[Federal Register Volume 85, Number 185 (Wednesday, September 23, 2020)]
[Proposed Rules]
[Pages 59702-59718]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-18303]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 23

RIN 3038-AF05


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

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is proposing to amend the margin requirements for uncleared 
swaps for swap dealers (``SDs'') and major swap participants (``MSPs'') 
for which there is no prudential regulator (``CFTC Margin Rule''). In 
particular, the Commission is proposing to revise the calculation 
method for determining whether certain entities come within the scope 
of the initial margin (``IM'') requirements under the CFTC Margin Rule 
beginning on September 1, 2021, and the timing for compliance with the 
IM requirements after the end of the phased compliance schedule. The 
proposed amendment would align certain aspects of the CFTC Margin Rule 
with the Basel Committee on Banking Supervision and Board of the 
International Organization of Securities Commissions' (``BSBS/IOSCO'') 
Framework for margin requirements for non-centrally cleared derivatives 
(``BCBS/IOSCO Framework''). The Commission is also proposing to allow 
SDs and MSPs subject to the CFTC Margin Rule to use the risk-based 
model calculation of IM of a counterparty that is a CFTC-registered SD 
or MSP to determine the amount of IM to be collected from the 
counterparty and to determine whether the IM threshold amount for the 
exchange of IM has been exceeded such that documentation concerning the 
collection, posting, and custody of IM would be required.

DATES: With respect to the proposed amendments, comments must be 
received on or before October 23, 2020.

ADDRESSES: You may submit comments, identified by RIN 3038-AF05, by any 
of the following methods:
     CFTC Comments Portal: https://comments.cftc.gov. Select 
the ``Submit Comments'' link for this rulemaking and follow the 
instructions on the Public Comment Form.
     Mail: Send to Christopher Kirkpatrick, Secretary of the 
Commission, Commodity Futures Trading Commission, Three Lafayette 
Center, 1155 21st Street NW, Washington, DC 20581.
     Hand Delivery/Courier: Follow the same instructions as for 
Mail, above.
    Please submit your comments using only one of these methods. 
Submissions through the CFTC Comments Portal are encouraged.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
https://comments.cftc.gov. You should submit only information that you 
wish to make available publicly. If you wish the Commission to consider 
information that you believe is exempt from disclosure under the 
Freedom of Information Act (``FOIA''), a petition for confidential 
treatment of the exempt information may be submitted according to the 
procedures established in Sec.  145.9 of the Commission's 
regulations.\1\
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    \1\ 17 CFR 145.9. Commission regulations referred to herein are 
found at 17 CFR Chapter I.
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    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 https://comments.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

[[Page 59703]]

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applicable laws, and may be accessible under the FOIA.

FOR FURTHER INFORMATION CONTACT: Joshua B. Sterling, Director, 202-418-
6056, [email protected]; Thomas J. Smith, Deputy Director, 202-418-
5495, [email protected]; Warren Gorlick, Associate Director, 202-418-
5195, [email protected]; or Carmen Moncada-Terry, Special Counsel, 202-
418-5795, [email protected], Division of Swap Dealer and 
Intermediary Oversight, Commodity Futures Trading Commission, Three 
Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.

SUPPLEMENTARY INFORMATION: 

