longer complied with this 
section.\71\
---------------------------------------------------------------------------

    \68\ Proposed Regulation Sec.  23.154(b)(1). See BCBS/IOSCO 
Report at 12: ``any quantitative model that is used for initial 
margin purposes must be approved by the relevant supervisory 
authority.''
    \69\ Id.
    \70\ Id.
    \71\ Id.
---------------------------------------------------------------------------

    Given the central place of modeling in most margin systems and the 
complexity of the process, the Commission believes that these oversight 
provisions are necessary. The resources that would be needed, however, 
to initially review and to periodically assess margin models present a 
significant challenge to the Commission. To address this issue, the 
Commission would seek to coordinate with both domestic and foreign 
authorities in the review of models.
    In many instances, CSEs whose margin models would be subject to 
Commission review would be affiliates of entities whose margin models 
would be subject to review by one of the Prudential Regulators. In such 
situations, the Commission would coordinate with the Prudential 
Regulators in order to avoid duplicative efforts and to provide 
expedited approval of models that a Prudential Regulator had already 
approved. For example, if a Prudential Regulator had approved the model 
of a depository institution registered as an SD, Commission review of a 
comparable model used by a non-bank affiliate of that SD would be 
greatly facilitated. Similarly, the Commission would coordinate with 
the SEC for CSEs that are dually registered and would coordinate with 
foreign regulators that had approved margin models for foreign CSEs. 
For CSEs that that wished to use models that were not reviewed by a 
Prudential Regulator, the SEC, or a foreign regulator, the Commission 
would coordinate, if possible, with the National Futures Association 
(``NFA'') as each CSE would be required to be a member of the NFA.
    The Commission requests comment on all aspects of the proposed 
margin approval process. Specifically, the Commission requests comment 
on the appropriateness and feasibility of coordinating with the 
Prudential Regulators, the SEC, foreign regulators, and the NFA in this 
regard.
    The Commission is also considering whether it would be appropriate 
to provide for provisional approval upon the filing of an application 
pending review. The Commission requests comment on the appropriateness 
of such an approach.
    In order to expedite the review of models further, the Commission 
is proposing to delegate authority to staff to perform the functions 
described above. As is the case with existing delegations to staff, the 
Commission would continue to reserve the right to perform these 
functions itself at any time.
    The Commission requests comment on whether additional procedural 
detail is appropriate. For example, should time frames be specified for 
completion of any of the functions?
b. Applicability to Multiple Swaps
    To the extent that more than one uncleared swap is executed 
pursuant to an eligible master netting agreement (``EMNA'') \72\ 
between a CSE and a covered counterparty, the CSE would be permitted to 
calculate initial margin on an aggregate basis with respect to all 
uncleared swaps governed by such agreement.\73\ As explained below, 
however, only exposures in certain asset classes could be offset. If 
the agreement covered uncleared swaps entered into before the 
applicable compliance date, those swaps would have to be included in 
the calculation.\74\
---------------------------------------------------------------------------

    \72\ This term is defined in Proposed Regulation Sec.  23.151.
    \73\ Proposed Regulation Sec.  23.154(b)(2).
    \74\ Id.
---------------------------------------------------------------------------

    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 to liquidate collateral and certain 
standards with respect to legal review of the agreement to ensure that 
it meets the criteria in the definition.
    The Commission requests comment on all aspects of the proposed 
definition of EMNA. In particular, the Commission requests comment on 
whether the proposal provides sufficient clarity regarding the laws of 
foreign jurisdictions that provide for limited stays to facilitate the 
orderly resolution of financial institutions. The Commission also seeks 
comment regarding whether the provision for a contractual agreement 
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.
c. Elements of a Model
    The proposal specifies a number of conditions that a model would 
have to meet to receive Commission approval.\75\ They include, among 
others, the following.
---------------------------------------------------------------------------

    \75\ Proposed Regulation Sec.  23.154(b)(3).
---------------------------------------------------------------------------

(i) Ten-Day Close-Out Period
    The model must calculate potential future exposure using a one-
tailed 99 percent confidence interval for an increase in the value of 
the uncleared swap or netting set of uncleared swaps due to an 
instantaneous price shock that is equivalent to a movement in all 
material underlying risk factors, including prices, rates, and spreads, 
over a holding period equal to the shorter of ten business days or the 
maturity of the swap.
    The required 10-day close-out period assumption is consistent with 
counterparty credit risk capital requirements for banks. The 
calculation must be performed directly over a 10-day period. In the 
context of bank regulatory capital rules, a long horizon calculation 
(such as 10 days), under certain circumstances, may be indirectly 
computed by making a calculation over a shorter horizon (such as 1 day) 
and then scaling the result of the shorter horizon calculation to be 
consistent with the longer horizon. The proposed rule does not provide 
this option to covered swap entities using an approved initial margin 
model. The Commission's understanding is that the rationale for 
allowing such indirect calculations that rely on scaling shorter 
horizon calculations has largely been based on computational and cost 
considerations that were material in the

[[Page 59910]]

past but are much less so in light of advances in computational speeds 
and reduced computing costs. The Commission seeks comment on whether 
the option to make use of such indirect calculations has a material 
effect on the burden of complying with the proposed rule, and whether 
such indirect methods are appropriate in light of current computing 
methods and costs.
(ii) Portfolio Offsets
    The model may reflect offsetting exposures, diversification, and 
other hedging benefits for uncleared swaps that are governed by the 
same EMNA by incorporating empirical correlations within the broad risk 
categories, provided the covered swap entity validates and demonstrates 
the reasonableness of its process for modeling and measuring hedging 
benefits. The categories are agriculture, credit, energy, equity, 
foreign exchange/interest rate, metals, and other. Empirical 
correlations under an eligible master netting agreement may be 
recognized by the model within each broad risk category, but not across 
broad risk categories. The sum of the initial margins calculated for 
each broad risk category must be used to determine the aggregate 
initial margin due from the counterparty.
    For example, if a CSE entered into two credit swaps and two energy 
swaps with a single counterparty, the CSE could use an approved initial 
margin model to perform two separate calculations: the initial margin 
calculation for the credit swaps and the initial margin calculation for 
the energy commodity swaps. Each calculation could recognize offsetting 
and diversification within the credit swaps and within the energy 
commodity swaps. The result of the two separate calculations would then 
be summed together to arrive at the total initial margin amount for the 
four swaps (two credit swaps and two energy commodity swaps).
    The Commission believes that the correlations of exposures across 
unrelated asset categories, such as credit and energy commodities, are 
not stable enough over time, and, in particular, during periods of 
financial stress, to be recognized in a regulatory margin model 
requirement. The Commission further believes that a single commodity 
asset class is too broad and that the relationship between disparate 
commodity types, such as aluminum and corn, are not stable enough to 
warrant hedging benefits within the initial margin model. The 
Commission seeks comment on this specific treatment of asset classes 
for initial margin purposes and whether fewer or more distinctions 
should be made.
    The Commission is aware that some swaps may be difficult to 
classify into one and only one asset class because some swaps may have 
characteristics that relate to more than one asset class. Under the 
proposal, the Commission expects that the CSE would make a 
determination as to which asset class best represents the swap based on 
a holistic view of the underlying swap. As a specific example, many 
swaps may have some sensitivity to interest rates even though most of 
the swap's sensitivity relates to another asset class such as equity or 
credit. The Commission seeks comment on whether or not this approach is 
reasonable and whether or not instances in which the classification of 
a swap into one of the broad asset classes described above is 
problematic and material. If such instances are material, the 
Commission seeks comment on alternative approaches to dealing with such 
swaps.
(iii) Stress Calibration
    The proposed rule requires the initial margin model to be 
calibrated to a period of financial stress. In particular, the initial 
margin model must employ a stress period calibration for each broad 
asset class (agricultural commodity, energy commodity, metal commodity, 
other commodity, credit, equity, and interest rate and foreign 
exchange). The stress period calibration employed for each broad asset 
class must be appropriate to the specific asset class in question. 
While a common stress period calibration may be appropriate for some 
asset classes, a common stress period calibration for all asset classes 
would only be considered appropriate if it is appropriate for each 
specific underlying asset class. Also, the time period used to inform 
the stress period calibration must include at least one year, but no 
more than five years, of equally-weighted historical data.
    This proposed requirement is intended to balance the tradeoff 
between shorter and longer data spans. Shorter data spans are sensitive 
to evolving market conditions but may also overreact to short-term and 
idiosyncratic spikes in volatility. Longer data spans are less 
sensitive to short-term market developments but may also place too 
little emphasis on periods of financial stress, resulting in 
requirements that are too low. The requirement that the data be equally 
weighted is intended to establish a degree of consistency in model 
calibration while also ensuring that particular weighting schemes do 
not result in excessive margin requirements during short-term bouts of 
heightened volatility.
    The model must use risk factors sufficient to measure all material 
price risks inherent in the transactions for which initial margin is 
being calculated. The risk categories must include, but should not be 
limited to, foreign exchange or interest rate risk, credit risk, equity 
risk, agricultural commodity risk, energy commodity risk, metal 
commodity risk, and other commodity risk, as appropriate. For material 
exposures in significant currencies and markets, modeling techniques 
must capture spread and basis risk and incorporate a sufficient number 
of segments of the yield curve to capture differences in volatility and 
imperfect correlation of rates along the yield curve.
    The initial margin model must include all material risks arising 
from the nonlinear price characteristics of option positions or 
positions with embedded optionality and the sensitivity of the market 
value of the positions to changes in the volatility of the underlying 
rates, prices, or other material risk factors.
(iv) Frequency of Margin Calculation
    The proposed rule requires daily calculation of initial margin. The 
use of an approved initial margin model may result in changes to the 
initial margin amount on a daily basis for a number of reasons.
    First, the characteristics of the swaps that have a material effect 
on their risk may change over time. As an example, the credit quality 
of a corporate reference entity upon which a credit default swap 
contract is written may undergo a measurable decline.
    Second, any change to the composition of the swap portfolio that 
results in the addition or deletion of swaps from the portfolio would 
result in a change in the initial margin amount.
    Third, the underlying parameters and data that are used in the 
model may change over time as underlying conditions change. For 
example, a new period of financial stress may be encountered in one or 
more asset classes. While the stress period calibration is intended to 
reduce the extent to which small or moderate changes in the risk 
environment influence the initial margin model's risk assessment, a 
significant change in the risk environment that affects the required 
stress period calibration could influence the margin model's overall 
assessment of the risk of a swap.
    Fourth, quantitative initial margin models are expected to be 
maintained and refined on a continuous basis to

[[Page 59911]]

reflect the most accurate risk assessment possible with available best 
practices and methods. As best practice risk management models and 
methods change, so too may the risk assessments of initial margin 
models.
(v) Benchmarking
    The proposed rule requires that a model used for calculating 
initial margin requirements be benchmarked periodically against 
observable margin standards to ensure that the initial margin required 
is not less than what a CCP would require for similar transactions.\76\ 
This benchmarking requirement is intended to ensure that any initial 
margin amount produced by a model is subject to a readily observable 
minimum. It will also have the effect of limiting the extent to which 
the use of models might disadvantage the movement of certain types of 
swaps to DCOs by setting lower initial margin amounts for uncleared 
transactions than for similar cleared transactions.
---------------------------------------------------------------------------

    \76\ Proposed Regulation Sec.  23.154(b)(5).
---------------------------------------------------------------------------

d. Control Mechanisms
    The proposal would require CSEs to implement certain control 
mechanisms.\77\ They include, among others, the following.
---------------------------------------------------------------------------

    \77\ Proposed Regulation Sec.  23.154(b)(5).
---------------------------------------------------------------------------

    The CSE must maintain a risk management unit in accordance with 
existing Commission Regulation 23.600(c)(4)(i) that reports directly to 
senior management and is independent from the business trading 
units.\78\ The unit must validate its model before implementation and 
on an ongoing basis. The validation process must include an evaluation 
of the conceptual soundness of the model, an ongoing monitoring process 
to ensure that the initial margin is not less than what a DCO would 
require for similar cleared products, and back testing.
---------------------------------------------------------------------------

    \78\ Commission Regulation Sec.  23.600 requires each registered 
SD/MSP to establish a risk management program that identifies the 
risks implicated by the SD/MSP's activities along with the risk 
tolerance limits set by the SD/MSP. The SD/MSP should take into 
account a variety of risks, including market, credit, liquidity, 
foreign currency, legal, operational, settlement, and other 
applicable risks. The risks would also include risks posed by 
affiliates. See 17 CFR 23.600.
---------------------------------------------------------------------------

    If the validation process revealed any material problems with the 
model, the CSE would be required to notify the Commission of the 
problems, describe to the Commission any remedial actions being taken, 
and adjust the model to insure an appropriate amount of initial margin 
is being calculated.
    The CSE must have an internal audit function independent of the 
business trading unit that at least annually assesses the effectiveness 
of the controls supporting the model. The internal audit function must 
report its findings to the CSE's governing body, senior management, and 
chief compliance officer at least annually.
    Given the complexity of margin models and the incentives to 
calculate lower margin amounts, the Commission believes that rigorous 
internal oversight is necessary to ensure proper functioning.
    The Commission seeks comment on all aspects of the proposed 
standards for models and the proposed levels of regulatory review.
    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.
3. Table-Based Method
a. Method of Calculation
    Some CSEs might not have the internal technical resources to 
develop initial margin models or have simple portfolios for which they 
want to avoid the complexity of modeling. The table-based method would 
allow a CSE to calculate its initial margin requirements using a 
standardized table.\79\ The table specifies the minimum initial margin 
amount that must be collected as a percentage of a swap's notional 
amount. This percentage varies depending on the asset class of the 
swap. Except as described below, a CSE would be required to calculate a 
minimum initial margin amount for each swap and sum up all the minimum 
initial margin amounts calculated under this section to arrive at the 
total amount of initial margin. The table is consistent with 
international standards.\80\
---------------------------------------------------------------------------

    \79\ Proposed Regulation Sec.  23.154(c).
    \80\ BCBS/IOSCO Report at Appendix A.
---------------------------------------------------------------------------

b. Net-to-Gross Ratio Adjustment
    The Commission recognizes that using a notional amount measure of 
initial margin without any adjustment for offsetting exposures, 
diversification, and other hedging benefits might not accurately 
reflect the size or risks of a CSE's swap-based positions in many 
situations. Moreover, not adequately recognizing the benefits of 
offsets, diversification, and hedging might lead to large disparities 
between model-based and table-based initial margin requirements. These 
disparities might give rise to inequities between CSEs that elect to 
use an approved model and CSEs that rely on the table for computing 
their respective initial margin requirements.
    To address these potential inequities, the Commission is proposing 
an adjustment to the table-based initial margin requirement. 
Specifically, the Commission would allow a CSE to calculate a net-to-
gross ratio adjustment.\81\
---------------------------------------------------------------------------

    \81\ This calculation is set forth in proposed Regulation Sec.  
23.154(c)(2).
---------------------------------------------------------------------------

    The net-to-gross ratio compares the net current replacement cost of 
the uncleared portfolio (in the numerator) with the gross current 
replacement cost of the uncleared portfolio (in the denominator). The 
net current replacement cost is the cost of replacing the entire 
portfolio of swaps that is covered under an eligible master netting 
agreement. The gross current replacement cost is the cost of replacing 
those swaps that have a strictly positive replacement cost.
    For example, consider a portfolio that consists of two uncleared 
swaps in which the mark-to-market value of the first swap is $10 (i.e., 
the CSE is owed $10 from its counterparty) and the mark-to-market value 
of the second swap is -$5 (i.e., the CSE owes $5 to its counterparty). 
The net current replacement cost is $5 ($10-$5), the gross current 
replacement cost is $10, and the net-to-gross ratio would be 5/10 or 
0.5.\82\
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    \82\ Note that in this example, whether or not the 
counterparties have agreed to exchange variation margin has no 
effect on the net-to-gross ratio calculation, i.e., the calculation 
is performed without considering any variation margin payments. This 
is intended to ensure that the net-to-gross ratio calculation 
reflects the extent to which the uncleared swaps generally offset 
each other and not whether the counterparties have agreed to 
exchange variation margin. As an example, if a swap dealer engaged 
in a single sold credit derivative with a counterparty, then the 
net-to-gross calculation would be 1.0 whether or not the dealer 
received variation margin from its counterparty.
---------------------------------------------------------------------------

    The net-to-gross ratio and gross standardized initial margin 
amounts provided in the table are used in conjunction with the notional 
amount of the transactions in the underlying swap portfolio to arrive 
at the total initial margin requirement as follows:
    Standardized Initial Margin = 0.4 x Gross Initial Margin + 0.6 x 
NGR x Gross Initial Margin
where:
    Gross Initial Margin = the sum of the notional value multiplied by 
the applicable initial margin requirement percentage from the table A 
for each uncleared swap in the portfolio
and

[[Page 59912]]

NGR = Net-to-Gross Ratio
    The Commission notes that the calculation of the net-to-gross ratio 
for margin purposes must be applied only to swaps subject to the same 
EMNA and that the calculation is performed across transactions in 
disparate asset classes within a single netting agreement. (Thus, all 
non-cleared swaps subject to the same EMNA can be netted against each 
other in the calculation of the net-to-gross ratio. By contrast, under 
a model, netting is only permitted within each asset class). This 
approach is consistent with the standardized counterparty credit risk 
capital requirements.
    The Commission also notes that if a counterparty maintains multiple 
swap portfolios under multiple EMNAs, the standardized initial margin 
amounts would be calculated separately for each portfolio with each 
calculation using the gross initial margin and net-to-gross ratio that 
is relevant to each portfolio. The total standardized initial margin 
would be the sum of the standardized initial margin amounts for each 
portfolio.
    The proposed net-to-gross ratio adjustment is consistent with 
international standards.\83\ The proposed table and adjustment are the 
same as the Prudential Regulators' proposal.
---------------------------------------------------------------------------

    \83\ BCBS/IOSCO Report at 13.
---------------------------------------------------------------------------

    The Commission seeks comment on all aspects of the proposed table-
based approach. The Commission notes that the BCBS has recently adopted 
a new method for the purpose of capitalizing counterparty credit 
risk.\84\ The Commission seeks comment on whether the BCBS's recently 
adopted standardized approach would represent a material improvement 
relative to the proposed method that employs the net-to-gross ratio.
---------------------------------------------------------------------------

    \84\ See the Basel Committee on Banking Supervision, ``The 
standardized approach for measuring counterparty credit risk 
exposures,'' (March 31, 2014), available at http://www.bis.org/publ/bcbs279.pdf.
---------------------------------------------------------------------------

    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.

F. Calculation of Variation Margin

1. Means of Calculation
    Under the proposal, each CSE would be required to calculate 
variation margin for itself and for each covered counterparty using a 
methodology and inputs that to the maximum extent practicable and in 
accordance with existing Regulation 23.504(b)(4) rely on recently-
executed transactions, valuations provided by independent third 
parties, or other objective criteria.\85\ In addition, each CSE would 
have to have in place alternative methods for determining the value of 
an uncleared swap in the event of the unavailability or other failure 
of any input required to value a swap.\86\
---------------------------------------------------------------------------

    \85\ Proposed Regulation Sec.  23.155(a)(1) and Commission 
Regulation Sec.  23.504(b)(4).
    \86\ Proposed Regulation Sec.  23.155(a)(2).
---------------------------------------------------------------------------

2. Control Mechanisms
    The proposal would also set forth several control mechanisms.\87\ 
Each CSE would be required to create and maintain documentation setting 
forth the variation margin methodology with sufficient specificity to 
allow the counterparty, the Commission, and any applicable Prudential 
Regulator to calculate a reasonable approximation of the margin 
requirement independently. Each CSE would be required to evaluate the 
reliability of its data sources at least annually, and make 
adjustments, as appropriate. The proposal would permit the Commission 
to require a CSE to provide further data or analysis concerning the 
methodology or a data source.
---------------------------------------------------------------------------

    \87\ Proposed Regulation Sec.  23.155(b).
---------------------------------------------------------------------------

    These provisions are consistent with international standards \88\ 
and the Prudential Regulators' proposed rules. The Commission's 
proposal, however, sets forth more detailed requirements. These 
requirements are consistent with an approach currently under 
consideration by an IOSCO working group.
---------------------------------------------------------------------------

    \88\ BCBS/IOSCO Report at 14-15.
---------------------------------------------------------------------------

    The Commission believes that the accurate valuation of positions 
and the daily payment of variation margin to remove accrued risk is a 
critical element in assuring the safety and soundness of CSEs and in 
preserving the financial integrity of the markets. The Commission 
believes that its experience with cleared markets \89\ coupled with the 
problems in the uncleared markets noted in section II.A. demonstrates 
this.
---------------------------------------------------------------------------

    \89\ For example, in May 2000, a clearing member defaulted to 
the New York Clearing Corporation. A significant contributing factor 
was the lack of a rigorous settlement price procedure which allowed 
prices in an illiquid market to be mismarked and unrealized losses 
to accumulate. See Report on Lessons Learned from the Failure of 
Klein & Co, Division of Trading and Markets, Commodity Futures 
Trading Commission (July 2001).
---------------------------------------------------------------------------

    The Commission believes that the proposed provisions avoid 
potential miscalculations and would allow the variation margin 
calculations to be monitored and, thereby, forestall potential problems 
that could exacerbate a crisis. These measures are designed to be 
prudent safeguards to be used to address weaknesses that may only 
become apparent over time.
    The Commission seeks comment on all aspects of the proposed 
requirements for calculating variation margin.
    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.

G. Forms of Margin

1. Initial Margin
    In general, the Commission believes that margin assets should share 
the following fundamental characteristics. The assets should be liquid 
and, with haircuts, hold their value in times of financial stress. The 
value of the assets should not exhibit a significant correlation with 
the creditworthiness of the counterparty or the value of the swap 
portfolio.\90\
---------------------------------------------------------------------------

    \90\ See BCBS/IOSCO Report at 16.
---------------------------------------------------------------------------

    Guided by these principles, the Commission is proposing that CSEs 
may only post or accept certain assets to meet initial margin 
requirements to or from covered counterparties.\91\ These include: U.S. 
dollars; cash in a currency in which payment obligations under the swap 
are required to be settled; U.S. Treasury securities; certain 
securities guaranteed by the U.S.; certain securities issued or 
guaranteed by the European Central bank, a sovereign entity, or the 
BIS; certain corporate debt securities; certain equity securities 
contained in major indices; major currencies,\92\ and gold.
---------------------------------------------------------------------------

    \91\ Proposed Regulation Sec.  23.156(a)(1).
    \92\ Major currencies are defined in Proposed Regulation Sec.  
23.151.
---------------------------------------------------------------------------

    These are assets for which there are deep and liquid markets and, 
therefore, assets that can be readily valued and easily liquidated. 
This list includes a number of assets that were not included in the 
2011 proposal. This is responsive to a number of commenters who 
expressed concern about the narrowness of that list and the potential 
that there would be insufficient available collateral.
    The Commission notes that 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

[[Page 59913]]

would be eligible collateral only if the security met the requirements 
for corporate debt securities.
    The Commission also notes that eligible collateral would include 
other publicly-traded debt that has been deemed acceptable as initial 
margin by a Prudential Regulator.\93\ The Prudential Regulators have 
indicated that this would include securities that meet the terms of 12 
CFR 1.2(d). That provision states that the issuer of a security must 
have adequate capacity to meet financial commitments under the security 
for the projected life of the asset or exposure. It further states an 
issuer has adequate capacity to meet financial commitments if the risk 
of default by the obligor is low and the full and timely payment of 
principal and interest is expected. For example, municipal bonds that 
meet this standard, as determined by a Prudential Regulator, would be 
eligible collateral.
---------------------------------------------------------------------------

    \93\ Proposed Regulation Sec.  23.156(a)(1)(ix).
---------------------------------------------------------------------------

    Under the proposal, certain assets would be prohibited from use as 
initial margin.\94\ These include any asset that is an obligation of 
the party providing such asset or an affiliate of that party. These 
also include instruments issued by bank holding companies, depository 
institutions and market intermediaries. The use of such assets as 
initial margin could compound risk. These restrictions reflect the 
Commission's view that the price and liquidity of securities issued by 
the foregoing entities are very likely to come under significant 
pressure during a period of financial stress when a CSE may be 
resolving a counterparty's defaulted swap position and present an 
additional source of risk.
---------------------------------------------------------------------------

    \94\ Proposed Regulation Sec.  23.156(a)(2).
---------------------------------------------------------------------------

    The Commission requests 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.
    Counterparties that wished 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, such as 
collateral transformation arrangements, using the cash or other 
eligible collateral received from that separate arrangement to meet the 
minimum margin requirements.
    Moreover, the Commission notes that the proposal would not restrict 
the types of collateral that could be collected or posted to satisfy 
margin terms that are bilaterally negotiated above required amounts. 
For example, if, notwithstanding the $65 million threshold, a CSE 
decided to collect initial margin to protect itself against the credit 
risk of a particular counterparty, the CSE could accept any form of 
collateral.
    Except for U.S. dollars and the currency in which the payment 
obligations of the swap is required, assets posted as required initial 
margin would be subject to haircuts in order to address the possibility 
that the value of the collateral could decline during the period that 
it took to liquidate a swap position in default. The proposed 
collateral haircuts have been calibrated to be broadly consistent with 
valuation changes observed during periods of financial stress.
    Because the value of noncash collateral and foreign currency may 
change over time, the proposal would require a CSE to monitor the value 
of such collateral previously collected to satisfy initial margin 
requirements and, to the extent the value of such collateral has 
decreased, to collect additional collateral with a sufficient value to 
ensure that all applicable initial margin requirements remain 
satisfied.\95\
---------------------------------------------------------------------------

    \95\ Proposed Regulation Sec.  23.156(a)(4).
---------------------------------------------------------------------------

    The Commission seeks comment on all aspects of the proposed 
requirements for eligible collateral for initial margin. In particular, 
the Commission requests comments on whether the list should be expanded 
or contracted in any way. If so, subject to what terms and conditions?
    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.
2. Variation Margin
    The proposal would require that variation margin be paid in U.S. 
dollars, or a currency in which payment obligations under the swap are 
required to be settled.\96\ 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.
---------------------------------------------------------------------------

    \96\ Proposed Regulation Sec.  23.156(b).
---------------------------------------------------------------------------

    The proposal is narrower than the 2011 proposal which also 
permitted U.S. Treasury securities.\97\ This change is designed to 
reinforce the concept that variation margin is paid and to reduce the 
potential for disputes to arise over the value of assets being used to 
meet this margin requirement. This proposed change is consistent with 
regulatory and industry initiatives to improve standardization and 
efficiency in the OTC derivatives market. For example, in June of 2013, 
ISDA published the 2013 Standard Credit Support Annex (``SCSA''). The 
SCSA provides for the sole use of cash as eligible collateral for 
variation margin. The Commission supports this and other ongoing 
regulatory and industry efforts at standardization that improve 
operational efficiency and reduce the differences between the bilateral 
and cleared OTC derivatives markets.
---------------------------------------------------------------------------

    \97\ 76 FR 23732 at 23747.
---------------------------------------------------------------------------

    In this regard, the Commission notes that central counterparties 
generally require that variation margin be paid in cash. U.S. law 
applicable to cleared swaps is consistent with this practice. Section 
5b(c)(2)(E) of the CEA requires derivatives clearing organizations to 
``complete money settlements on a timely basis (but not less frequently 
than once each business day).'' CFTC Regulation 39.14(a)(1) defines 
``settlement'' as, among other things, ``payment and receipt of 
variation margin for futures, options, and swaps.'' CFTC Regulation 
39.14(b) requires 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.''
    The Commission believes that this change from the 2011 proposal is 
appropriate because it better reflects that counterparties to swap 
transactions generally view variation margin payments as the daily 
settlement of their exposure(s) to one another. Additionally, limiting 
variation margin to cash should sharply reduce the potential for 
disputes over the value of variation margin.
    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. Therefore, haircuts are not a

[[Page 59914]]

necessary component of the regulatory requirements for cash variation 
margin.
    The proposal is stricter than international standards which do not 
require that variation margin be in cash.\98\ It is the same as the 
Prudential Regulators' proposal.
---------------------------------------------------------------------------

    \98\ BCBS/IOSCO Report at 14-15. The international standards do 
not distinguish between initial margin and variation margin in 
discussing eligible assets.
---------------------------------------------------------------------------

    The Commission seeks comment on all aspects of the proposed 
requirements for forms of variation margin.
    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.

H. Custodial Arrangements

    The proposal sets forth requirements for the custodial arrangements 
for initial margin posted for transactions between CSEs and covered 
counterparties.\99\ Each CSE that posts initial margin with respect to 
an uncleared swap would be mandated to require that all funds or other 
property that it provided as initial margin be held by one or more 
custodians that were not affiliates of the CSE or the counterparty. 
Each CSE that collects initial margin with respect to an uncleared swap 
would be mandated to require that such initial margin be held at one or 
more custodians that were not affiliates of the CSE or the 
counterparty.
---------------------------------------------------------------------------

    \99\ Proposed Regulation Sec.  23.157.
---------------------------------------------------------------------------

    Each CSE would be required to enter into custodial agreements 
containing specified terms. These would include a prohibition on 
rehypothecating the margin assets and standards for the substitution of 
assets.
    The proposed rules are consistent with international standards 
except that international standards would allow rehypothecation under 
certain circumstances.\100\ The proposal is the same as the Prudential 
Regulators' proposal. The Commission also notes that the European 
Supervisory Authorities have proposed to prohibit rehypothecation.\101\
---------------------------------------------------------------------------

    \100\ BCBS/IOSCO Report at 19-20.
    \101\ 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).
---------------------------------------------------------------------------

    The proposed approach is grounded in several provisions of section 
4s(e) of the CEA. First, section 4s(e)(3)(A)(i) mandates that margin 
rules ``help ensure the safety and soundness of [SDs] and [MSPs].'' 
Maintaining margin collateral at an independent custodian subject to 
specified terms protects both parties to a transaction by preventing 
assets from being lost or misused. In particular, a prohibition on 
rehypothecation enhances safety by avoiding the possibility that a 
margin asset will be lost because of the failure of a third party who 
was not a party to the original transaction.
    Second, section 4s(e)(3)(C) mandates that margin rules preserve 
``the financial integrity of the markets trading swaps'' and ``the 
stability of the United States financial system.'' Maintaining margin 
collateral at an independent custodian preserves financial integrity 
and financial stability by preventing the same asset from supporting 
multiple positions. If an SD could take collateral posted by a 
counterparty for one swap and reuse it to margin a second swap with 
another SD, and that SD could, in turn, do the same, this would 
increase leverage in the system and create the possibility of a cascade 
of defaults if one of these firms failed.
    Third, section 4s(e)(3)(A) refers to the ``greater risk'' to SDs, 
MSPs, and the financial system ``arising from the use of swaps that are 
not cleared.'' It mandates rules ``appropriate for the risk'' 
associated with uncleared swaps. Margin posted by customers to futures 
commission merchants (``FCMs'') and by FCMs to DCOs for cleared swaps 
is subject to segregation requirements.\102\ It would be inappropriate 
to address the greater risk of uncleared swaps with a lesser standard.
---------------------------------------------------------------------------

    \102\ Section 4d(f) of the CEA.
---------------------------------------------------------------------------

    The proposed rules can be harmonized with section 4s(l) of the CEA 
which authorizes counterparties of an SD or an MSP to request that 
margin be segregated. As discussed above, covered counterparties pose 
risk to the financial system. The primary purpose of the proposed 
custodial arrangements is preservation of the financial integrity of 
the markets and the U.S. financial system although the arrangements 
will also have the effect of protecting individual market participants. 
Section 4s(l) is not made superfluous by the proposed rules because it 
would still be available for financial end users with less than 
material swaps exposure, for financial end users that post initial 
margin in excess of the required amount, and for non-financial end 
users that post initial margin. Such entities would be posting margin, 
by agreement, with SDs or MSPs. Section 4s(l) would provide them with 
an opportunity to obtain additional protection if they desired.
    The Commission previously adopted rules implementing section 
4s(l).\103\ The Commission is now proposing to amend those rules to 
reflect the approach described above where segregation of initial 
margin would be mandatory under certain circumstances. The Commission 
is proposing three changes.
---------------------------------------------------------------------------

    \103\ Protection of Collateral of Counterparties to Uncleared 
Swaps; Treatment of Securities in a Portfolio Margining Account in a 
Commodity Broker Bankruptcy, 78 FR 66621 (Nov. 6, 2013).
---------------------------------------------------------------------------

    First, the proposal would amend Sec.  23.701(a)(1) to read as 
follows: Notify each counterparty to such transaction that the 
counterparty has the right to require that any Initial Margin the 
counterparty provides in connection with such transaction be segregated 
in accordance with Sec. Sec.  23.702 and 23.703 except in those 
circumstances where segregation is mandatory pursuant to Sec.  23.157. 
(New language in italics.)
    Second, the proposal would amend Sec.  23.701(d) to read as 
follows: Prior to confirming the terms of any such swap, the swap 
dealer or major swap participant shall obtain from the counterparty 
confirmation of receipt by the person specified in paragraph (c) of 
this section of the notification specified in paragraph (a) of this 
section, and an election, if applicable, to require such segregation or 
not. The swap dealer or major swap participant shall maintain such 
confirmation and such election as business records pursuant to Sec.  
1.31 of this chapter. (New language in italics.)
    Third, the proposal would amend Sec.  23.701(f) to read as follows: 
A counterparty's election, if applicable, to require segregation of 
Initial Margin or not to require such segregation, may be changed at 
the discretion of the counterparty upon written notice delivered to the 
swap dealer or major swap participant, which changed election shall be 
applicable to all swaps entered into between the parties after such 
delivery. (New language in italics.)
    The Commission seeks comment on all aspects of the proposed 
requirements regarding custodial arrangements.
    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.

I. Documentation

    The proposal sets forth documentation requirements for CSEs.\104\ 
For uncleared swaps between a CSE and a covered counterparty, the

[[Page 59915]]

documentation would be required to provide the CSE with the contractual 
right and obligation to exchange initial margin and variation margin in 
such amounts, in such form, and under such circumstances as are 
required by Sec.  23.150 through Sec.  23.160 of this part. For 
uncleared swaps between a CSE and a non-financial entity, the 
documentation would be required to specify whether initial and/or 
variation margin will be exchanged and, if so, to include the 
information set forth in the rule. That information would include the 
methodology and data sources to be used to value positions and to 
calculate initial margin and variation margin, dispute resolution 
procedures, and any margin thresholds.
---------------------------------------------------------------------------

    \104\ Proposed Regulation Sec.  23.158.
---------------------------------------------------------------------------

    The international standards do not contain a specific requirement 
for documentation. The requirements in the Prudential Regulators' 
proposal are consistent with the Commission proposal but the Commission 
proposal contains additional elements.
    The Commission proposal contains a cross-reference to an existing 
Commission rule which already imposes documentation requirements on SDs 
and MSPs.\105\ Consistent with that rule, the proposal would apply 
documentation requirements not only to covered counterparties but also 
to non-financial end users. Having comprehensive documentation in 
advance concerning these matters would allow each party to a swap to 
manage its risks more effectively throughout the life of the swap and 
to avoid disputes regarding issues such as valuation during times of 
financial turmoil. This would benefit not only the CSE but the non-
financial end user as well.
---------------------------------------------------------------------------

    \105\ Commission Regulation Sec.  23.504.
---------------------------------------------------------------------------

    The Commission seeks comment on all aspects of the proposed 
requirements for documentation.
    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.

J. Implementation Schedule

    The proposed rules establish the following implementation schedule: 
\106\
---------------------------------------------------------------------------

    \106\ Proposed Regulation Sec.  23.160.
---------------------------------------------------------------------------

    December 1, 2015 for the requirements in Sec.  23.153 for variation 
margin;
    December 1, 2015 for the requirements in Sec.  23.152 for initial 
margin for any uncleared swaps where both (i) the CSE combined with all 
its affiliates and (ii) its counterparty combined with all its 
affiliates, have an average daily aggregate notional amount of 
uncleared swaps, uncleared security-based swaps, foreign exchange 
forwards, and foreign exchange swaps in June, July, and August 2015 
that exceeds $4 trillion, where such amounts are calculated only for 
business days;
    December 1, 2016 for the requirements in Sec.  23.152 for initial 
margin for any uncleared swaps where both (i) the CSE combined with all 
its affiliates and (ii) its counterparty combined with all its 
affiliates, have an average daily aggregate notional amount of 
uncleared swaps, uncleared security-based swaps, foreign exchange 
forwards, and foreign exchange swaps in June, July and August 2016 that 
exceeds $3 trillion, where such amounts are calculated only for 
business days;
    December 1, 2017 for the requirements in Sec.  23.152 for initial 
margin for any uncleared swaps where both (i) the CSE combined with all 
its affiliates and (ii) its counterparty combined with all its 
affiliates have an average daily aggregate notional amount of uncleared 
swaps, uncleared security-based swaps, foreign exchange forwards, and 
foreign exchange swaps in June, July and August 2017 that exceeds $2 
trillion, where such amounts are calculated only for business days;
    December 1, 2018 for the requirements in Sec.  23.152 for initial 
margin for any uncleared swaps where both (i) the CSE combined with all 
its affiliates and (ii) its counterparty combined with all its 
affiliates have an average daily aggregate notional amount of uncleared 
swaps, uncleared security-based swaps, foreign exchange forwards, and 
foreign exchange swaps in June, July and August 2018 that exceeds $1 
trillion, where such amounts are calculated only for business days;
    December 1, 2019 for the requirements in Sec.  23.152 for initial 
margin for any other CSE with respect to uncleared swaps entered into 
with any other counterparty.
    This extended schedule is designed to give market participants 
ample time to develop the systems and procedures necessary to exchange 
margin and to make arrangements to have sufficient assets available for 
margin purposes. The requirements would be phased-in in steps from the 
largest covered parties to the smallest.
    Variation margin would be implemented on the first date for two 
reasons. First, a significant part of the market currently pays 
variation margin so full implementation would be less disruptive. 
Second, the elimination of current exposures through the daily use of 
variation margin would be an effective first step in enhancing the 
safety and soundness of market participants and the financial integrity 
of the markets.
    The proposal is consistent with international standards except for 
the 8 billion euro threshold, discussed above, that would apply 
starting Dec. 1, 2019 under the international standards.\107\ The 
proposal is the same as the proposal of the Prudential Regulators.
---------------------------------------------------------------------------

    \107\ BCBS/IOSCO Report at 23-24.
---------------------------------------------------------------------------

    The Commission requests comment on the costs and benefits of the 
proposed approach. Commenters are urged to quantify the costs and 
benefits, if practicable. Commenters also may suggest alternatives to 
the proposed approach where the commenters believe that the 
alternatives would be appropriate under the CEA.

K. Request for Comment

    The Commission requests comment on all aspects of the proposed 
rules. In particular, as noted above, the Commission invites comments 
on the potential costs and benefits of each provision. Commenters are 
urged to quantify the costs and benefits, if practicable. Commenters 
also may suggest alternatives to the proposed approach where the 
commenters believe that the alternatives would be appropriate under the 
CEA.

III. Advance Notice of Proposed Rulemaking on the Cross-Border 
Application of the Proposed Margin Rules

A. Alternative Options

    Section 2(i) of the CEA \108\ provides that the provisions of the 
CEA relating to swaps that were enacted by the Wall Street Transparency 
and Accountability Act of 2010 (including any rule prescribed or 
regulation promulgated under that Act, shall not apply to activities 
outside the United States unless those activities (1) have a direct and 
significant connection with activities in, or effect on, commerce of 
the United States or (2) contravene such rules or regulations as the 
Commission may prescribe or promulgate as are necessary or appropriate 
to prevent the evasion of any provision of this chapter that was 
enacted by the Wall Street Transparency and Accountability Act of 2010.
---------------------------------------------------------------------------

    \108\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------

    Section 2(i) provides the Commission with express authority over 
activities outside the United States relating to swaps when certain 
conditions are met.

[[Page 59916]]

As discussed in part I.A. above, the primary purpose of the margin 
provision in section 4s(e) is to address risk to SDs, MSPs, and the 
financial system arising from uncleared swaps. Given the risk-
mitigation function of the margin rules for uncleared swaps, the 
Commission believes that the rules should apply on a cross-border basis 
in a manner that effectively addresses risks to the registered SD or 
MSP. At the same time, it may be appropriate, consistent with 
principles of international comity and statutory objectives underlying 
the margin requirements, to allow SDs and MSPs to satisfy the margin 
requirements by complying with a comparable regime in the relevant 
foreign jurisdiction, or to not apply the margin requirements under 
certain circumstances.
    In this Advance Notice of Proposed Rulemaking, the Commission is 
considering three approaches to applying the margin requirements to 
Commission-registered SDs and MSPs, consistent with section 2(i): (1) A 
transaction-level approach that is consistent with the Commission's 
cross-border guidance (``Guidance Approach''); \109\ (2) the Prudential 
Regulators' approach; and (3) an entity-level approach (``Entity-Level 
Approach''). The general framework for each of these approaches is 
described below. The Commission is not endorsing at this time any 
particular approach and invites comments on all aspects of the three 
approaches and welcomes any suggestions on other possible approaches. 
The Commission may propose and ultimately adopt one of the three 
approaches with modifications.
---------------------------------------------------------------------------

    \109\ Interpretative Guidance and Policy Statement Regarding 
Compliance with Certain Swap Regulations, 78 FR 45292 (July 26, 
2013) (``Guidance''). The Commission addressed, among other things, 
how the swap provisions in the Dodd-Frank Act (including the margin 
requirement for uncleared swaps) would apply on a cross-border 
basis. In this regard, the Commission stated that as a general 
policy matter it would apply the margin requirement as a 
transaction-level requirement.
---------------------------------------------------------------------------

1. The Cross-Border Guidance Approach
    Under the first option, the Commission would apply the margin 
requirements consistent with the Cross-Border Guidance. The Commission 
stated in the Guidance that it would generally treat the margin 
requirements (for uncleared swaps) as a transaction-level requirement. 
Consistent with the rationale stated in the Guidance, under this 
approach, the proposed margin requirements would apply to a U.S. SD/MSP 
(other than a foreign branch of a U.S. bank that is a SD/MSP) for all 
of their uncleared swaps (as applicable), irrespective of whether the 
counterparty is a U.S. person \110\ or not, without substituted 
compliance.
---------------------------------------------------------------------------

    \110\ The scope of the term ``U.S. person'' as used in the 
Cross-Border Guidance Approach and the Entity-Level Approach would 
be the same as under the Guidance. See Guidance at 45316-45317 for a 
summary of the Commission's interpretation of the term ``U.S. 
person.''
---------------------------------------------------------------------------

    On the other hand, under this approach, the proposed margin 
requirements would apply to a non-U.S. SD/MSP (whether or not it is a 
``guaranteed affiliate'' \111\ or an ``affiliate conduit'' \112\) only 
with respect to its uncleared swaps with a U.S. person counterparty 
(including a foreign branch of U.S. bank that is a SD/MSP) and a non-
U.S. counterparty that is guaranteed by a U.S. person or is an 
affiliate conduit. Where the counterparty is a guaranteed affiliate or 
is an affiliate conduit, the Commission would allow substituted 
compliance (i.e., the non-U.S. SD/MSP would be permitted to comply with 
the margin requirements of its home country's regulator if the 
Commission determines that such requirements are comparable to the 
Commission's margin requirements).
---------------------------------------------------------------------------

    \111\ Under the Guidance, id. at 45318, the term ``guaranteed 
affiliate'' refers to a non-U.S. person that is an affiliate of a 
U.S. person and that is guaranteed by a U.S. person. The scope of 
the term ``guarantee'' under the Cross-Border Guidance Approach and 
the Entity-Level Approach would be the same as under note 267 of the 
Guidance and accompanying text.
    \112\ Under the Guidance, id. at 45359, the factors that are 
relevant to the consideration of whether a person is an ``affiliate 
conduit'' include whether: (i) The non-U.S. person is majority-
owned, directly or indirectly, by a U.S. person; (ii) the non-U.S. 
person controls, is controlled by, or is under common control with 
the U.S. person; (iii) the non-U.S. person, in the regular course of 
business, engages in swaps with non-U.S. third party(ies) for the 
purpose of hedging or mitigating risks faced by, or to take 
positions on behalf of, its U.S. affiliate(s), and enters into 
offsetting swaps or other arrangements with such U.S. affiliate(s) 
in order to transfer the risks and benefits of such swaps with 
third-party(ies) to its U.S. affiliates; and (iv) the financial 
results of the non-U.S. person are included in the consolidated 
financial statements of the U.S. person. Other facts and 
circumstances also may be relevant.
---------------------------------------------------------------------------

    For trades between a non-U.S. SD/MSP (whether or not it is a 
guaranteed affiliate or an affiliate conduit) and a non-U.S. 
counterparty that is not a guaranteed affiliate or affiliate conduit, 
the Commission would not apply the margin requirements to such swaps.
    In the case of a foreign branch of a U.S. bank that is a SD/MSP, 
the proposed margin requirements would apply with respect to all of its 
uncleared swaps, regardless of the counterparty. However, where the 
counterparty to the trade is another foreign branch of a U.S. bank that 
is a SD/MSP or is a non-U.S. person counterparty (whether or not it is 
a guaranteed affiliate or an affiliate conduit), the Commission would 
allow substituted compliance (i.e., the foreign branch of a U.S. bank 
that is a SD/MSP would be permitted to comply with the margin 
requirements of the regulator in the foreign jurisdiction where the 
foreign branch is located if the Commission determines that such 
requirements are comparable to the Commission's margin 
requirements).\113\
---------------------------------------------------------------------------

    \113\ Under a limited exception, where a swap between the 
foreign branch of a U.S. SD/MSP and a non-U.S. person (that is not a 
guaranteed or conduit affiliate) takes place in a foreign 
jurisdiction other than Australia, Canada, the European Union, Hong 
Kong, Japan, or Switzerland, the counterparties generally may comply 
only with the transaction-level requirements in the foreign 
jurisdiction where the foreign branch is located if the aggregate 
notional value of all the swaps of the U.S. SD's foreign branches in 
such countries does not exceed 5% of the aggregate notional value of 
all of the swaps of the U.S. SD, and the U.S. person maintains 
records with supporting information for the 5% limit and can 
identify, define, and address any significant risk that may arise 
from the non-application of the Transaction-Level Requirements.
---------------------------------------------------------------------------

    Below is a summary of how the margin requirements would apply under 
the Cross-Border Guidance Approach.

----------------------------------------------------------------------------------------------------------------
                                  U.S. person (other
                                     than Foreign      Foreign Branch of    Non-U.S. person     Non-U.S. person
                                    Branch of U.S.     U.S. Bank that is   guaranteed by, or  not guaranteed by,
                                    Bank that is a     a Swap Dealer or    affiliate conduit      and not an
                                    Swap Dealer or            MSP          of, a U.S. person   affiliate conduit
                                         MSP)                                                  of, a U.S. person
----------------------------------------------------------------------------------------------------------------
U.S. Swap Dealer or MSP           Apply.............  Apply.............  Apply.............  Apply
 (including an affiliate of a
 non-U.S. person).
Foreign Branch of U.S. Bank that  Apply.............  Substituted         Substituted         Substituted
 is a Swap Dealer or MSP.                              Compliance.         Compliance.         Compliance
Non-U.S. Swap Dealer or MSP       Apply.............  Substituted         Substituted         Do Not Apply
 (including an affiliate of a                          Compliance.         Compliance.
 U.S. person).
----------------------------------------------------------------------------------------------------------------


[[Page 59917]]

2. Prudential Regulators' Approach
    Under the second option, the Commission would adopt the Prudential 
Regulators' approach to cross-border application of the margin 
requirements.\114\ Under the Prudential Regulators' proposal, the 
Prudential Regulators would not assert authority over trades between a 
non-U.S. SD/MSP \115\ that is not guaranteed by a U.S. person and 
either a (i) non-U.S. SD/MSP that is not guaranteed by a U.S. person or 
(ii) a non-U.S. person that is not guaranteed by a U.S. person. The 
Prudential Regulators' approach is generally consistent with the 
Entity-Level Approach described below, with the exception of the 
application of the margin requirements to certain non-U.S. SD/MSPs.
---------------------------------------------------------------------------

    \114\ See Section 9 of Margin and Capital Requirements for 
Covered Swap Entities, 12 CFR Part 237 (Sept. 3, 2014), available at 
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20140903c1.pdf.
    \115\ Under the Prudential Regulators' approach, if an SD/MSP is 
under the control of a U.S. person, it would not be considered a 
non-U.S. SD/MSP.
---------------------------------------------------------------------------

    However, the Prudential Regulators' proposal in this regard would 
be consistent with the Commission's Cross-Border Guidance Approach to 
margin requirements with respect to a trade between a non-U.S. SD/MSP 
and a non-U.S. person that is not guaranteed by a U.S. person. But 
under the definition of ``foreign covered swap entity'' in the 
Prudential Regulators' approach, a non-U.S. SD/MSP controlled by a U.S. 
person would not be a foreign covered swap entity, and thus, would not 
qualify for the exclusion from the margin requirement. In addition, the 
Prudential Regulators' proposal incorporates a ``control'' test for 
purposes of determining whether a registered SD/MSP (or in the 
Prudential Regulators' proposal, a ``covered swap entity'') is not a 
``foreign'' entity.
3. Entity-Level Approach
    Under the third option, the Commission would treat the margin 
requirements as an entity-level requirement. Under this Entity-Level 
Approach, the Commission would apply its cross-border rules on margin 
on a firm-wide level, irrespective of whether the counterparty is a 
U.S. person.\116\ At the same time, in recognition of international 
comity, the Commission is considering, where appropriate, to allow SDs/
MSPs to satisfy the margin requirements by complying with a comparable 
regime in the relevant foreign jurisdiction, as described in the table 
below. This approach would be intended to address the concern that the 
source of the risk to a firm--given that the non-U.S. SD/MSP has 
sufficient contact with the United States to require registration as an 
SD/MSP--is not confined to its uncleared swaps with U.S. counterparties 
or to its uncleared swaps executed within the United States. A firm's 
losses in uncleared swaps with non-U.S. counterparties, for example, 
could have a direct and significant impact on the firm's financial 
integrity and on the U.S. financial system.
---------------------------------------------------------------------------

    \116\ However, substituted compliance may be available under 
certain circumstances, as described in the Guidance for entity-level 
requirements.

------------------------------------------------------------------------
                                                          Applicable
         Counterparty A             Counterparty B       requirements
------------------------------------------------------------------------
1. U.S. SD/MSP..................  U.S. person.......  U.S. (All).
2. U.S. SD/MSP..................  Non U.S. person     U.S. (All).
                                   guaranteed by a
                                   U.S. person.
3. Non-U.S. SD/MSP guaranteed by  U.S. person not     U.S. (All).
 a U.S. person.                    registered as an
                                   SD/MSP.
4. Non-U.S. SD/MSP guaranteed by  Non-U.S. person     U.S. (All).
 a U.S. person.                    guaranteed by a
                                   U.S. person.
5. U.S. SD/MSP..................  Non-U.S. person     U.S. (Initial
                                   not guaranteed by   Margin collected
                                   a U.S. person.      by U.S. SD/MSP).
                                                      Substituted
                                                       Compliance
                                                       (Initial Margin
                                                       collected by non-
                                                       U.S. person not
                                                       guaranteed by a
                                                       U.S. person).
                                                      U.S. (Variation
                                                       Margin).
6. Non-U.S. SD/MSP guaranteed by  Non-U.S. person     U.S. (Initial
 a U.S. person.                    not guaranteed by   Margin collected
                                   a U.S. person.      by non-U.S. SD/
                                                       MSP guaranteed by
                                                       a U.S. person).
                                                      Substituted
                                                       Compliance
                                                       (Initial Margin
                                                       collected by non-
                                                       U.S. person not
                                                       guaranteed by a
                                                       U.S. person).
                                                      U.S. (Variation
                                                       Margin).
7. Non-U.S. SD/MSP not            U.S. person not     Substituted
 guaranteed by a U.S. person.      registered as an    Compliance (All).
                                   SD/MSP.
8 Non-U.S. SD/MSP not guaranteed  Non-U.S. person     Substituted
 by a U.S. person.                 guaranteed by a     Compliance (All).
                                   U.S. person.
9. Non-U.S. SD/MSP not            Non-U.S. SD/MSP     Substituted
 guaranteed by a U.S. person.      not guaranteed by   Compliance (All).
                                   a U.S. person.
10. Non-U.S. SD/MSP not           Non-U.S. person     Substituted
 guaranteed by a U.S. person.      not registered as   Compliance (All).
                                   an SD/MSP and not
                                   guaranteed by a
                                   U.S. person.
------------------------------------------------------------------------

B. Questions

    In this Advance Notice of Proposed Rulemaking, the Commission 
requests comment on all aspects of these options to the cross-border 
application of the margin requirements. In particular, the Commission 
is interested in comments relating to the costs and benefits of the 
various approaches so that it can take that into consideration when 
developing proposed rules relating to the cross-border application of 
the margin rules. Commenters are encouraged to address, among other 
things, the following questions:
    1. Under the Guidance Approach and Prudential Regulators Approach, 
certain trades involving a non-U.S. SD/MSP would be excluded from the 
Commission's margin rules. The Commission seeks comment on whether this 
exclusion is over- or under-inclusive, and if so, please explain why.
    2. Each of the options provides for substituted compliance under 
certain situations. In light of the equal or greater supervisory 
interest of the foreign regulator in certain circumstances, the 
Commission is seeking comment on whether the scope of substituted 
compliance under each option is appropriate.

[[Page 59918]]

    3. The Commission is seeking comments on whether, in defining a 
non-U.S. covered swap entity, it should use the concept of ``control,'' 
in determining whether a covered swap entity is (or should be treated 
as) a non-U.S. covered swap entity. If the Commission uses a concept of 
control, should it be the same as that used by the Prudential 
Regulators, or should it be different?
    4. In the Commission's view, it is the substance, rather than the 
form, of an agreement, arrangement or structure that should determine 
whether it should be considered a ``guarantee.'' The Commission invites 
comment on how the term ``guarantee'' should be construed or defined in 
the context of these margin rules. For example, should the definition 
cover the multitude of different agreements, arrangements and 
structures that transfer risk directly back to the United States with 
respect to financial obligations arising out of a swap? Should the 
definition cover such agreements, arrangements and structures even if 
they do not specifically reference the relevant swap or affirmatively 
state that it does not apply to such swap? Should the definition cover 
agreements, arrangements and structures even if the other party to the 
swap terminates, waives, or revokes the benefit of such agreements, 
arrangements or structures?
    5. The Commission seeks comments on the costs and benefits of 
harmonization with the Prudential Regulators' proposal.
    6. The Commission invites commenters to comment in particular on 
the benefits of each of the approaches with respect to the statutory 
goal of protecting the financial system against the risks associated 
with uncleared swaps.
    7. Given that some foreign jurisdictions may not adopt comparable 
margin requirements, the Commission seeks comment on the costs and 
benefits of not requiring substituted compliance in emerging markets 
with respect to certain transactions and what might be an appropriate 
threshold percentage of a swap portfolio of participants or other 
standard for a de minimis level. In particular, the Commission is 
seeking comment on potential competitive impacts. Commenters are 
encouraged to quantify, if practical.
    8. The Commission seeks comment, including quantitative estimates 
in terms of notional volumes of swap activity, about how the different 
cross-border alternatives may impact the competitive landscape between 
U.S. entities and non-U.S. entities participating in swap markets. 
Specifically, the Commission seeks quantitative estimates of costs of 
transacting uncleared swaps with each category of counterparties, and/
or access specific geographical markets, under each of the different 
alternatives. Commission seeks quantitative estimates of such impact on 
the ability of the affected market participants (who might be unable to 
access specific markets or counterparties) to hedge their risks using 
uncleared swaps. As the proposed margins on uncleared swaps are 
designed to strengthen market integrity, the Commission seeks comments 
on potential impact of each of these alternatives on market 
participants' business models and trading strategies that could 
potentially compromise this policy goal. Commenters are encouraged to 
quantify and provide institutional details.
    9. The Commission is seeking comments on how the different 
alternatives impact price discovery? Commenters are encouraged to 
quantify, if practical. For instance, will different cross-border 
alternatives impact the ability of different categories of market 
participants, as contemplated in these alternatives, to transact 
uncleared swaps with each other? The Commission seeks quantitative 
estimates of such impact on transacted volumes and the pricing of 
uncleared swaps.
    10. The Commission is seeking comments on the relative costs and 
difficulty of compliance associated with each of the three approaches. 
Is one of the approaches preferable to the others in this regard?
    11. The Commission is seeking comments on the impact of each of the 
three approaches on a SD/MSP's risk management practices.

IV. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires that agencies 
consider whether the regulations they propose will have a significant 
economic impact on a substantial number of small entities.\117\ The 
Commission previously has established certain definitions of ``small 
entities'' to be used in evaluating the impact of its regulations on 
small entities in accordance with the RFA.\118\ The proposed 
regulations would affect SDs and MSPs and their counterparties to 
uncleared swaps. As the only counterparties of SDs and MSPs to 
uncleared swaps can be other SDs, MSPs or ECPs, the following RFA will 
only discuss these entities.
---------------------------------------------------------------------------

    \117\ 5 U.S.C. 601 et seq.
    \118\ 47 FR 18618 (Apr. 30, 1982).
---------------------------------------------------------------------------

    The Commission previously has determined that SDs and MSPs are not 
small entities for purposes of the RFA.\119\ The Commission also 
previously has determined that ECPs are not small entities for RFA 
purposes.\120\ Because ECPs are not small entities, and persons not 
meeting the definition of ECP may not conduct transactions in uncleared 
swaps, the Commission need not conduct a regulatory flexibility 
analysis respecting the effect of these proposed rules on ECPs.
---------------------------------------------------------------------------

    \119\ See 77 FR 30596, 30701 (May 23, 2012).
    \120\ See 66 FR 20740, 20743 (April 25, 2001).
---------------------------------------------------------------------------

    Accordingly, this proposed rule will not have a significant 
economic effect on any small entity. Therefore, the Chairman, on behalf 
of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that 
the proposed regulations will not have a significant economic impact on 
a substantial number of small entities.

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \121\ imposes certain 
requirements on Federal agencies, including the Commission, in 
connection with their conducting or sponsoring any collection of 
information, as defined by the PRA. This proposed rulemaking would 
result in the collection of information requirements within the meaning 
of the PRA, as discussed below. The proposed rulemaking contains 
collections of information for which the Commission has previously 
received control numbers from OMB. The titles for these collections of 
information are ``Regulations and Forms Pertaining to Financial 
Integrity of the Market Place, OMB control number 3038-0024'' and 
``Swap Trading Relationship Documentation Requirements for Swap Dealers 
and Major Swap Participants, OMB control number 3038-0088.''
---------------------------------------------------------------------------

    \121\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    The collections of information that are proposed by this rulemaking 
are necessary to implement section 4s(e) of the CEA, which expressly 
requires the Commission to adopt rules governing margin requirements 
for SDs and MSPs. If adopted, responses to this collection of 
information would be mandatory. An agency may not conduct or sponsor, 
and a person is not required to respond to, a collection of information 
unless it displays a currently valid control number.
1. Clarification of Collection 3038-0088
    This proposed rulemaking clarifies the existing collection of 
information found in OMB Control Number 3038-

[[Page 59919]]

0088.\122\ Regulation 23.151 defines terms used in the proposed rule, 
including the definition of ``eligible master netting agreement,'' 
which provides that a CSE that relies on the agreement for purpose of 
calculating the required margin must (1) conduct sufficient legal 
review of the agreement to conclude with a well-founded basis that the 
agreement meets specified criteria and (2) establish and maintain 
written procedures for monitoring relevant changes in the law and to 
ensure that the agreement continues to satisfy the requirements of this 
section. The term ``eligible master netting agreement'' is used 
elsewhere in the proposed rule to specify instances in which a CSE may 
(1) calculate variation margin on an aggregate basis across multiple 
non-cleared swaps and (2) calculate initial margin requirements under 
an initial margin model for one or more swaps.
---------------------------------------------------------------------------

    \122\ See OMB Control No. 3038-0088, available at http://www.reginfo.gov/public/do/PRAOMBHistory?ombControlNumber=3038-0088.
---------------------------------------------------------------------------

    Proposed Regulations Sec. Sec.  23.152(c) and 23.153(d) specify 
that a CSE shall not be deemed to have violated its obligation to 
collect or post initial and variation margin, respectively, from or to 
a counterparty if the CSE has made the necessary efforts to collect or 
post the required margin, including the timely initiation and continued 
pursuit of formal dispute resolution mechanisms, or has otherwise 
demonstrated upon request to the satisfaction of the Commission that it 
has made appropriate efforts to collect or post the required margin.
    Proposed Regulation Sec.  23.154 establishes standards for initial 
margin models. These standards include (1) a requirement that a CSE 
review its initial margin model annually (Sec.  23.154(b)(4)); (2) a 
requirement that the covered swap entity validate its initial margin 
model initially and on an ongoing basis, describe to the Commission any 
remedial actions being taken, and report internal audit findings 
regarding the effectiveness of the initial margin model to the CSE's 
board of directors or a committee thereof (Sec. Sec.  23.154(b)(5)(ii) 
through 23.154(b)(5)(iv)); (3) a requirement that the CSE adequately 
documents all material aspects of its initial margin model (Sec.  
23.154(b)(6)); and (4) a requirement that the CSE adequately documents 
internal authorization procedures, including escalation procedures that 
require review and approval of any change to the initial margin 
calculation under the initial margin model, demonstrable analysis that 
any basis for any such change is consistent with the requirements of 
this section, and independent review of such demonstrable analysis and 
approval (Sec.  23.154(b)(7)).
    Proposed Regulation Sec.  23.155(b) requires a covered swap entity 
to create and maintain documentation setting forth the variation margin 
methodology, evaluate the reliability of its data sources at least 
annually, and make adjustments, as appropriate, and provides that the 
Commission at any time may require a covered swap entity to provide 
further data or analysis concerning the methodology or a data source.
    Proposed Regulation Sec.  23.158 requires a covered swap entity to 
execute trading documentation with each counterparty that is either a 
swap entity or financial end user regarding credit support arrangements 
that (1) provides the contractual right to collect and post initial 
margin and variation margin in such amounts, in such form, and under 
such circumstances as are required; and (2) specifies the methods, 
procedures, rules, and inputs for determining the value of each non-
cleared swap or non-cleared security-based swap for purposes of 
calculating variation margin requirements, and the procedures for 
resolving any disputes concerning valuation. The reporting and 
recordkeeping requirements of proposed Regulation Sec.  23.158, 
proposed Regulations Sec.  23.154(b)(4) through (7), and proposed 
Regulation Sec.  23.155(b) are contained in the provisions of 
Commission Regulations 23.500 through 23.506, which were adopted on 
September 11, 2012, and part of OMB Control No. 3038-0088.\123\ Thus, 
the requirements in this proposal that are subject to collection 3038-
0088 were previously addressed by the Commission in adopting the swap 
documentation trading requirements and simply further clarified in this 
proposal.
---------------------------------------------------------------------------

    \123\ 77 FR 55904 (Sept. 12, 2012).
---------------------------------------------------------------------------

    To be sure, Commission Regulation Sec.  23.504(b) requires an SD or 
MSP to maintain written swap trading relationship documentation that 
must include all terms governing the trading relationship between the 
SD or MSP and its counterparty, and Commission Regulation Sec.  
23.504(d) requires that each SD and MSP maintain all documents required 
to be created pursuant to Commission Regulation 23.504. Also, 
Commission Regulation Sec.  23.502(c) requires each SD and MSP to 
notify the Commission and any applicable Prudential Regulator of any 
swap valuation dispute in excess of $20 million if not resolved in 
specified timeframes. Accordingly, this proposed rulemaking, 
specifically the requirements found in proposed Regulation Sec.  
23.154(b)(4) through (7), proposed Regulations Sec. Sec.  23.155(b) and 
23.158, would not impact the burden estimates currently provided for in 
OMB Control No. 3038-0088.
2. Revisions to Collection 3038-0024
    Collection 3038-0024 is currently in force with its control number 
having been provided by OMB. The proposal would revise collection 3038-
0024 as discussed below.
    Proposed Regulation Sec.  23.154(b)(1) requires CSEs that wish to 
use initial margin models to obtain the Commission's approval, and to 
demonstrate to the Commission that the models satisfy standards 
established in Sec.  23.154.\124\ These standards include (1) a 
requirement that a CSE receive approval from the Commission based on a 
demonstration that the initial margin model meets specific requirements 
(Sec.  23.154(b)(1)); (2) a requirement that a CSE notify the 
Commission in writing 60 days before extending the use of the model to 
additional product types, making certain changes to the initial margin 
model, or making material changes to modeling assumptions (Sec.  
23.154(b)(1)); and (3) a variety of quantitative requirements, 
including requirements that the CSE validate and demonstrate the 
reasonableness of its process for modeling and measuring hedging 
benefits, demonstrate to the satisfaction of the Commission that the 
omission of any risk factor from the calculation of its initial margin 
is appropriate, demonstrate to the satisfaction of the Commission that 
incorporation of any proxy or approximation used to capture the risks 
of the covered swap entity's non-cleared swaps or non-cleared security-
based swaps is appropriate, periodically review and, as necessary, 
revise the data used to calibrate the initial margin model to ensure 
that the data incorporate an appropriate period of significant 
financial stress (Sec.  23.154(b)(3)).
---------------------------------------------------------------------------

    \124\ The Commission previously proposed to adopt regulations 
governing standards and other requirements for initial margin models 
that would be used by SDs and MSPs to margin uncleared swap 
transactions. See Capital Requirements of Swap Dealers and Major 
Swap Participants, 76 FR 27,802 (May 12, 2011). As part of the 
proposal, the Commission submitted proposed revisions to collection 
3038-0024 for the estimated burdens associated with the margin model 
to OMB. The Commission is resubmitting new estimated burden as part 
of this re-proposal of the regulations.
---------------------------------------------------------------------------

    The requirement of proposed Regulation Sec.  23.154(b)(1) that a 
CSE

[[Page 59920]]

must obtain the Commission's approval to use an initial margin model by 
submitting documentation demonstrating that the initial margin model 
meets the standards set forth in Sec.  23.154, and the requirement that 
a CSE must provide the Commission with written notice 60 days prior to 
extending the use of the initial margin model to additional product 
types or making material changes to the model would result in revisions 
to the collection.
    Currently, there are approximately 100 SDs and MSPs provisionally 
registered with the Commission. The Commission further estimates that 
approximately 60 of the SDs and MSPs will be subject to the 
Commission's margin rules as they are not subject to a Prudential 
Regulator. The Commission further estimates that all SDs and MSPs will 
seek to obtain Commission approval to use models for computing initial 
margin requirements. The Commission estimates that the initial margin 
model requirements will impose an average of 240 burden hours per 
registrant.
    Based upon the above, the estimated additional hour burden for 
collection 3038-0024 was calculated as follows:
    Number of registrants: 60.
    Frequency of collection: Initial submission and periodic updates.
    Estimated annual responses per registrant: 1.
    Estimated aggregate number of annual responses: 60.
    Estimated annual hour burden per registrant: 240 hours.
    Estimated aggregate annual hour burden: 14,400 hours [60 
registrants x 240 hours per registrant].
3. Information Collection Comments
    The Commission invites the public and other Federal agencies to 
comment on any aspect of the reporting burdens discussed above. 
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments 
in order to: (1) Evaluate whether the proposed collection of 
information is necessary for the proper performance of the functions of 
the Commission, including the information will have practical utility; 
(2) evaluate the accuracy of the Commission's estimate of the burden of 
the proposed collection of information; (3) determine whether there are 
ways to enhance the quality, utility, and clarity of the information to 
be collected; and (4) minimize the burden of the collection of 
information on those who are to respond, including through the use of 
automated collection techniques or other forms of information 
technology.
    Comments may be submitted directly to the Office of Information and 
Regulatory Affairs, by fax at (202) 395-6566 or by email at 
[email protected]. Please provide the Commission with a copy 
of submitted comments so that all comments can be summarized and 
addressed in the final rule preamble. Refer to the ADDRESSES section of 
this notice of proposed rulemaking for comment submission instructions 
to the Commission. A copy of the supporting statements for the 
collections of information discussed above may be obtained by visiting 
RegInfo.gov. OMB is required to make a decision concerning the 
collection of information between 30 and 60 days after publication of 
this document in the Federal Register. Therefore, a comment is best 
assured of having its full effect if OMB receives it within 30 days of 
publication.

C. Cost-Benefit Considerations

1. Introduction
    Section 15(a) of the CEA requires the Commission to consider the 
costs and benefits of its actions before promulgating a regulation 
under the CEA or issuing certain orders.\125\ Section 15(a) further 
specifies that the costs and benefits shall be evaluated in light of 
five broad areas of market and public concern: (1) Protection of market 
participants and the public; (2) efficiency, competitiveness, and 
financial integrity of futures markets; (3) price discovery; (4) sound 
risk management practices; and (5) other public interest 
considerations. The Commission considers the costs and benefits 
resulting from its discretionary determinations with respect to the 
section 15(a) factors.
---------------------------------------------------------------------------

    \125\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    The Commission recognizes that there is an inherent trade-off 
involved in setting minimum collateral standards. Such standards could 
increase margin requirements, which in turn would require market 
participants to post additional collateral. Posting additional 
collateral may result in opportunity costs in terms of lost returns 
from investing the funds in collateral, or in interest expenses 
incurred to raise additional funds. Such costs may reduce the 
investment returns for market participants posting collateral. On the 
other hand, minimum collateral standards help to mitigate counterparty 
credit risk. This is achieved by requiring market participants to post 
collateral that is sufficient to cover potential losses from default 
most of the time. The potential reduction in investment returns for 
market participants posting collateral might also be offset to some 
degree by improvements in pricing as a result of the reduction in risk 
of the swap. The reduction in counterparty credit risk from the posting 
of collateral may result in tighter spreads quoted by liquidity 
providers.\126\ From a regulatory perspective, minimum collateral 
standards introduce a trade-off between potentially lowering 
anticipated returns for market participants and lowering systemic risk 
from counterparty defaults. A substantial loss from a default might 
induce a cascade of defaults in a financial network, and perhaps, 
induce a liquidity crisis and the seizing up of parts of the financial 
system. In developing this proposal, the Commission has sought to 
reduce the potential lowering of investment returns of market 
participants by allowing them to use approved models to set margin 
collateral for certain swap transactions while still guarding against 
the dangers of systemic risk from counterparty defaults, along with 
other parts of the rule.
---------------------------------------------------------------------------

    \126\ Posting collateral for swap transactions may result in 
other changes in the relationship between the CSE and counterparty 
instead of just pricing terms of swap contracts. For instance, bank 
CSEs might lower the required minimum balance on checking accounts 
that counterparty maintain with the bank, instead.
---------------------------------------------------------------------------

2. Rule Summary
    This proposed rulemaking is a re-proposal of prior CFTC proposed 
rulemaking.\127\ It is the result of a working group consultation paper 
issued by BCBS-IOSCO on margin for OTC-derivative contracts not cleared 
by a CCP (uncleared derivatives).\128\ This proposed rulemaking would 
implement the new statutory framework of section 4s(e) of the CEA, 
added by section 731 of the Dodd-Frank Act, which requires the 
Commission to adopt capital and initial and variation margin 
requirements for certain SDs and MSPs. Generally, the proposed rule 
would require the exchange (collection, posting, and payment) of margin 
by SDs and MSPs for trades with other SDs, MSPs and financial end-
users. Initial margin is required to be held at third-party custodians 
with no rehypothecation. These CSEs would not be required to collect 
margin from or post margin to commercial end-users.
---------------------------------------------------------------------------

    \127\ See 76 FR 23732 (April 28, 2011).
    \128\ Margin requirements for non-centrally cleared derivatives 
at http://www.bis.org/publ/bcbs261.pdf, September 2013. The proposed 
rule establishes minimum standards for margin requirements for non-
centrally cleared derivatives as agreed by BIS and IOSCO.
---------------------------------------------------------------------------

    Generally, the CFTC's margin rules will apply to a SD or MSP 
whenever

[[Page 59921]]

there is no Prudential Regulator for that covered swap entity.\129\ The 
CFTC's margin rules will apply to swaps that are not cleared and that 
are executed subsequent to applicable compliance dates set out below, 
based on an entity's level of uncleared swaps activity during a 
particular period.
---------------------------------------------------------------------------

    \129\ For this rulemaking, a swap entity is either a swap dealer 
or a major swap participant.
---------------------------------------------------------------------------

    Generally, a CSE must collect IM from a counterparty that is (i) a 
swap entity, or (ii) a financial end-user with material swaps exposure 
($3 billion notional during June, July and August of the previous year) 
in an amount that is no less than the greater of: (i) Zero (0) or (ii) 
the IM collection amount for such swap less the IM threshold amount 
($65 million--not including any portion of the IM threshold amount 
already applied by the covered swap entity or its affiliates to other 
swaps with the counterparty or its affiliates).
    Generally, a CSE must post IM for any swap with a counterparty that 
is a financial end-user with material swaps exposure (see above). A CSE 
is not required to collect IM from or post IM to commercial end-users.
    There are two general methods for calculating initial margin, the 
standardized approach and the model-based approach. Under the 
standardized approach, the CSE must calculate IM collection amounts 
using a table/grid that is set out in the proposed rule.
    The model-based approach calculates an amount of IM that is equal 
to the potential future exposure (``PFE'') of a swap or a netting set 
of swaps. PFE is an estimate of the one-tailed 99% confidence interval 
for an increase in the value of the swap over a 10 day period (i.e., 
VaR model for a 10 day period). The model-based approach must meet the 
following requirements: (1) The model must have prior written approval 
by the Commission; (2) a CSE must demonstrate that the initial margin 
model continuously satisfies the rule's requirements; (3) a covered 
swap entity must notify the Commission in writing prior to making 
material changes to the model, such as: (a) Extending the use of the 
model to an additional product type; (b) making any change that results 
in material changes to the amount of IM; or (c) making any material 
changes to the assumptions of the model. The Commission may rescind its 
approval in whole or in part of an entity's margin model at any time.
    The rules for variation margin are as follows: (1) On or before the 
business day after execution of an uncleared swap between a covered 
swap entity and a counterparty that is a swap entity or a financial end 
user, the covered swap entity must collect variation margin from or pay 
variation margin to the counterparty; (2) a CSE is not required to 
collect or pay variation from commercial end-users; and (3) a CSE is 
not required to collect, post, or pay margin unless and until the total 
amount of margin transfer to be collected or posted for an individual 
counterparty exceeds the minimum transfer amount.
    The eligible collateral for variation margin is cash funds 
denominated in (a) USD, or (b) a currency in which payment under the 
swap contracts is required. The eligible collateral for initial margin 
includes (subject to haircuts on value) financial instruments in 
various categories, including cash, Treasury securities, and various 
publicly traded debt and equity instruments. A CSE may not collect or 
post as initial margin any asset that is a security issued by (i) the 
party providing such asset or an affiliate of that party; (ii) various 
banking entities as listed in the proposed rule; or (iii) certain 
government-sponsored enterprises unless an exception applies.
    As defined in the rule, a financial end-user is any counterparty 
that is not a covered swap entity and includes, among others: (i) A 
commodity pool, commodity trading advisor and commodity pool operator 
(all defined in the CEA); (ii) a private fund (defined in Investment 
Advisers Act); (iii) an employee benefit plan, as defined in ERISA 
section 3; (iv) a person predominantly engaged in activities that are 
in the business of banking, or in activities that are financial in 
nature (defined in section 4(k) of the BHCA); (v) a person defined in 
(a)-(d), if that person organized under the laws of the U.S.; and (vi) 
any other entity that in the Commission's discretion is a financial 
end-user. A non-financial end-user is any entity that is not a 
financial end-user or an SD/MSP.
    Generally, a CSE entering into a swap with a swap entity or a 
financial end-user with material swap exposure who posts initial margin 
to the counterparty must comply with the following conditions: (1) All 
funds posted as initial margin must be held by a third-party custodian 
(unaffiliated with either party in the swap); (2) the third-party 
custodian is prohibited from re-hypothecating (or otherwise 
transferring) the initial margin; (3) the third-party custodian is 
prohibited from reinvesting the initial margin in any asset that would 
not qualify as eligible collateral; and (4) the custodial agreement is 
legal, valid, binding and enforceable in the event of bankruptcy, 
insolvency, or similar proceedings.
    Generally, a CSE entering into a swap with a swap entity or a 
financial end-user with a material swap exposure that collects initial 
margin from the counterparty must require the same conditions listed 
above for initial margin posted.
    Generally, CSEs must comply with the minimum margin requirements 
for uncleared swaps on or before the following dates. For variation 
margin, covered swap entities must comply by December 1, 2015. Initial 
margin is subject to a phased-in period. The compliance date is 
December 1, 2015 when both (i) the CSE and its affiliates and (ii) its 
counterparty and its affiliates, have an average daily aggregate 
notional amount of uncleared swaps, uncleared security-based swaps, 
foreign exchange forwards and foreign exchange swaps for each business 
day in June, July and August 2015 that exceeds $4 trillion. The 
compliance date is December 1, 2016 when both (i) the CSE and its 
affiliates and (ii) its counterparty and its affiliates, have an 
average daily aggregate notional amount of uncleared swaps, uncleared 
security-based swaps, foreign exchange forwards and foreign exchange 
swaps for each business day in June, July and August 2016 that exceeds 
$3 trillion. The compliance date is December 1, 2017 when both (i) the 
CSE and its affiliates and (ii) its counterparty and its affiliates, 
have an average daily aggregate notional amount of uncleared swaps, 
uncleared security-based swaps, foreign exchange forwards and foreign 
exchange swaps for each business day in June, July and August 2017 that 
exceeds $2 trillion. The compliance date is December 1, 2018 when both 
(i) the CSE and its affiliates and (ii) its counterparty and its 
affiliates, have an average daily aggregate notional amount of 
uncleared swaps, uncleared security-based swaps, foreign exchange 
forwards and foreign exchange swaps for each business day in June, July 
and August 2018 that exceeds $1 trillion. The compliance date is 
December 1, 2019 for any other covered swap entity with respect to 
uncleared swaps and uncleared security-based swaps entered into with 
any other counterparty.
3. Status Quo Baseline
    The baseline against which this proposed rule will be compared is 
the status quo. This requires the Commission to assess what is the 
current practice within the swaps industry. At present, swap market 
participants are not legally required to post either initial or 
variation margin

[[Page 59922]]

when engaging in uncleared swaps. Nevertheless, for risk management 
purposes, many market participants currently undertake this practice.
    In determining the current market practices, the Commission 
utilized several sources of swaps market data. These sources include 
(i) the ISDA Margin Survey 2014 (``ISDA Survey''), (ii) BIS's 
Quantitative impact study on margin requirements for non-centrally-
cleared OTC derivatives (``BCBS/IOSCO Quantitative Impact Study''), and 
(iii) Swap Data Repository data (``SDR Data''). Although the data the 
Commission is considering might not be complete, the Commission 
requests comments regarding whether there is additional data that it 
should consider when developing its baseline.
a. ISDA Margin Survey
    A resource containing current market practice for uncleared swaps 
is the ISDA Survey.\130\ The use of collateral agreements (those with 
exposure and/or collateral balances) is substantial. The ISDA Survey 
estimates that roughly 90% of all global uncleared OTC derivatives 
trades have collateral agreements. 97% and 86% of global bilateral 
transactions involving credit and fixed income, respectively, are 
subject to collateral agreements or credit support annexes. The survey 
reports that the use of cash and government securities accounts for 
roughly 90% of uncleared global OTC derivative collateral, as has been 
the case in prior years. The total global collateral related to 
uncleared derivatives has decreased 14% from $3.7 trillion at the end 
of 2012 to $3.2 trillion at the end of 2013. The survey asserts that 
this decrease can be largely attributed to mandatory clearing 
requirements.
---------------------------------------------------------------------------

    \130\ See http://www2.isda.org/functional-areas/research/surveys/margin-surveys.
---------------------------------------------------------------------------

b. BCBS/IOSCO's Quantitative Impact Study
    Another source containing current market practices for uncleared 
swaps is the BCBS/IOSCO Quantitative Impact Study.\131\ According to 
the Study, BCBS/IOSCO Quantitative Impact Study respondents have 
roughly [euro]319 trillion (approximately $415 trillion) in total 
outstanding notional derivative positions, are collecting a total of 
roughly [euro]95 billion (approximately $124 billion) in initial margin 
and are posting roughly [euro]6 billion (approximately $7.8 billion) in 
initial margin. Hence, average margin represents about 0.03% of the 
gross notional exposure.'' \132\ The large difference between collected 
and posted margin reflects the fact that the BCBS/IOSCO Quantitative 
Impact Study respondents tend to be large derivative dealers with large 
swap portfolios with transactions that on aggregate mostly offset, have 
substantial capital, and who have high credit ratings, this generally 
leads to lower margins.
---------------------------------------------------------------------------

    \131\ Bank for International Settlements, February 2013, page 
31, see http://www.bis.org/publ/bcbs242.pdf.
    \132\ Bank for International Settlements, February 2013, page 
31. See http://www.bis.org/publ/bcbs242.pdf.
---------------------------------------------------------------------------

    In light of the definition of potential future exposure in this 
proposal, it is useful to examine current practice. The table below, 
reproduced from the BCBS/IOSCO Quantitative Impact Study provides some 
statistics on potential future exposure, and related industry 
practices.

                             Table 4b--Current Margin Practices for Uncleared Swaps
----------------------------------------------------------------------------------------------------------------
                                                                                                     Number of
                                                                      Average         Median        respondents
----------------------------------------------------------------------------------------------------------------
Margin period of risk (or risk horizon) in days.................             8.1            10.0              15
Confidence level (%) used.......................................           96.2%           96.3%              14
Length of the look-back period (in years) used in calibration of             2.9             2.0              13
 model..........................................................
Level of initial margin as a percentage of potential future                97.5%          100.0%              10
 exposure.......................................................
Margin frequency (in days) Variation margin.....................             2.3             1.0              31
Initial margin..................................................             1.0             1.0              21
----------------------------------------------------------------------------------------------------------------
Respondents have provided information on initial margin frequency. Eight (8) of these respondents collect
  initial margin at deal inception. One (1) of them collects initial margin on an event-driven basis. The
  remaining 12 respondents collect initial margin daily.

    The Commission seeks comment on the representativeness of the BCBS/
IOSCO's Quantitative Impact Study. How do the calculations in the BCBS/
IOSCO's Quantitative Impact Study compare to the experience of 
financial institutions? Commenters are encouraged to quantify when 
possible.
c. Estimates Using SDR Data
    Finally, the Commission reports aggregated data derived from data 
submitted to swap data repositories in a weekly swaps market 
report.\133\ Open swap positions in credit and interest rates as of 
June 27, 2014 for CFTC regulated CSEs (59 entities) are presented 
below. The table also includes total notional amount of swaps 
transacted by these entities in credit and interest rates during the 
period January to June 2014:
---------------------------------------------------------------------------

    \133\ See http://www.cftc.gov/MarketReports/SwapsReports/index.htm.

                     Open Swaps as of June 27, 2014
            [Notional amount in US$ billions (double count)]
------------------------------------------------------------------------
                                             Uncleared        Cleared
------------------------------------------------------------------------
Interest Rates..........................         253,434         223,744
Credit..................................          10,039             879
------------------------------------------------------------------------


[[Page 59923]]


       Aggregate Notional Swaps Transaction (January to June 2014)
            [Notional amount in US$ billions (double count)]
------------------------------------------------------------------------
                                             Uncleared        Cleared
------------------------------------------------------------------------
Interest Rates..........................          12,630          39,816
Credit..................................           1,362           5,717
------------------------------------------------------------------------

    The Commission notes that OCC's Economic Impact Analysis for Swaps 
Margin Proposed Rule \134\ has estimated that in year one, OCC-
supervised institutions will have to post total initial margin of 
approximately $331 billion with approximately $283 billion in interest 
rate and credit swaps. Using annualized notional swaps activity for 
just interest rate and credit, and adopting a similar methodology to 
the OCC's Economic Impact Analysis, the Commission estimates that the 
59 CFTC regulated CSEs will have to post initial margin in year one of 
approximately $340 billion or possibly less as noted below. The OCC's 
estimate and the Commission's estimate are not based on the same data. 
The OCC's estimates are based on transactions activity implied by the 
open swaps positions from Call Report schedule RC-L. The Commission's 
estimates are based on transaction data reported to SDRs. To the extent 
SDR data includes financial end users without material swaps exposure, 
nonfinancial end users, sovereigns, and multilateral development banks 
who do not have to post collateral, the amount of required initial 
margin would be less than the Commission's estimate of approximately 
$340 billion. Further, the amount of required initial margin will be 
lower as a result of the $65 million threshold, too. While the OCC has 
made certain assumptions regarding coverage of the swaps activity by 
its regulated entities during the different compliance dates, the 
Commission does not have access to relevant data to make similar 
estimates. The Commission's initial margin estimates assume that 
uncleared swaps activities by CFTC regulated CSEs in these two asset 
classes will remain the same. These differences in approaches and the 
data sources means that the Commission's estimates will likely have 
overstated the actual margins that will be posted in year one after 
enactment.
---------------------------------------------------------------------------

    \134\ See http://www.regulations.gov/#!documentDetail;D=OCC-
2011-0008-0131.
---------------------------------------------------------------------------

    The Commission points out that prudentially regulated CSEs, CFTC 
regulated CSEs, and SEC regulated CSEs will trade with each other. 
Thus, one cannot simply add the margin estimates by various regulators 
as this will double count the amount of initial margin collateral for 
swap transactions between differently regulated CSEs. The Commission 
seeks comment on how it should consider or allocate the common costs 
and benefits of the margin collateral that is required by more than one 
CSE regulator. Further, the Commission seeks comments on all aspects of 
its initial margin estimates and methods. Commenters are encouraged to 
quantify, if practical.
4. Section 15(a) Factors
a. Protection of Market Participants and the Public
    Margin helps to protect market participants from counterparty 
credit risk. It also helps to protect the public by lowering the 
probability of a financial crisis, because margin helps to impede or 
contain the risk of a cascade of defaults occurring. A cascade occurs 
when one participant defaulting causes subsequent defaults by its 
counterparties, and so on, resulting in a domino effect and a potential 
financial crisis.
    The derivatives positions of swap market participants are limited 
by their ability to post margin. If the ability to post margin is 
binding, then required margin may reduce swap market exposures for some 
participants. In many cases, reduced swap market exposure for a 
participant may lower their probability of default, all else equal. 
Further, when a swap participant defaults, the margin can be used to 
absorb the losses to the counterparty. This facilitates the non-
defaulting party reestablishing a similar position with a new 
counterparty.
    In requiring daily variation margin payments, the proposed rule 
would require counterparties to mark-to-market all open swap positions. 
The process of marking swap contracts to market or model, forces 
participants to recognize losses promptly and to adjust collateral 
accordingly. This helps to prevent the accumulation of large 
unrecognized losses and exposures. Consequently, this frequent settling 
up may reduce the probability of default of the party who has been 
experiencing losses on the contract. The proposed rule however, 
requires a minimum payment amount of $650,000, which provides 
counterparties with operational relief. This minimum payment does not 
lower the amount owed, but permits deferral of margin exchanges until 
it is operationally efficient. In providing this relief the Commission 
believes that it will lower the overall burden on the financial system, 
but as a result of this amount being relatively small the Commission 
believes this deferral would not noticeably increase the overall risk 
to the financial system and the general public.
    The proposed rule also provides that initial margin must be held at 
a third-party custodian. The margin amount held there cannot be 
rehypothecated with both parties having access to the collateral. This 
access is designed to prevent a liquidity event, inducing a cascading 
event. With rehypothecation, the collateral of some parties may be 
linked or used as collateral posted for other positions--the same 
collateral is posted for many positions for many different entities, 
resulting in a rehypothecation chain. When a default or liquidity event 
occurs at one link along the rehypothecation chain, it might induce 
further defaults or liquidity events for other links in the 
rehypothecation chain, because access to the collateral for other 
positions may be obstructed by a default along the chain, which may 
result in a liquidity event along the entire chain.
    The cost of providing initial margin collateral reflects the cost 
of obtaining the assets used as collateral, which is either the cost of 
raising external funds, or the foregone income that could been earned 
had the firm invested in a different asset (opportunity cost). The 
effective cost is the difference between the relevant cost of obtaining 
eligible assets and the return on the assets that can be pledged as 
collateral. The effective cost will likely differ between entities and 
even desks in the same entity as well as over time as conditions 
change. At one extreme, it may be that some entities providing initial 
margin, such as pension funds and asset managers, will provide assets 
as initial margin that they already own and would have owned even if no 
requirements were in place. In such cases the economic cost of 
providing initial margin collateral is anticipated to be low. In other 
cases, entities engaging

[[Page 59924]]

in uncleared swaps will have to raise additional funds to secure assets 
that can be pledged as initial margin. The greater the costs of their 
funding, relative to the rates of return on the initial margin 
collateral, the greater the cost of providing collateral assets. It is 
difficult, however, to estimate these costs due to differences in 
funding costs across different types of entities as well as differences 
in funding costs over time, and differences in the rate of return on 
different collateral assets that may be used to satisfy the initial 
margin requirements. In addition, as a result of the fact that posting 
margin reduces the risk of default, the posting party could receive a 
benefit in the form of improved pricing of the swap or other beneficial 
changes to the relationship between the CSE and the counterparty. To 
the extent any such benefit is realized, it would offset a portion of 
the cost incurred in posting collateral.
    The Commission seeks comment on the appropriate cost or a proxy for 
the costs to posting collateral for CFTC regulated entities, 
recognizing that CFTC entities may have different costs for pledging 
collateral. The Commission also seeks comments on the quantitative 
impact of these proposed rules on the pricing of swaps or other changes 
in the relationships between CSEs and counterparties.
    The proposal also requires that variation margin be exchanged 
between covered swap entities and other swap entities and financial 
end-users. The Commission preliminarily believes that the impact of 
such requirements are low in the aggregate because: (i) regular 
exchange of variation margin is already a well-established market 
practice among a large number of market participants, and (ii) exchange 
of variation margin simply redistributes resources from one entity to 
another in a manner that imposes no aggregate liquidity costs. An 
entity that suffers a reduction in liquidity from posting variation 
margin is offset by an increase in the liquidity enjoyed by the entity 
receiving the variation margin because variation margin is posted with 
cash. The Commission notes that if the margin payments are not 
instantaneous, however, there may be a slight loss in liquidity while 
payments are being posted.
    Posting margin may discourage some parties from hedging certain 
risks because it is no longer cost effective for them to do so. 
Consequently, this may reduce liquidity for some swap contracts. This 
concern is mitigated somewhat by exempting non-financial end users from 
having to post margin. Furthermore, not requiring parties to exchange 
variation margin when the change in valuation is small enough, 
$650,000, achieves additional cost savings. The proposed rule will 
create additional demand for eligible collateral to post as margin. 
Some advocates have expressed concern regarding the future availability 
of eligible assets for market participants to post as margin; \135\ 
however, in developing this proposal, the Commission has added 
additional types of financial instruments to the list of eligible 
collateral in an attempt to mitigate this concern. That being said, it 
is too early to tell the extent to which eligible collateral will 
become more expensive to obtain. Even if higher demand for collateral 
does increase the price of certain existing assets, the Commission 
surmises that markets for various forms of collateral will clear. 
Higher prices may create incentives for creators of high quality assets 
to supply more in the future. For instance, sovereigns and credit 
worthy corporations may find it advantageous to issue more debt; as 
demand increases for their debt, prices will rise with corresponding 
borrowing rates decreasing. In addition, mutual funds and hedge funds 
may be willing for a fee to lend out assets that they hold in their 
portfolios to be pledged as initial margin. Some financial 
intermediaries may set up services to transform other financial 
instruments into eligible collateral, too.
---------------------------------------------------------------------------

    \135\ See, for instances, Singh (2010), ``Under-
collateralisation and rehypothecation in the OTC derivatives 
markets,'' Banque de France Financial Stability Review (14); 
Sidanius and Zikes (2012), ``OTC derivatives reform and collateral 
demand impact,'' Financial Stability Paper (18); and Duffie, 
Scheicher, and Vuillemey (2014), ``Central Clearing and Collateral 
Demand,'' working paper, Stanford University.
---------------------------------------------------------------------------

    According to the Committee on the Global Financial System, there 
seems to be sufficient eligible collateral at present and in the near 
term, as they noted that ``Current estimates suggest that the combined 
impact of liquidity regulation and OTC derivatives reforms could 
generate additional collateral demand to the tune of $4 trillion. At 
the same time, the supply of collateral assets is known to have risen 
significantly since end-2007. Outstanding amounts of AAA- and AA-rated 
government securities alone--based on the market capitalization of 
widely used benchmark indices--increased by $10.8 trillion between 2007 
and 2012. Other measures suggest even greater increases in supply.'' 
\136\ As discussed above, there may be a reduction in the number of 
swap contracts due to the cost of posting margin. Indeed, this may be 
the case even if the cost of posting eligible collateral does not 
increase in price. Finally, the proposed margin rules will be phased in 
gradually. This gives regulators the ability to make adjustments, if 
necessary.
---------------------------------------------------------------------------

    \136\ Committee on the Global Financial System, ``Asset 
encumbrance and the demand for collateral assets'', CGFS Papers, no. 
49, May 2013, http://www.bis.org/publ/cgfs49.pdf.
---------------------------------------------------------------------------

b. The Efficiency, Competitiveness, and Integrity of Markets
    The proposed margin requirements make cleared swaps relatively more 
attractive. The Commission is requiring ten day initial margins for 
uncleared swaps and only five day margin for cleared swaps. In 
addition, the Commission is only allowing limited netting for uncleared 
swaps. All else equal, due to multilateral netting, less collateral may 
be required in a cleared environment relative to an uncleared 
environment.\137\
---------------------------------------------------------------------------

    \137\ Anderson and Joeveer (2014), ``The Economics of 
Collateral,'' working paper, London School of Economics.
---------------------------------------------------------------------------

    The Commission is allowing only limited netting for uncleared 
swaps. Limited netting may encourage participants to use a small number 
of counterparties for multiple swap transactions, because participants 
can only net swaps from those made with the same counterparty. This may 
encourage the concentration of risk among a few counterparties. 
However, these concerns may be mitigated somewhat by performing 
frequent portfolio compression exercises that facilitate multilateral 
netting.
    Another cost of the rules may be a reduction in the efficacy of 
hedging. Rules that make standardized swaps relatively less expensive 
may induce some entities to forego some customized swaps that may 
better match their exposures. However, before an entity decides to use 
a standardized swap over a customized uncleared swap, it must weigh the 
potentially lower margin costs from using standardized swaps against 
potentially losses from imperfect hedges. Consequently, market 
participants will still use customized swaps when they believe such 
swaps are superior for their hedging needs.
    All the market protection benefits discussed above may help to 
improve the integrity of markets, because they make it more likely that 
swap market participants will be able to perform on their contractual 
obligations. This comes with potential losses to participants who have 
to place their capital into margin and, hence potentially receive lower 
anticipated returns on their capital.

[[Page 59925]]

    The Commission has endeavored to harmonize this rulemaking with the 
domestic prudential regulators, as well as with foreign regulators. Two 
of the goals of harmonization are to satisfy the statute as well as to 
create a more level playing field thereby promoting fairer competition 
between entities regulated in different jurisdictions or by different 
regulators. Otherwise, regulatory arbitrage opportunities might be 
substantial. Price arbitrage occurs when an identical asset 
simultaneously has two different prices, so that an arbitrager may buy 
that asset where it is cheaper and sell it where it is more expensive 
to garner a risk free profit. Similarly, a regulatory arbitrager takes 
advantage of regulatory discrepancies by adapting activities so as to 
locate them in jurisdictions to increase the arbitrager's regulatory 
profits (i.e., regulatory benefits minus regulatory burdens).
    The Commission is in discussion with domestic and foreign 
regulators on the material swap exposure threshold for financial end 
users to be required to post margin collateral. The Commission notes 
that some foreign regimes have proposed a higher threshold than $3 
billion. In addition, the Commission realizes that setting a threshold 
lower than another jurisdiction may result in some market participants 
conducting some swaps in the jurisdiction with a lower threshold. The 
Commission is required, to the maximum extent practicable, to harmonize 
with prudential regulators, and domestic regulators are endeavoring to 
harmonize with foreign regulators, as well. Therefore, the Commission 
expects to consider the relative benefits that might come from having 
consistent standards against those that might come from having 
different thresholds. The Commission is seeking comment on the costs 
and benefits of setting the threshold for material swap exposure for 
financial end users to be required to post margin collateral at various 
levels. In particular, commenters are encouraged to discuss competitive 
impacts and to quantify, if practical. In addition, the Commission is 
seeking comments on the costs and benefits of not fully harmonizing its 
rules with those of the prudential regulators. Commenters are 
encouraged to discuss the operational difficulties and to quantify, if 
practical.
    Inasmuch as larger banks tend to have a lower cost of capital than 
smaller banks, the posting of margin for uncleared swaps may result in 
a competitive advantage for larger banks when engaging in swaps, all 
else equal. Even though they are exempted from clearing as financial 
end users, small banks that have a material swaps exposure generally 
will have to post margin collateral when engaging in uncleared swaps 
with CFTC regulated CSEs. Thus, small banks may have to fund additional 
collateral to post as margin for uncleared swaps or engage in more 
cleared swaps that require relatively less collateral to post. The 
Commission is seeking comment on the costs and benefits of requiring 
small banks with material swaps exposures to post collateral with CFTC 
regulated CSEs. Commenters may choose to recognize that under the 
prudential regulators' proposal, small banks that have a material swaps 
exposure and that engage in swaps with prudentially regulated CSEs 
would have to post margin collateral for uncleared swaps, too. Further, 
commenters may also choose to recognize that the Commission is required 
to harmonize this rulemaking, to the maximum extent practicable, with 
the prudential regulators. Comments are encouraged to quantify, if 
practical.
c. Price Discovery
    The Commission is requiring ten day initial margins for uncleared 
swaps and only five day margin for cleared swaps. In addition, the 
Commission is only allowing limited netting for uncleared swaps. 
Consequently, these rules promote the use of more standardized cleared 
swaps at the expense of more customized and opaque swaps.
    To the extent traders increase the use of standardized cleared 
swaps in response to these rules, it may lead to greater transparency, 
overall, in the swaps markets. Compared to uncleared swaps, 
standardized swaps' prices tend to be more transparent and the price 
discovery process for such swaps may improve with higher volumes. 
Conversely, lower volumes for uncleared swaps may negatively impact the 
price discovery process for such swaps. However, the Commission 
believes that the potential reduction in the efficacy of the price 
discovery process for uncleared swaps is less of a concern, because the 
price-setting process for uncleared swaps is not conducted on a 
regulated platform or pursuant to rules requiring transparency and is 
therefore relatively opaque in the current environment, anyway.
    The Commission recognizes that another way the rules may affect 
price discovery is by promoting confidence in the market. As such, the 
margin collateral rules may protect, prophylactically, the price 
discovery process of some swap contracts in some circumstances. The 
rules might protect price discovery by reducing the frequency of 
trading interruptions in segments of the swap market due to credit risk 
concerns. This rulemaking might improve price discovery in these 
instances, because the presence of collateral mitigates credit risk 
concerns, and thereby allows these swap contract markets to remain 
functioning. In turn, this permits market participants to continue to 
observe the prices of these swaps.
    The Commission requests comment on potential effects of the rule on 
price discovery as well as on the relative use of cleared and uncleared 
swaps, and on whether particular types of market participants, 
including intermediaries such as regulated trading platforms, will be 
impacted differently by the rule. Commenters are urged to quantify the 
costs and benefits, if practicable.
d. Sound Risk Management Practices
    Margin helps to mitigate the credit risk exposure resulting from 
swap contracts. Further, it is a sound practice to regularly mark to 
market or model to prevent the accumulation of unrecognized losses and 
exposures (through the exchange of variation margin). At the same time, 
requiring margin may help deter traders from taking advantage of the 
inherent leverage in certain swap transactions.
    The Commission is requiring ten day initial margins for uncleared 
swaps and only five day initial margin for cleared swaps. Thus, the 
rule may result in the use of more standardized cleared swaps at the 
expense of more customized swaps which may be harder to evaluate and 
risk manage; however, this may result in market participants using non-
optimal hedging techniques, as noted above, which may increase overall 
risk at a firm.
    Prohibiting rehypothecation at third-party custodians when both 
parties have access to the collateral will be helpful in the time of 
default. Otherwise, a liquidity event might occur that induces a 
cascading event, in which the positions will be linked to other 
positions and counterparties. The policy of not allowing 
rehypothecation, however, requires that more collateral be available to 
post as margin. As discussed above, this does not seem to be a serious 
problem at present, but it might become one in the future. In addition, 
to protect parties against the circumstance when pledged collateral 
might be appropriated by the counterparty, margins must be held at 
third parties. Facilitating the use of more customized models might 
induce market participants to more thoroughly analyze the risks of 
their swap transactions, and may lead to better risk

[[Page 59926]]

management practices overall. The Commission is allowing various 
methods to model the amount of collateral required as initial margin 
for uncleared swap transactions, including Commission-approved standard 
models or more customized ones.
    In this proposal, the Commission has added flexibility to what 
constitutes eligible collateral, allowing participants in uncleared 
swap transactions to `optimize' their collateral inasmuch as they may 
reduce their opportunity cost losses from pledging assets with lower 
anticipated returns. This may result in market participants focusing on 
improving their margin and risk management practices.
e. Other Public Interest Considerations
    The Commission has not identified any other public interest 
considerations.

List of Subjects

17 CFR Part 23

    Swaps, Swap dealers, Major swap participants, Capital and margin 
requirements.

17 CFR Part 140

    Authority delegations (Government agencies), Organization and 
functions (Government agencies).

    For the reasons discussed in the preamble, the Commodity Futures 
Trading Commission proposes to amend 17 CFR chapter I as set forth 
below:

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

0
1. The authority citation for part 23 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t, 
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.

0
2. Add subpart E to part 23 to read as follows:

Subpart E--Capital and Margin Requirements for Swap Dealers and 
Major Swap Participants

Sec.
23.100-23.149 [Reserved]
23.150 Scope.
23.151 Definitions applicable to margin requirements.
23.152 Collection and posting of initial margin.
23.153 Collection and payment of variation margin.
23.154 Calculation of initial margin.
23.155 Calculation of variation margin.
23.156 Forms of margin.
23.157 Custodial arrangements.
23.158 Margin documentation.
23.159 Compliance dates.
23.160-23.199 [Reserved]


Sec. Sec.  23.100-23.149  [Reserved]


Sec.  23.150  Scope.

    The margin requirements set forth in Sec.  23.150 through Sec.  
23.159 shall apply to uncleared swaps, as defined in Sec.  23.151, that 
are executed after the applicable compliance dates set forth in Sec.  
23.159.


Sec.  23.151  Definitions applicable to margin requirements.

    For the purposes of Sec. Sec.  23.150 through 23.159:
    Affiliate means any company that controls, is controlled by, or is 
under common control with another company.
    Bank holding company has the meaning specified in section 2 of the 
Bank Holding Company Act of 1956 (12 U.S.C. 1841).
    Broker dealer means an entity registered with the Securities and 
Exchange Commission under section 15 of the Securities Exchange Act of 
1934 (15 U.S.C. 78o).
    Control of another company means:
    (1) 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;
    (2) 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
    (3) Control in any manner of the election of a majority of the 
directors or trustees of the company.
    Counterparty means the other party to a swap to which a covered 
swap entity is a party.
    Covered counterparty means a financial end user with material swaps 
exposure, a swap dealer, or a major swap participant that enters into a 
swap with a covered swap entity.
    Covered swap entity means a swap dealer or major swap participant 
for which there is no prudential regulator.
    Cross-currency swap means 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 
reversal of the exchange of principal at a later date that is agreed 
upon at the inception of the swap.
    Data source means an entity and/or method from which or by which a 
covered swap entity obtains prices for swaps or values for other inputs 
used in a margin calculation.
    Depository institution has the meaning specified in section 3(c) of 
the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
    Eligible collateral means collateral described in Sec.  23.157.
    Eligible master netting agreement means a written, legally 
enforceable agreement provided that:
    (1) The agreement creates a single legal obligation for all 
individual transactions covered by the agreement upon an event of 
default, including upon an event of receivership, insolvency, 
liquidation, or similar proceeding, of the counterparty;
    (2) The agreement provides the covered swap entity the right to 
accelerate, terminate, and close out on a net basis all transactions 
under the agreement and to liquidate or set off collateral promptly 
upon an event of default, including upon an event of receivership, 
insolvency, liquidation, or similar proceeding, of the counterparty, 
provided that, in any such case, any exercise of rights under the 
agreement will not be stayed or avoided under applicable law in the 
relevant jurisdictions, other than in receivership, conservatorship, 
resolution under the Federal Deposit Insurance Act (12 U.S.C. 1811 et 
seq.), Title II of the Dodd-Frank Act (12 U.S.C. 4617) or under any 
similar insolvency law applicable to U.S. Government-sponsored 
enterprises (12 U.S.C. 2183 and 2279cc);
    (3) The agreement does not contain a walkaway clause (that is, a 
provision that permits a non-defaulting counterparty to make a lower 
payment than it otherwise would make under the agreement, or no payment 
at all, to a defaulter or the estate of a defaulter, even if the 
defaulter or the estate of the defaulter is a net creditor under the 
agreement); and
    (4) A covered swap entity that relies on the agreement for purposes 
of calculating the margin required by this part:
    (i) Conducts sufficient legal review (and maintains sufficient 
written documentation of that legal review) to conclude with a well-
founded basis that:
    (A) The agreement meets the requirements of paragraphs (1) through 
(3) of this definition; and
    (B) In the event of a legal challenge (including one resulting from 
default or from receivership, insolvency, liquidation, or similar 
proceeding) the relevant court and administrative authorities would 
find the agreement to be legal, valid, binding, and enforceable under 
the law of the relevant jurisdictions; and
    (ii) Establishes and maintains written procedures to monitor 
possible changes in relevant law and to ensure that the agreement 
continues to satisfy the requirements of this definition.
    Financial end user means

[[Page 59927]]

    (1) A counterparty that is not a swap entity and that is:
    (i) A bank holding company or an affiliate thereof; a savings and 
loan holding company; or a nonbank financial institution supervised by 
the Board of Governors of the Federal Reserve System under Title I of 
the Dodd-Frank Act (12 U.S.C. 5323);
    (ii) A depository institution; a foreign bank; a Federal credit 
union or State credit union as defined in section 2 of the Federal 
Credit Union Act (12 U.S.C. 1752(1) and (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));
    (iii) An entity that is state-licensed or registered as:
    (A) 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; except 
entities registered or licensed solely on account of financing the 
entity's direct sales of goods or services to customers;
    (B) A money services business, including a check casher; money 
transmitter; currency dealer or exchange; or money order or traveler's 
check issuer;
    (iv) 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;
    (v) 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.;
    (vi) 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 Securities and Exchange Commission under the 
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).
    (vii) 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);
    (viii) A commodity pool, a commodity pool operator, a commodity 
trading advisor, or a futures commission merchant;
    (ix) 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);
    (x) 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;
    (xi) 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;
    (xii) A person that would be a financial entity described in 
paragraphs (1)(i)-(xi) of this definition if it were organized under 
the laws of the United States or any State thereof; or
    (xiii) Notwithstanding paragraph (2) of this definition, any other 
entity that the Commission determines should be treated as a financial 
end user.
    (2) The term ``financial end user'' does not include any 
counterparty that is:
    (i) A sovereign entity;
    (ii) A multilateral development bank;
    (iii) The Bank for International Settlements;
    (iv) An entity that is exempt from the definition of financial 
entity pursuant to section 2(h)(7)(C)(iii) of the Act and implementing 
regulations; or
    (v) An affiliate that qualifies for the exemption from clearing 
pursuant to section 2(h)(7)(D) of the Act.
    Foreign bank has the meaning specified in section 1 of the 
International Banking Act of 1978 (12 U.S.C. 3101).
    Foreign exchange forward and foreign exchange swap mean any foreign 
exchange forward, as that term is defined in section 1a(24) of the Act, 
and foreign exchange swap, as that term is defined in section 1a(25) of 
the Act.
    Initial margin means collateral collected or posted to secure 
potential future exposure under one or more uncleared swaps.
    Initial margin threshold amount means an aggregate credit exposure 
of $65 million resulting from all uncleared swaps and uncleared 
security-based swaps between a covered swap entity and its affiliates, 
and a covered counterparty and its affiliates.
    Major currencies means
    (1) United States Dollar (USD);
    (2) Canadian Dollar (CAD);
    (3) Euro (EUR);
    (4) United Kingdom Pound (GBP);
    (5) Japanese Yen (JPY);
    (6) Swiss Franc (CHF);
    (7) New Zealand Dollar (NZD);
    (8) Australian Dollar (AUD);
    (9) Swedish Kronor (SEK);
    (10) Danish Kroner (DKK);
    (11) Norwegian Krone (NOK); and
    (12) Any other currency designated by the Commission.
    Market intermediary means
    (1) A securities holding company;
    (2) A broker or dealer;
    (3) A futures commission merchant;
    (4) A swap dealer; or
    (5) A security-based swap dealer.
    Material swaps exposure for an entity means that the entity and its 
affiliates have an average daily aggregate notional amount of uncleared 
swaps, uncleared 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.
    Minimum transfer amount means an initial margin or variation margin 
amount under which no actual transfer of funds is required. The minimum 
transfer amount shall be $650,000 or such other amount as the 
Commission may establish by order.
    Multilateral development bank means
    (1) The International Bank for Reconstruction and Development;
    (2) The Multilateral Investment Guarantee Agency;
    (3) The International Finance Corporation;
    (4) The Inter-American Development Bank;
    (5) The Asian Development Bank;
    (6) The African Development Bank;
    (7) The European Bank for Reconstruction and Development;
    (8) The European Investment Bank;
    (9) The European Investment Fund;
    (10) The Nordic Investment Bank;
    (11) The Caribbean Development Bank;
    (12) The Islamic Development Bank;
    (13) The Council of Europe Development Bank; and
    (14) Any other entity that provides financing for national or 
regional

[[Page 59928]]

development in which the U.S. government is a shareholder or 
contributing member or which the Commission determines poses comparable 
credit risk.
    Non-financial end user means a counterparty that is not a swap 
dealer, a major swap participant, or a financial end user.
    Prudential regulator has the meaning specified in section 1a(39) of 
the Act.
    Savings and loan holding company has the meaning specified in 
section 10(n) of the Home Owners' Loan Act (12 U.S.C. 1467a(n)).
    Securities holding company has the meaning specified in section 618 
of the Dodd-Frank Act (12 U.S.C. 1850a).
    Security-based swap has the meaning specified in section 3(a)(68) 
of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(68)).
    Sovereign entity means a central government (including the U.S. 
government) or an agency, department, ministry, or central bank of a 
central government.
    State means 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 Islands, American Samoa, 
Guam, or the United States Virgin Islands.
    Subsidiary means a company that is controlled by another company.
    Swap entity means a swap dealer or major swap participant.
    Uncleared security-based swap means a security-based swap that is 
not cleared by a clearing agency registered with the Securities and 
Exchange Commission.
    Uncleared swap means a swap that is not cleared by a registered 
derivatives clearing organization, or by a clearing organization that 
has received a no-action letter or other exemptive relief from the 
Commission permitting it to clear certain swaps for U.S. persons 
without being registered as a derivatives clearing organization.
    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 U.S. government.
    Variation margin means a payment by a party to its counterparty to 
meet an obligation under one or more swaps between the parties as a 
result of a change in value of such obligations since the trade was 
executed or the previous time such payment was made.


Sec.  23.152   Collection and posting of initial margin.

    (a) Collection--(1) Initial obligation. On or before the business 
day after execution of an uncleared swap between a covered swap entity 
and a covered counterparty, the covered swap entity shall collect 
initial margin from the covered counterparty in an amount equal to or 
greater than an amount calculated pursuant to Sec.  23.154, in a form 
that complies with Sec.  23.156, and pursuant to custodial arrangements 
that comply with Sec.  23.157.
    (2) Continuing obligation. The covered swap entity shall continue 
to hold initial margin from the covered counterparty in an amount equal 
to or greater than an amount calculated each business day pursuant to 
Sec.  23.154, in a form that complies with Sec.  23.156, and pursuant 
to custodial arrangements that comply with Sec.  23.157, until such 
uncleared swap is terminated or expires.
    (b) Posting--(1) Initial obligation. On or before the business day 
after execution of an uncleared swap between a covered swap entity and 
a covered counterparty that is a financial end user, the covered swap 
entity shall post initial margin with the covered counterparty in an 
amount equal to or greater than an amount calculated pursuant to Sec.  
23.154, in a form that complies with Sec.  23.156, and pursuant to 
custodial arrangements that comply with Sec.  23.157.
    (2) Continuing obligation. The covered swap entity shall continue 
to post initial margin with the covered counterparty in an amount equal 
to or greater than an amount calculated each business day pursuant to 
Sec.  23.154, in a form that complies with Sec.  23.156, and pursuant 
to custodial arrangements that comply with Sec.  23.157, until such 
uncleared swap is terminated or expires.
    (c) Satisfaction of collection and posting requirements. A covered 
swap entity shall not be deemed to have violated its obligation to 
collect or to post initial margin from a covered counterparty if:
    (1) The covered counterparty has refused or otherwise failed to 
provide, or to accept, the required initial margin to, or from, the 
covered swap entity; and
    (2) The covered swap entity has:
    (i) Made the necessary efforts to collect or to post the required 
initial margin, including the timely initiation and continued pursuit 
of formal dispute resolution mechanisms, including pursuant to Sec.  
23.504(b)(4), if applicable, or has otherwise demonstrated upon request 
to the satisfaction of the Commission that it has made appropriate 
efforts to collect or to post the required initial margin; or
    (ii) Commenced termination of the uncleared swap with the covered 
counterparty promptly following the applicable cure period and 
notification requirements.


Sec.  23.153   Collection and payment of variation margin.

    (a) Initial obligation. On or before the business day after 
execution of an uncleared swap between a covered swap entity and a 
counterparty that is a swap entity or a financial end user, the covered 
swap entity shall collect variation margin from, or pay variation 
margin to, the counterparty as calculated pursuant to Sec.  23.155 and 
in a form that complies with Sec.  23.156.
    (b) Continuing obligation. The covered swap entity shall continue 
to collect variation margin from, or to pay variation margin to, the 
counterparty as calculated each business day pursuant to Sec.  23.155 
and in a form that complies with Sec.  23.156 each business day until 
such uncleared swap is terminated or expires.
    (c) Netting. To the extent that more than one uncleared swap is 
executed pursuant to an eligible master netting agreement between a 
covered swap entity and a counterparty, a covered swap entity may 
calculate and comply with the variation margin requirements of this 
section on an aggregate basis with respect to all uncleared swaps 
governed by such agreement. If the agreement covers uncleared swaps 
entered into before the applicable compliance date set forth in Sec.  
23.159, those swaps must be included in the aggregate for the purposes 
of calculation and complying with the variation margin requirements of 
this section.
    (d) Satisfaction of collection and payment requirements. A covered 
swap entity shall not be deemed to have violated its obligation to 
collect or to pay variation margin from a counterparty if:
    (1) The counterparty has refused or otherwise failed to provide or 
to accept the required variation margin to or from the covered swap 
entity; and
    (2) The covered swap entity has:
    (i) Made the necessary efforts to collect or to pay the required 
variation margin, including the timely initiation and continued pursuit 
of formal dispute resolution mechanisms, or has otherwise demonstrated 
upon request to the satisfaction of the Commission that it has made 
appropriate efforts to collect or to pay the required variation margin; 
or
    (ii) Commenced termination of the uncleared swap with the 
counterparty promptly following the applicable cure period and 
notification requirements.

[[Page 59929]]

Sec.  23.154   Calculation of initial margin.

    (a) Means of calculation. (1) Each business day each covered swap 
entity shall calculate an initial margin amount to be collected from 
each covered counterparty using:
    (i) A risk-based model that meets the requirements of paragraph (b) 
of this section; or
    (ii) The table-based method set forth in paragraph (c) of this 
section.
    (2) Each business day each covered swap entity shall calculate an 
initial margin amount to be posted with each covered counterparty that 
is a financial end user using:
    (i) A risk-based model that meets the requirements of paragraph (b) 
of this section; or
    (ii) The table-based method set forth in paragraph (c) of this 
section.
    (3) Each covered swap entity may reduce the amounts calculated 
pursuant to paragraphs (a)(1) and (2) of this section by the initial 
margin threshold amount provided that the reduction does not include 
any portion of the initial margin threshold amount already applied by 
the covered swap entity or its affiliates in connection with other 
uncleared swaps or uncleared security-based swaps with the counterparty 
or its affiliates.
    (4) The amounts calculated pursuant to paragraph (a)(3) of this 
section shall not be less than zero.
    (5) A covered swap entity shall not be required to collect or to 
post an amount below the minimum transfer amount.
    (6) For risk management purposes, each business day each covered 
swap entity shall calculate a hypothetical initial margin requirement 
for each swap for which the counterparty is a non-financial end user 
that has material swaps exposure to the covered swap entity as if the 
counterparty were a covered counterparty and compare that amount to any 
initial margin required pursuant to the margin documentation.
    (b) Risk-based Models--(1) Commission approval. (i) A covered swap 
entity shall obtain the written approval of the Commission to use a 
model to calculate the initial margin required in this part.
    (ii) A covered swap entity shall demonstrate that the model 
satisfies all of the requirements of this section on an ongoing basis.
    (iii) A covered swap entity shall notify the Commission in writing 
60 days prior to:
    (A) Extending the use of an initial margin model that has been 
approved to an additional product type;
    (B) Making any change to any initial margin model that has been 
approved that would result in a material change in the covered swap 
entity's assessment of initial margin requirements; or
    (C) Making any material change to modeling assumptions used by the 
initial margin model.
    (iv) The Commission may rescind its approval of the use of any 
initial margin model, in whole or in part, or may impose additional 
conditions or requirements if the Commission determines, in its sole 
discretion, that the model no longer complies with this section.
    (2) Applicability to multiple swaps. To the extent that more than 
one uncleared swap is executed pursuant to an eligible master netting 
agreement between a covered swap entity and a covered counterparty, a 
covered swap entity may use its initial margin model to calculate and 
comply with the initial margin requirements on an aggregate basis with 
respect to all uncleared swaps governed by such agreement. If the 
agreement covers uncleared swaps entered into before the applicable 
compliance date, those swaps must be included in the aggregate in the 
initial margin model for the purposes of calculating and complying with 
the initial margin requirements.
    (3) Elements of the model. (i) The model shall calculate an amount 
of initial margin that is equal to the potential future exposure of the 
uncleared swap or netting set of uncleared swaps covered by an eligible 
master netting agreement. Potential future exposure is an estimate of 
the one-tailed 99 percent confidence interval for an increase in the 
value of the uncleared swap or netting set of uncleared swaps due to an 
instantaneous price shock that is equivalent to a movement in all 
material underlying risk factors, including prices, rates, and spreads, 
over a holding period equal to the shorter of ten business days or the 
maturity of the swap.
    (ii) All data used to calibrate the model shall be based on an 
equally weighted historical observation period of at least one year and 
not more than five years and must incorporate a period of significant 
financial stress for each broad asset class that is appropriate to the 
uncleared swaps to which the initial margin model is applied.
    (iii) The model shall use risk factors sufficient to measure all 
material price risks inherent in the transactions for which initial 
margin is being calculated. The risk categories shall include, but 
should not be limited to, foreign exchange or interest rate risk, 
credit risk, equity risk, agricultural commodity risk, energy commodity 
risk, metal commodity risk, and other commodity risk, as appropriate. 
For material exposures in significant currencies and markets, modeling 
techniques shall capture spread and basis risk and shall incorporate a 
sufficient number of segments of the yield curve to capture differences 
in volatility and imperfect correlation of rates along the yield curve.
    (iv) In the case of an uncleared cross-currency swap, the model 
need not recognize any risks or risk factors associated with the fixed, 
physically-settled foreign exchange transactions associated with the 
exchange of principal embedded in the cross-currency swap. The model 
shall recognize all material risks and risk factors associated with all 
other payments and cash flows that occur during the life of the 
uncleared cross-currency swap.
    (v) The model may calculate initial margin for an uncleared swap or 
netting set of uncleared swaps covered by an eligible master netting 
agreement. It may reflect offsetting exposures, diversification, and 
other hedging benefits for uncleared swaps that are governed by the 
same eligible master netting agreement by incorporating empirical 
correlations within the following broad risk categories, provided the 
covered swap entity validates and demonstrates the reasonableness of 
its process for modeling and measuring hedging benefits: agriculture, 
credit, energy, equity, foreign exchange/interest rate, metals, and 
other. Empirical correlations under an eligible master netting 
agreement may be recognized by the model within each broad risk 
category, but not across broad risk categories.
    (vi) If the model does not explicitly reflect offsetting exposures, 
diversification, and hedging benefits between subsets of uncleared 
swaps within a broad risk category, the covered swap entity shall 
calculate an amount of initial margin separately for each subset of 
uncleared swaps for which offsetting exposures, diversification, and 
other hedging benefits are explicitly recognized by the model. The sum 
of the initial margin amounts calculated for each subset of uncleared 
swaps within a broad risk category shall be used to determine the 
aggregate initial margin due from the counterparty for the portfolio of 
uncleared swaps within the broad risk category.
    (vii) The sum of the initial margins calculated for each broad risk 
category shall be used to determine the aggregate initial margin due 
from the counterparty.

[[Page 59930]]

    (viii) The model shall not permit the calculation of any initial 
margin amount to be offset by, or otherwise take into account, any 
initial margin that may be owed or otherwise payable by the covered 
swap entity to the counterparty.
    (ix) The model shall include all material risks arising from the 
nonlinear price characteristics of option positions or positions with 
embedded optionality and the sensitivity of the market value of the 
positions to changes in the volatility of the underlying rates, prices, 
or other material risk factors.
    (x) The covered swap entity shall not omit any risk factor from the 
calculation of its initial margin that the covered swap entity uses in 
its model unless it has first demonstrated to the satisfaction of the 
Commission that such omission is appropriate.
    (xi) The covered swap entity shall not incorporate any proxy or 
approximation used to capture the risks of the covered swap entity's 
actual swaps unless it has first demonstrated to the satisfaction of 
the Commission that such proxy or approximation is appropriate.
    (xii) The covered swap entity shall have a rigorous and well-
defined process for re-estimating, re-evaluating, and updating its 
internal models to ensure continued applicability and relevance.
    (xiii) The covered swap entity shall review and, as necessary, 
revise the data used to calibrate the model at least monthly, and more 
frequently as market conditions warrant, ensuring that the data 
incorporate a period of significant financial stress appropriate to the 
uncleared swaps to which the model is applied.
    (xiv) The level of sophistication of the initial margin model shall 
be commensurate with the complexity of the swaps to which it is 
applied. In calculating an initial margin amount, the model may make 
use of any of the generally accepted approaches for modeling the risk 
of a single instrument or portfolio of instruments.
    (xv) The Commission may in its sole discretion require a covered 
swap entity using a model to collect a greater amount of initial margin 
than that determined by the covered swap entity's model if the 
Commission determines that the additional collateral is appropriate due 
to the nature, structure, or characteristics of the covered swap 
entity's transactions or is commensurate with the risks associated with 
the transaction.
    (4) Periodic review. A covered swap entity shall periodically, but 
no less frequently than annually, review its model in light of 
developments in financial markets and modeling technologies, and 
enhance the model as appropriate to ensure that it continues to meet 
the requirements for approval in this section.
    (5) Control, oversight, and validation mechanisms. (i) The covered 
swap entity shall maintain a risk management unit in accordance with 
Sec.  23.600(c)(4)(i) that is independent from the business trading 
unit (as defined in Sec.  23.600).
    (ii) The covered swap entity's risk control unit shall validate its 
model prior to implementation and on an ongoing basis. The covered swap 
entity's validation process shall be independent of the development, 
implementation, and operation of the model, or the validation process 
shall be subject to an independent review of its adequacy and 
effectiveness. The validation process shall include:
    (A) An evaluation of the conceptual soundness of (including 
developmental evidence supporting) the model;
    (B) An ongoing monitoring process that includes verification of 
processes and benchmarking by comparing the covered swap entity's model 
outputs (estimation of initial margin) with relevant alternative 
internal and external data sources or estimation techniques including 
benchmarking against observable margin standards to ensure that the 
initial margin is not less than what a derivatives clearing 
organization would require for similar cleared transactions; and
    (C) An outcomes analysis process that includes back testing the 
model.
    (iii) If the validation process reveals any material problems with 
the model, the covered swap entity shall notify the Commission of the 
problems, describe to the Commission any remedial actions being taken, 
and adjust the model to insure an appropriately conservative amount of 
required initial margin is being calculated.
    (iv) In accordance with Sec.  23.600(e)(2), the covered swap entity 
shall have an internal audit function independent of the business 
trading unit and the risk management unit that at least annually 
assesses the effectiveness of the controls supporting the model 
measurement systems, including the activities of the business trading 
units and risk control unit, compliance with policies and procedures, 
and calculation of the covered swap entity's initial margin 
requirements under this part. At least annually, the internal audit 
function shall report its findings to the covered swap entity's 
governing body, senior management, and chief compliance officer.
    (6) Documentation. The covered swap entity shall adequately 
document all material aspects of its model, including management and 
valuation of uncleared swaps to which it applies, the control, 
oversight, and validation of the model, any review processes and the 
results of such processes.
    (7) Escalation procedures. The covered swap entity must adequately 
document authorization procedures, including escalation procedures that 
require review and approval of any change to the initial margin 
calculation under the model, demonstrable analysis that any basis for 
any such change is consistent with the requirements of this section, 
and independent review of such demonstrable analysis and approval.
    (c) Table-based method. If a model meeting the standards set forth 
in paragraph (b) of this section is not used, initial margin shall be 
calculated in accordance with this paragraph.
    (1) Standardized initial margin schedule.

------------------------------------------------------------------------
                                                          Initial margin
                                                          requirement (%
                       Asset class                          of notional
                                                             exposure)
------------------------------------------------------------------------
Credit: 0-2 year duration...............................               2
Credit: 2-5 year duration...............................               5
Credit: 5+ year duration................................              10
Commodity...............................................              15
Equity..................................................              15
Foreign Exchange/Currency...............................               6
Cross Currency Swaps: 0-2 year duration.................               1
Cross Currency Swaps: 2-5 year duration.................               2
Cross currency Swaps: 5+ year duration..................               4
Interest Rate: 0-2 year duration........................               1
Interest Rate: 2-5 year duration........................               2
Interest Rate: 5+ year duration.........................               4
Other...................................................              15
------------------------------------------------------------------------

    (2) Net to gross ratio adjustment. (i) For multiple uncleared swaps 
subject to an eligible master netting agreement, the initial margin 
amount under the standardized table shall be computed according to this 
paragraph.
    (ii) Initial Margin = 0.4 x Gross Initial Margin + 0.6 x Net-to-
Gross Ratio x Gross Initial Margin, where
    (A) Gross Initial Margin = the sum of the product of each uncleared 
swap's effective notional amount and the gross initial margin 
requirement for all uncleared swaps subject to the eligible master 
netting agreement;
    (B) Net-to-Gross Ratio = the ratio of the net current replacement 
cost to the gross current replacement cost;
    (C) Gross Current Replacement cost = the sum of the replacement 
cost for each uncleared swap subject to the eligible master netting 
agreement for which the cost is positive; and

[[Page 59931]]

    (D) Net Current Replacement Cost = the total replacement cost for 
all uncleared swaps subject to the eligible master netting agreement.


Sec.  23.155  Calculation of variation margin.

    (a) Means of calculation. (1) Each business day each covered swap 
entity shall calculate variation margin for itself and for each 
counterparty that is a swap entity or a financial end user using a 
methodology and inputs that to the maximum extent practicable rely on 
recently-executed transactions, valuations provided by independent 
third parties, or other objective criteria.
    (2) Each covered swap entity shall have in place alternative 
methods for determining the value of an uncleared swap in the event of 
the unavailability or other failure of any input required to value a 
swap.
    (3) For risk management purposes, each business day each covered 
swap entity shall calculate a hypothetical variation margin requirement 
for each swap for which the counterparty is a non-financial end user 
that has material swaps exposure to the covered counterparty as if the 
counterparty were a covered swap entity and compare that amount to any 
variation margin required pursuant to the margin documentation.
    (b) Control mechanisms. (1) Each covered swap entity shall create 
and maintain documentation setting forth the variation methodology with 
sufficient specificity to allow the counterparty, the Commission, and 
any applicable prudential regulator to calculate a reasonable 
approximation of the margin requirement independently.
    (2) Each covered swap entity shall evaluate the reliability of its 
data sources at least annually, and make adjustments, as appropriate.
    (3) The Commission at any time may require a covered swap entity to 
provide further data or analysis concerning the methodology or a data 
source, including:
    (i) An explanation of the manner in which the methodology meets the 
requirements of this section;
    (ii) A description of the mechanics of the methodology;
    (iii) The theoretical basis of the methodology;
    (iv) The empirical support for the methodology; and
    (v) The empirical support for the assessment of the data sources.


Sec.  23.156  Forms of margin.

    (a) Initial margin--(1) Eligible collateral. A covered swap entity 
shall collect and post as initial margin for trades with a covered 
counterparty only the following assets:
    (i) U.S. dollars;
    (ii) A major currency;
    (iii) A currency in which payment obligations under the swap are 
required to be settled;
    (iv) A security that is issued by, or unconditionally guaranteed as 
to the timely payment of principal and interest by, the U.S. Department 
of Treasury;
    (v) 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 Treasury) whose obligations 
are fully guaranteed by the full faith and credit of the U.S. 
government;
    (vi) 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 
government-sponsored enterprise's eligible securities; or
    (vii) A security that is issued by, or fully guaranteed as to the 
payment of principal and interest by, the European Central Bank or a 
sovereign entity that is assigned no higher than a 20 percent risk 
weight under the capital rules applicable to swap dealers subject to 
regulation by a prudential regulator;
    (viii) A security that is issued by, or fully guaranteed as to the 
payment of principal and interest by, the Bank for International 
Settlements, the International Monetary Fund, or a multilateral 
development bank;
    (ix) Other publicly-traded debt that has been deemed acceptable as 
initial margin by a prudential regulator; or
    (x) A publicly traded common equity security that is included in:
    (A) The Standard & Poor's Composite 1500 Index or any other similar 
index of liquid and readily marketable equity securities as determined 
by the Commission; or
    (B) An index that a covered swap entity's supervisor in a foreign 
jurisdiction recognizes for purposes of including publicly traded 
common equity as initial margin under applicable regulatory policy, if 
held in that foreign jurisdiction; or
    (xi) Gold.
    (2) Prohibition of certain assets. A covered swap entity may not 
collect or post as initial margin any asset that is a security issued 
by:
    (i) The party providing such asset or an affiliate of that party,
    (ii) A bank holding company, a savings and loan holding company, a 
foreign bank, a depository institution, a market intermediary, a 
company that would be any of the foregoing if it were organized under 
the laws of the United States or any State, or an affiliate of any of 
the foregoing institutions, or
    (iii) A U.S. government-sponsored enterprise after the termination 
of capital support or another form of direct financial assistance 
received from the U.S. government that enables the repayments of the 
government-sponsored enterprise's eligible securities unless:
    (A) The security meets the requirements of paragraph (a)(1)(iv) of 
this section;
    (B) The security meets the requirements of paragraph (a)(1)(vii) of 
this section; or
    (C) The security meets the requirements of paragraph (a)(1)(viii) 
of this section.
    (3) Haircuts. (i) Each covered swap entity shall apply haircuts to 
any asset posted or received as initial margin under this section that 
reflect the credit and liquidity characteristics of the asset.
    (ii) At a minimum, each covered swap entity shall apply haircuts to 
any asset posted or received as initial margin under this section in 
accordance with the following table:

                      Standardized Haircut Schedule
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Cash in same currency as swap obligation.......................      0.0
Eligible government and related debt (e.g., central bank,            0.5
 multilateral development bank, GSE securities identified in
 paragraph (a)(1)(iv) of this section): Residual maturity less
 than one-year.................................................
Eligible government and related debt (e.g., central bank,            2.0
 multilateral development bank, GSE securities identified in
 paragraph (a)(1)(iv) of this section): Residual maturity
 between one and five years....................................
Eligible government and related debt (e.g., central bank,            4.0
 multilateral development bank, GSE securities identified in
 paragraph (a)(1)(iv) of this section): Residual maturity
 greater than five years.......................................
Eligible corporate debt (including eligible GSE debt securities      1.0
 not identified in paragraph (a)(1)(iv) of this section):
 Residual maturity less than one-year..........................
Eligible corporate debt (including eligible GSE debt securities      4.0
 not identified in paragraph (a)(1)(iv) of this section):
 Residual maturity between one and five years..................
Eligible corporate debt (including eligible GSE debt securities      8.0
 not identified in paragraph (a)(1)(iv) of this section):
 Residual maturity greater than five years.....................
Equities included in S&P 500 or related index..................     15.0

[[Page 59932]]

 
Equities included in S&P 1500 Composite or related index but        25.0
 not S&P 500 or related index..................................
Gold...........................................................     15.0
Additional (additive) haircut on asset in which the currency of      8.0
 the swap obligation differs from that of the collateral asset.
------------------------------------------------------------------------

    (iii) The value of initial margin collateral that is calculated 
according to the schedule in paragraph (a)(3)(ii) of this section will 
be computed as follows: The value of initial margin collateral for any 
collateral asset class will be computed as the product of the total 
value of collateral in any asset class and one minus the applicable 
haircut expressed in percentage terms. The total value of all initial 
margin collateral is calculated as the sum of the value of each type of 
collateral asset.
    (4) Monitoring Obligation. A covered swap entity shall monitor the 
market value and eligibility of all collateral collected and held to 
satisfy initial margin required by this part. To the extent that the 
market value of such collateral has declined, the covered swap entity 
shall promptly collect such additional eligible collateral as is 
necessary to bring itself into compliance with the margin requirements 
of this part. To the extent that the collateral is no longer eligible, 
the covered swap entity shall promptly obtain sufficient eligible 
replacement collateral to comply with this part.
    (5) Excess initial margin. A covered swap entity may collect 
initial margin that is not required pursuant to this part in any form 
of collateral.
    (b) Variation margin--(1) Eligible assets. A covered swap entity 
shall pay and collect as variation margin to or from a covered 
counterparty only cash in the form of:
    (i) U.S. dollars; or
    (ii) A currency in which payment obligations under the swap are 
required to be settled.
    (2) Collection obligation. A covered swap entity shall not be 
deemed to have violated its obligation under this paragraph to collect 
variation margin if:
    (i) The counterparty has refused or otherwise failed to provide the 
variation margin to the covered swap entity; and
    (ii) The covered swap entity:
    (A) Has made the necessary efforts to collect the variation margin, 
including the timely initiation and continued pursuit of formal dispute 
resolution mechanisms, including Sec.  23.504(b), if applicable, or has 
otherwise demonstrated upon request to the satisfaction of the 
Commission that it has made appropriate efforts to collect the 
variation margin; or
    (B) Has commenced termination of the swap or security-based swap 
with the counterparty.


Sec.  23.157  Custodial arrangements.

    (a) Initial margin posted by covered swap entities. Each covered 
swap entity that posts initial margin with respect to an uncleared swap 
shall require that all funds or other property that the covered swap 
entity provides as initial margin be held by one or more custodians 
that are not affiliates of the covered swap entity or the counterparty.
    (b) Initial margin collected by covered swap entities. Each covered 
swap entity that collects initial margin required by Sec.  23.152 with 
respect to an uncleared swap shall require that such initial margin be 
held at one or more custodians that are not affiliates of the covered 
swap entity or the counterparty.
    (c) Custodial agreement. Each covered swap entity shall enter into 
an agreement with each custodian that holds funds pursuant to 
paragraphs (a) or (b) of this section that:
    (1) Prohibits 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;
    (2) Notwithstanding paragraph (c)(1) of this section, with respect 
to collateral posted or collected pursuant to Sec.  23.152, requires 
the posting party, when it substitutes or directs the reinvestment of 
posted collateral held by the custodian:
    (i) To substitute only funds or other property that are in a form 
that meets the requirements of Sec.  23.156 and in an amount that meets 
the requirements of Sec.  23.152, subject to applicable haircuts; and
    (ii) To reinvest funds only in assets that are in a form that meets 
the requirements of Sec.  23.156 and in an amount that meets the 
requirements of Sec.  23.152, subject to applicable haircuts;
    (3) Is legal, valid, binding, and enforceable under the laws of all 
relevant jurisdictions including in the event of bankruptcy, 
insolvency, or a similar proceeding.


Sec.  23.158  Margin documentation.

    (a) General requirement. Each covered swap entity shall execute 
documentation with each counterparty that complies with the 
requirements of Sec.  23.504 and that complies with this section. For 
uncleared swaps between a covered swap entity and a covered 
counterparty, the documentation shall provide the covered swap entity 
with the contractual right and obligation to exchange initial margin 
and variation margin in such amounts, in such form, and under such 
circumstances as are required by Sec. Sec.  23.150 through 23.159. For 
uncleared swaps between a covered swap entity and a non-financial 
entity, the documentation shall specify whether initial and/or 
variation margin will be exchanged and, if so, the documentation shall 
comply with paragraph (b) of this section.
    (b) Contents of the documentation. The margin documentation shall 
specify the following:
    (1) The methodology and data sources to be used to value uncleared 
swaps and collateral and to calculate initial margin for uncleared 
swaps entered into between the covered swap entity and the 
counterparty;
    (2) The methodology and data sources to be used to value positions 
and to calculate variation margin for uncleared swaps entered into 
between the covered swap entity participant and the counterparty;
    (3) The procedures by which any disputes concerning the valuation 
of uncleared swaps, or the valuation of assets posted as initial margin 
or paid as variation margin may be resolved;
    (4) Any thresholds below which initial margin need not be posted by 
the covered swap entity and/or the counterparty; and
    (5) Any thresholds below which variation margin need not be paid by 
the covered swap entity and/or the counterparty.


Sec.  23.159  Compliance dates.

    (a) Covered swap entities must comply with the minimum margin 
requirements for uncleared swaps on or before the following dates for 
uncleared swaps entered into on or after the following dates:
    (1) December 1, 2015 for the requirements in Sec.  23.153 for 
variation margin.
    (2) December 1, 2015 for the requirements in Sec.  23.152 for 
initial margin for any uncleared swaps where both the covered swap 
entity combined with all its affiliates and its counterparty combined 
with all its affiliates, have an average daily aggregate notional 
amount of uncleared swaps, uncleared security-based swaps, foreign 
exchange forwards, and foreign exchange swaps in June, July, and August 
2015 that exceeds $4 trillion, where such amounts are calculated only 
for business days.
    (3) December 1, 2016 for the requirements in Sec.  23.152 for 
initial margin for any uncleared swaps where

[[Page 59933]]

both the covered swap entity combined with all its affiliates and its 
counterparty combined with all its affiliates, have an average daily 
aggregate notional amount of uncleared swaps, uncleared security-based 
swaps, foreign exchange forwards, and foreign exchange swaps in June, 
July and August 2016 that exceeds $3 trillion, where such amounts are 
calculated only for business days.
    (4) December 1, 2017 for the requirements in Sec.  23.152 for 
initial margin for any uncleared swaps where both the covered swap 
entity combined with all its affiliates and its counterparty combined 
with all its affiliates have an average daily aggregate notional amount 
of uncleared swaps, uncleared security-based swaps, foreign exchange 
forwards, and foreign exchange swaps in June, July and August 2017 that 
exceeds $2 trillion, where such amounts are calculated only for 
business days.
    (5) December 1, 2018 for the requirements in Sec.  23.152 for 
initial margin for any uncleared swaps where both the covered swap 
entity combined with all its affiliates and its counterparty combined 
with all its affiliates have an average daily aggregate notional amount 
of uncleared swaps, uncleared security-based swaps, foreign exchange 
forwards, and foreign exchange swaps in June, July and August 2018 that 
exceeds $1 trillion, where such amounts are calculated only for 
business days.
    (6) December 1, 2019 for the requirements in Sec.  23.152 for 
initial margin for any other covered swap entity with respect to 
uncleared swaps entered into with any other counterparty.
    (b) Once a covered swap entity and its counterparty must comply 
with the margin requirements for uncleared swaps based on the 
compliance dates in paragraph (a) of this section, the covered swap 
entity and its counterparty shall remain subject to the requirements of 
this subpart.


Sec. Sec.  23.160-23.199  [Reserved]

0
3. In Sec.  23.701 revise paragraphs (a)(1), (d), and (f) to read as 
follows:


Sec.  23.701  Notification of right to segregation.

    (a) * * *
    (1) Notify each counterparty to such transaction that the 
counterparty has the right to require that any Initial Margin the 
counterparty provides in connection with such transaction be segregated 
in accordance with Sec. Sec.  23.702 and 23.703 except in those 
circumstances where segregation is mandatory pursuant to Sec.  23.157;
* * * * *
    (d) Prior to confirming the terms of any such swap, the swap dealer 
or major swap participant shall obtain from the counterparty 
confirmation of receipt by the person specified in paragraph (c) of 
this section of the notification specified in paragraph (a) of this 
section, and an election, if applicable, to require such segregation or 
not. The swap dealer or major swap participant shall maintain such 
confirmation and such election as business records pursuant to Sec.  
1.31 of this chapter.
* * * * *
    (f) A counterparty's election, if applicable, to require 
segregation of Initial Margin or not to require such segregation, may 
be changed at the discretion of the counterparty upon written notice 
delivered to the swap dealer or major swap participant, which changed 
election shall be applicable to all swaps entered into between the 
parties after such delivery.

PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

0
4. The authority citation for part 140 continues to read as follows:

    Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and 
16(b).

0
5. In Sec.  140.93, add paragraph (a)(6) to read as follows:


Sec.  140.93  Delegation of authority to the Director of the Division 
of Swap Dealer and Intermediary Oversight.

    (a) * * *
    (6) All functions reserved to the Commission in Sec. Sec.  23.150 
through 23.159 of this chapter.
* * * * *

    Issued in Washington, DC, on September 23, 2014, by the 
Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.

    Note: The following appendices will not appear in the Code of 
Federal Regulations.

Appendices to Margin Requirements for Uncleared Swaps for Swap Dealers 
and Major Swap Participants--Commission Voting Summary, Chairman's 
Statement, and Commissioner's Statement

Appendix 1--Commission Voting Summary

    On this matter, Chairman Massad and Commissioners Wetjen, Bowen, 
and Giancarlo voted in the affirmative. No Commissioner voted in the 
negative.

Appendix 2--Statement of Chairman Timothy G. Massad

    I support this proposed rule on margin requirements for uncleared 
swaps.
    A key mandate of the Dodd-Frank Act was central clearing of swaps. 
This is a significant tool to monitor and mitigate risk, and we have 
already succeeded in increasing the overall percentage of the market 
that is cleared from an estimated 17% in 2007 to 60% last month, when 
measured by notional amount.
    But cleared swaps are only part of the market. Uncleared, bilateral 
swap transactions will continue to be an important part of the 
derivatives market. This is so for a variety of reasons. Sometimes, 
commercial risks cannot be hedged sufficiently through clearable swap 
contracts. Therefore market participants must craft more tailored 
contracts that cannot be cleared. In addition, certain products may 
lack sufficient liquidity to be centrally risk-managed and cleared. 
This may be true even for products that have been in existence for some 
time. And there will--and always should be--innovation in the market, 
which will lead to new products.
    That is why margin for uncleared swaps is important. It is a means 
to mitigate the risk of default and therefore the potential risk to the 
financial system as a whole. To appreciate the importance of the rule 
being proposed, we need only recall how Treasury and the Federal 
Reserve had to commit $182 billion to AIG, because its uncleared swap 
activities threatened to bring down our financial system.
    The proposed rule requires swap dealers and major swap participants 
to post and collect margin in their swaps with one another. They must 
also do so in their swaps with financial entities, if the level of 
activity is above certain thresholds. The proposal does not require 
commercial end-users to post or collect margin, nor does it require any 
swap dealer or major swap participant to collect margin from or post 
margin to commercial end-users. This is an important point.
    Today's proposal on margin also reflects the benefit of substantial 
collaboration between our staff and our colleagues at the Federal 
Reserve, the Office of the Comptroller of the Currency, and the Federal 
Deposit Insurance Corporation, as well as significant public comment. 
The Dodd-Frank Act directs each of the prudential regulators to propose 
rules on margin for the entities for which it is the primary regulator, 
whereas the CFTC is directed to propose a rule for other

[[Page 59934]]

entities engaging in uncleared swap transactions. The Dodd-Frank Act 
also directed us to harmonize our rules as much as possible. Today's 
proposed rule is very similar to the proposal of the prudential 
regulators that was published recently. I want to again thank our 
staff, as well as the staffs of the prudential regulators, for working 
together so well to accomplish that task.
    We have also sought to harmonize our proposal with rules being 
developed in Europe and Asia. Our proposed rule is largely consistent 
with the standards proposed by Basel Committee on Banking Supervision 
and the International Organization of Securities Commissions, and we 
have been in touch with overseas regulators as we developed our 
proposal.
    The importance of international harmonization cannot be 
understated. It is particularly important to reach harmonization in the 
area of margin for uncleared swaps, because this is a new requirement 
and we do not want to create the potential for regulatory arbitrage in 
the market by creating unnecessary differences. Margin for uncleared 
swaps goes hand in hand with the global mandates to clear swaps. 
Imposing margin on uncleared swaps will level the playing field between 
cleared and uncleared swaps and remove any incentive not to clear swaps 
that can be cleared.
    Proposing this rule is an important step in our effort to finish 
the job of implementing the Dodd-Frank Act and will help us achieve the 
full benefit of the new regulatory framework, while at the same time 
protecting the interests of--and minimizing the burdens on--commercial 
end-users who depend on the derivatives markets to hedge normal 
business risks.
    We recognize that more stringent margin requirements impose costs 
on market participants, and therefore the proposal includes a detailed 
cost-benefit analysis. I believe the proposed rule balances the 
inherent trade-off between mitigating systemic risk and minimizing 
costs on individual participants. I look forward to having public 
feedback on that analysis, as well as on the proposal as a whole.

Appendix 3--Statement of Commissioner J. Christopher Giancarlo

    I support the issuance of the proposed rules for uncleared 
margin. I look forward to reviewing well-considered, responsive and 
informative comments from the public. Seeking further public comment 
on this proposal is necessary given the passage of time and the 
further deliberations with our fellow regulators since the 
publishing of our 2011 proposal. For the same reasons, I urge the 
Commission to re-propose capital requirements for swap dealers and 
major swap participants, which are closely linked to the uncleared 
margin rules.
    Uncleared over-the-counter swaps (OTC) and derivatives are vital 
to the U.S. economy. Used properly, they enable American companies 
and the banks they borrow from to manage changing commodity and 
energy prices, fluctuating currency and interest rates, and credit 
default exposure. They allow our state and local governments to 
manage their obligations and our pension funds to support healthy 
retirements. Uncleared swaps serve a key role in American business 
planning and risk management that cannot be filled by cleared 
derivatives. They do so by allowing businesses to avoid basis risk 
and obtain hedge accounting treatment for more complex, non-
standardized exposures. While much of the swaps and OTC derivatives 
markets will eventually be cleared--a transition I have long 
supported--uncleared swaps will remain an important tool for 
customized risk management by businesses, governments, asset 
managers and other institutions whose operations are essential to 
American economic growth.

Advance Notice of Proposed Rulemaking: Cross-Border

    I support the Commission's decision to issue an advance notice 
of proposed rulemaking to determine how the uncleared margin rule 
should apply extraterritorially. I have long advocated that the 
Commission take a holistic, global approach to the cross-border 
application of its rules. This approach should prioritize the 
critical need for international harmony and certainty for American 
businesses and other market participants. It is undeniable that the 
lack of such certainty in the Commission's cross-border framework is 
causing fragmentation of what were once global markets, increasing 
systemic risk rather than diminishing it. I therefore applaud the 
Commission's decision to seek public comment on the most optimal 
cross-border framework with respect to uncleared margin.
    In light of the recent decision from the U.S. District Court for 
the District of Columbia holding that the Commission's cross-border 
guidance is non-binding and that the Commission will have to justify 
the cross-border application of its rules each time it brings an 
enforcement action,\1\ it is important that the Commission provide 
swaps market participants with certainty on how the uncleared margin 
rule will apply extraterritorially.
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    \1\ SIFMA v. CFTC, No. 13-cv-1916 slip op. at 72 (D.D.C. Sept. 
16, 2014).
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    I believe that the advance notice of proposed rulemaking for the 
cross-border application of the uncleared margin rules demonstrates 
a pragmatism and flexibility that belies the oft repeated notion 
that CFTC rulemaking widely and woodenly overreaches in its 
assertion of extraterritorial jurisdiction. I commend it to our 
fellow regulators abroad as a portent of greater accord in global 
regulatory reform.
    I look forward to reading and addressing well-considered 
comments on the cross-border issues. In particular, I join 
Commissioner Wetjen in welcoming thoughtful comment and analysis on 
the potential competitive impacts associated with each of the 
different approaches identified in the advance notice of proposed 
rulemaking. I encourage commentators to quantify, if practical, and 
be specific about particular provisions or concerns.
    Furthermore, I think this rulemaking should be a template for 
things to come. I urge the Commission to follow the Securities and 
Exchange Commission's (SEC) lead and replace its non-binding 
guidance with a comprehensive set of rules, supported by a rigorous 
cost-benefit analysis, delineating when activities outside the 
United States will have a direct and significant connection with 
activities in, or effect on, commerce in the United States. Good 
regulation requires nothing less.
    Notwithstanding my support for the issuance of these proposed 
rules and the advance notice of proposed rulemaking on cross-border 
issues in order to solicit comment, I have a number of substantive 
concerns which I will now address.

Ten-Day Margin Requirement

    Today's proposal requires collateral coverage on uncleared swaps 
equal to a ten-day liquidation period. This ten-day calculation 
comports with rules adopted recently by the U.S. prudential bank 
regulators. Yet, it still must be asked: Is ten days the right 
calculation? Why not nine days; why not eleven? Should it be the 
same ten days for uncleared credit default swaps as it is for 
uncleared interest rate swaps and for all other swaps products? 
Surely, all non-cleared swap products do not have the same liquidity 
characteristics or risk profiles. I encourage commenters to provide 
their input on these questions.
    SEC Chair Mary Jo White recently stated: ``Our regulatory 
changes must be informed by clear-eyed, unbiased, and fact-based 
assessments of the likely impacts--positive and negative--on market 
quality for investors and issuers.'' \2\ Chair White's standard of 
assessment must surely apply to the proposed margin rule on 
uncleared swaps. Where is the clear-eyed assessment of the ten-day 
margin requirement? Where is the cost benefit analysis? What are the 
intended consequences? What will be the unintended ones? Will 
American swaps end users wind up paying for the added margin costs 
even though they are meant to be exempt? I would be interested to 
hear from commentators on this issue.
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    \2\ Phillip Stafford, Sense of Urgency Underpins Fresh Scrutiny 
of Markets, Financial Times, Sept. 16, 2014, available at http://www.ft.com/intl/cms/s/0/a373646a-344b-11e4-b81c-00144feabdc0.html?siteedition=intl#axzz3DPM3AEzi.
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    I am troubled by recent press reports of remarks by unnamed Fed 
officials that the coverage period may be intentionally ``punitive'' 
in order to move the majority of trades into a cleared 
environment.\3\ I would

[[Page 59935]]

be interested to review any considered analysis of the likely impact 
of the ten-day liquidation period and whether or not it may have a 
punitive effect on markets for uncleared swaps products.
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    \3\ Mike Kentz, Derivatives: Fed backs off corporate margin 
requirements, IFRAsia, Sept. 11, 2014, available at http://www.ifrasia.com/derivatives-fed-backs-off-corporate-margin-requirements/21162697.fullarticle.
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    Any punitive or arbitrary squeeze on non-cleared swaps will 
surely have consequences--likely unintended--for American businesses 
and their ability to manage risk. With tens of millions of Americans 
falling back on part-time work, it is not in our national interest 
to deter U.S. employers from safely hedging commercial risk to free 
capital for new ventures that create full-time jobs. It is time we 
move away from punishing U.S. capital markets toward rules designed 
to revive American prosperity. I look forward to reviewing well-
considered comments as to the appropriateness of a ten-day 
liquidation period, as well as its estimated costs and benefits, 
particularly the impact on American economic growth.

End Users

    As noted in the preamble, the Dodd-Frank Act requires the CFTC, 
the SEC, and the prudential regulators to establish comparable 
initial and variation margin requirements for uncleared swaps.\4\ In 
2011, however, the Commission and the prudential regulators issued 
proposals that varied significantly in several respects. In 
particular, the rules proposed by the prudential regulators in 2011 
would have required non-financial end users to pay initial and 
variation margin to banks, while the Commission's rules exempted 
these entities in accordance with Congressional intent.\5\
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    \4\ CEA section 4s(e)(3)(D)(ii).
    \5\ Margin Requirements for Uncleared Swaps for Swap Dealers and 
Major Swap Participants, 76 FR 23732, 23736-37 (Apr. 28, 2011).
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    I am pleased that the prudential regulators have moved in the 
CFTC's direction and will not require that non-financial end users 
pay margin unless necessary to address the credit risk posed by the 
counterparty and the risks of the swap.\6\ It is widely recognized 
that non-financial end users, that generally use swaps to hedge 
their commercial risk, pose less risk as counterparties than 
financial entities. It is my hope that upon finalization of these 
rules, swap dealers and major swap participants will treat non-
financial end users consistently when it comes to margin, no matter 
which set of rules apply.
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    \6\ The prudential regulator's proposal contains the following 
provision: ``A covered swap entity is not required to collect 
initial margin with respect to any non-cleared swap or non-cleared 
security-based swap with a counterparty that is neither a financial 
end user with material swaps exposure nor a swap entity but shall 
collect initial margin at such times and in such forms (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 and non-cleared security-based swaps.'' Margin and Capital 
Requirements for Covered Swap Entities, slip copy at 167, available 
at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20140903c1.pdf. This is somewhat different, but not 
inconsistent with the Commission's proposal, which will allow the 
parties to exchange margin by agreement, or to arrange other types 
of collateral agreements consistent with their needs.
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Threshold for Swaps Exposure

    I am also pleased that our collaboration with the BCBS/IOSCO \7\ 
international working group has resulted in proposed rules that are 
largely harmonious with the 2013 international framework. There is a 
particular and significant difference that troubles me, however. The 
CFTC and the prudential regulators have set the threshold for 
material swaps exposure by financial end users at $3 billion, while 
the 2013 international framework sets the threshold at [euro]8 
billion (approximately $11 billion). This means that a whole middle-
tier of American financial end users could be subject to margin 
requirements that will not be borne by similar firms overseas. It 
may well limit the number of counterparties willing to enter into 
swaps with these important lenders to American business. I am 
concerned that this could potentially reduce the utility of risk 
reducing strategies for a class of middle-tier, U.S. financial 
institutions that have already been hit hard by new capital 
constraints, among other rules.
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    \7\ Basel Committee on Banking Supervision/International 
Organization of Securities Commissions.
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    In this time of dismal economic growth, it is hard to justify 
placing higher burdens on America's medium-sized financial firms 
than those their overseas competitors face. We have not, in my 
opinion, sufficiently addressed in our cost benefit analysis the 
impact of this threshold difference on American firms and their 
customers. Where is the clear-eyed analysis of the impact of this 
rule on the American economy? I hope that the Commission will not 
perpetuate this divergence in the final rules without carefully 
weighing the costs and benefits. I encourage commenters to address 
this point and to supply any data and analysis that may be 
illuminating. It is time our rules were designed less to punish and 
more to promote U.S. capital markets. Punishment as a singular 
regulatory policy is getting old and counterproductive. It is time 
our rules focused on returning America to work and prosperity.

Increase Reliance on International Collaboration

    Similarly, I want to echo Commissioner Wetjen's call for 
comments on two areas where the Commission can harness international 
collaboration. First, I welcome comments on whether the Commission 
should exclude from the scope of this rulemaking any derivative 
cleared by a central counterparty (CCP) that is subject to 
regulation and supervision consistent with the CPSS-IOSCO Principles 
for Financial Market Infrastructures (PFMIs), an alternative on 
which the Commission seeks comment in the preamble. It is reported 
that at least one U.S. financial firm is a member at 70 different 
CCPs around the globe. The present proposal, if finalized, could 
result in trades cleared on many of these CCPs being treated as if 
they are uncleared.\8\ This would seem to be a needlessly costly and 
burdensome imposition on American commerce. Global regulators have 
already agreed on international standards in the PFMIs to determine 
how CCPs should be regulated and supervised. It makes sense to 
leverage these standards where we can. I encourage comment on this 
issue.
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    \8\ Sam Fleming and Phillip Stafford, JPMorgan Tells Clearers to 
Build Bigger Buffers, Financial Times, Sept. 11, 2014 available at 
http://www.ft.com/intl/cms/s/0/48aa6b02-38f9-11e4-9526-00144feabdc0.html#axzz3DPM3AEzi.
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    I would also be interested in commenters' views on how the 
Commission should conduct its comparability analysis under this 
rulemaking. In the advance notice of proposed rulemaking, the 
Commission proposes to permit market participants to comply with 
foreign rules, if such rules are comparable to the Commission's 
margin requirements. Yet, a better approach may be to compare a 
foreign regime to the international standards put forward by the 
BCBS/IOSCO international working group that included participation 
from over 20 regulatory authorities. Doing so would give the 
Commission some comfort that foreign rules meet a necessary 
baseline, but could avoid unnecessary and potentially destabilizing 
disputes over comparability in the future. I hope the insights of 
interested parties will guide not only the Commission, but also the 
prudential regulators. I further hope all concerned parties can use 
this rulemaking as an opportunity to promote international comity at 
a time when it is sorely needed.

Treatment of Small Financial Entities

    Another aspect of the proposed rules that concerns me is the 
treatment of financial entities that qualify for the small bank 
exemption from clearing and financial cooperatives. Section 
2(h)(7)(C)(ii) of the CEA directed the Commission to consider 
whether to exempt from the definition of ``financial entity'' small 
banks, savings associations, farm credit system institutions and 
credit unions with total assets of $10 billion or less. In response, 
the Commission exempted these small financial institutions from the 
definition of financial entity for purposes of clearing. It 
recognized that these institutions serve a crucial function in the 
markets for hedging the commercial risk of non-financial end users. 
Moreover, the Commission acknowledged that the costs associated with 
clearing, including margin and other fees and expenses, may be 
prohibitive relative to the small number of swaps these firms 
execute over a given period of time.\9\ In addition, using its 
Section 4(c) exemptive authority, the Commission permits cooperative 
financial entities, including those with total assets exceeding $10 
billion, to elect an exemption from mandatory clearing for swaps 
executed in connection with originating loans for their members, or 
that hedge or mitigate commercial risk related to loans or swaps 
with their members.\10\
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    \9\ End-User Exception to the Clearing Requirement for Swaps, 77 
FR 42560, 42578 (Jul. 19, 2012); 17 CFR 50.50(d).
    \10\ Clearing Exemption for Certain Swaps Entered into by 
Cooperatives, 78 FR 52286 (Aug. 22, 2013); 17 CFR 50.51.
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    Despite the CFTC's otherwise appropriate treatment of these 
small banks and financial cooperatives, the proposed margin rules 
treat them as financial institutions required to post

[[Page 59936]]

margin when their swaps exposure exceeds the $3 billion threshold. 
This means that small banks and cooperative financial institutions 
entitled to a clearing exemption will have to pay margin for their 
uncleared activity with swap dealers or major swap participants when 
they have material swaps exposure. It makes no sense to provide 
these entities with an exemption from clearing on the one hand, only 
to turn around and require them to bear the potentially even greater 
costs associated with uncleared swaps. They deserve the full benefit 
of their clearing exemption, which they may not get if they have to 
post margin. I encourage comment on this issue, which I will weigh 
carefully in the process of considering a final rule.

Inter-Affiliate Exemption

    The proposed rules may also diminish the utility of the 
critically important, inter-affiliate clearing exemption the 
Commission adopted last year for certain eligible affiliate 
counterparties.\11\ The exemption was premised on recognition that 
transactions between affiliates do not present the same risks as 
market-facing swaps, and generally provide risk-mitigating, hedging, 
and netting benefits within a corporate group.\12\ I welcome 
comments addressing the impact the proposed rules may have on the 
ability of affiliated entities to efficiently manage their risk.\13\
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    \11\ Clearing Exemption for Swaps Between Certain Affiliated 
Entities, 78 FR 21750 (Apr. 11, 2013); 17 CFR 50.52.
    \12\ Id. at 21751-54.
    \13\ Separately, I also welcome comments on the sufficiency of 
the no-action relief issued by the Division of Clearing and Risk for 
swaps entered into by treasury affiliates, and whether it may serve 
as a model for future rulemaking to provide greater certainty in 
this area. See CFTC Letter No. 13-22 (Jun. 4, 2013).
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Use of Approved Models to Calculate Capital

    Finally, I believe it is important to allow the use of models 
when calculating initial margin. The proposed rules require the 
Commission's prior written approval before a model can be used, even 
though the Commission lacks adequate staff and expertise for 
evaluating models. We recognize in the preamble that many covered 
swap entities are affiliates of entities whose margin models are 
reviewed by one of the prudential regulators, the SEC, or a foreign 
regulator, and to avoid duplicative efforts we plan to coordinate 
with other regulators in an effort to expedite our review. Rather 
than go through a special approval process, however, I believe we 
should accept models approved by our fellow regulators, so long as 
they contain the required elements. Alternatively, as mentioned in 
the preamble and discussed at the open meeting, this may be an area 
in which the National Futures Association can provide assistance, 
and I am interested in hearing its views on the issue. I also join 
Commissioner Wetjen's call for discussion on the circumstances in 
which the Commission may permit market participants to continue 
using models while Commission staff is reviewing them. Given the 
CFTC's limited resources, I believe we should make every effort to 
leverage the expertise of other qualified regulators before asking 
for more tax dollars from Americans working two jobs just to stay 
afloat.

Conclusion

    In spite of my stated concerns, I support the issuance of these 
proposed rules in order to solicit comment. They raise a number of 
important issues, particularly in their impact on the U.S. economy 
and job creation and the extent of their application across the 
globe. It is vital that we hear from interested parties on how to 
get them right. I commend the Chairman and my fellow Commissioners 
for their thoughtfulness and open-mindedness in arriving at the 
final proposals. I look forward to receiving and reviewing comments 
on the issues discussed above and all aspects of the rules.

[FR Doc. 2014-22962 Filed 10-2-14; 8:45 am]
BILLING CODE 6351-01-P