I. Background

    Section 4s(e) of the Commodity Exchange Act (``CEA'' or ``Act'') 
\2\ requires the Commission to adopt rules establishing minimum initial 
and variation margin requirements for all swaps \3\ that are (i) 
entered into by an SD or MSP for which there is no prudential regulator 
\4\ (collectively, ``covered swap entities'' or ``CSEs'') \5\ and (ii) 
not cleared by a registered derivatives clearing organization 
(``uncleared swaps'').\6\ To offset the greater risk to the SD \7\ or 
MSP \8\ and the financial system arising from the use of uncleared 
swaps, these requirements must (i) help ensure the safety and soundness 
of the SD or MSP and (ii) be appropriate for the risk associated with 
the uncleared swaps held by the SD or MSP.\9\
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    \2\ 7 U.S.C. 6s(e) (capital and margin requirements).
    \3\ CEA section 1a(47), 7 U.S.C. 1a(47) (swap definition); 
Commission regulation 1.3, 17 CFR 1.3 (further definition of a 
swap). A swap includes, among other things, an interest rate swap, 
commodity swap, credit default swap, and currency swap.
    \4\ CEA section 1a(39), 7 U.S.C. 1a(39) (defining the term 
``prudential regulator'' to include the Board of Governors of the 
Federal Reserve System; the Office of the Comptroller of the 
Currency; the Federal Deposit Insurance Corporation; the Farm Credit 
Administration; and the Federal Housing Finance Agency). The 
definition of prudential regulator further specifies the entities 
for which these agencies act as prudential regulators. The 
prudential regulators published final margin requirements in 
November 2015. See generally Margin and Capital Requirements for 
Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015) (``Prudential 
Margin Rule''). The Prudential Margin Rule is substantially similar 
to the CFTC Margin Rule, including with respect to the CFTC's 
phasing-in of margin requirements, as discussed below.
    \5\ CEA section 4s(e)(1)(B), 7 U.S.C. 6s(e)(1)(B). SDs and MSPs 
for which there is a prudential regulator must meet the margin 
requirements for uncleared swaps established by the applicable 
prudential regulator. CEA section 4s(e)(1)(A), 7 U.S.C. 6s(e)(1)(A).
    \6\ CEA section 4s(e)(2)(B)(ii), 7 U.S.C. 6s(e)(2)(B)(ii). In 
Commission regulation 23.151, the Commission further defined this 
statutory language to mean all swaps that are not cleared by a 
registered derivatives clearing organization or a derivatives 
clearing organization that the Commission has exempted from 
registration as provided under the CEA. 17 CFR 23.151.
    \7\ CEA section 1a(49), 7 U.S.C. 1a(49) (swap dealer 
definition); Commission regulation 1.3 (further definition of swap 
dealer).
    \8\ CEA section 1a(32), 7 U.S.C. 1a(32) (major swap participant 
definition); Commission regulation 1.3 (further definition of major 
swap participant).
    \9\ CEA section 4s(e)(3)(A), 7 U.S.C. 6s(e)(3)(A).
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    Following the mandate under Section 4s(e), the Commission in 2016 
promulgated Commission regulations 23.150 through 23.161, namely the 
CFTC Margin Rule, which requires CSEs to collect and post initial 
margin (``IM'') \10\ and variation margin (``VM'') \11\ for uncleared 
swaps.\12\ In implementing the CFTC Margin Rule, the Commission has 
identified certain issues that it understands would likely impede a 
smooth transition to compliance for entities required to comply with 
the IM requirements beginning on September 1, 2021.
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    \10\ Initial margin is the collateral (calculated as provided by 
Commission regulation 23.154) that is collected or posted in 
connection with one or more uncleared swaps pursuant to regulation 
23.152. Initial margin is intended to secure potential future 
exposure following default of a counterparty (i.e., adverse changes 
in the value of an uncleared swap that may arise during the period 
of time when it is being closed out). See CFTC Margin Rule, 81 FR at 
683.
    \11\ Variation margin, as defined in Commission regulation 
23.151, is the collateral provided by a party to its counterparty to 
meet the performance of its obligations under one or more uncleared 
swaps between the parties as a result of a change in the value of 
such obligations since the trade was executed or the last time such 
collateral was provided. 17 CFR 23.151.
    \12\ See generally Margin Requirements for Uncleared Swaps for 
Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016). 
The CFTC Margin Rule, which became effective April 1, 2016, is 
codified in part 23 of the Commission's regulations. 17 CFR 23.150-
23.159, 23.161. In May 2016, the Commission amended the CFTC Margin 
Rule to add Commission regulation 23.160, 17 CFR 23.160, providing 
rules on its cross-border application. See generally Margin 
Requirements for Uncleared Swaps for Swap Dealers and Major Swap 
Participants--Cross-Border Application of the Margin Requirements, 
81 FR 34818 (May 31, 2016).
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A. Calculation Method for Determining Whether Certain Entities Are 
Subject to the IM Requirements and the Timing for Compliance With the 
IM Requirements After the End of the Phased Compliance Schedule

    Commission regulation 23.161 sets forth a schedule for compliance 
with the CFTC Margin Rule, spanning from September 1, 2016, to 
September 1, 2021.\13\ Under the schedule, entities are required to 
comply with the IM requirements in staggered phases,\14\ starting with 
entities with the largest average aggregate notional amounts 
(``AANA''), calculated on a daily basis, of uncleared swaps and certain 
other financial products, and then successively with lesser AANA.
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    \13\ 17 CFR 23.161(a). On July 10, 2020, the Commission 
published a notice of proposed rulemaking proposing to amend 
Commission regulation 23.161(a)(7) by deferring the compliance date 
for entities with an average aggregate notional amount between $8 
billion and $50 billion, from September 1, 2021, to September 1, 
2022. See Margin Requirements for Uncleared Swaps for Swap Dealers 
and Major Swap Participants, 85 FR 41463 (July 10, 2020) (``July 
2020 Proposal''). The notice of proposed rulemaking herein describes 
current Commission requirements under the CFTC Margin Rule. If the 
July 2020 Proposal becomes final prior to this notice of proposed 
rulemaking, all references to September 1, 2021, referring to the 
beginning of the last phase of compliance under the phased 
compliance schedule, should be deemed automatically superseded and 
replaced with September 1, 2022.
    \14\ The schedule also addresses the variation margin 
requirements under the CFTC Margin Rule, providing a compliance 
period of September 1, 2016, through March 1, 2017. See 17 CFR 
23.161(a). The compliance period (including a six-month extension to 
September 1, 2017 through no-action relief) has long expired and all 
eligible entities are required to comply with the VM requirements.
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    The last phase of compliance, which begins on September 1, 2021, 
encompasses two sets of entities: (i) CSEs and covered counterparties 
with an AANA between $750 billion and $50 billion (``Phase 5 
entities''); \15\ and (ii) all other remaining CSEs and covered 
counterparties,\16\ including financial end users (``FEUs'') with 
material swaps exposure (``MSE'') of more than $8 billion in AANA,\17\ 
(``Phase 6 entities'').\18\ These entities had been scheduled to begin 
compliance in separate phase-in dates, with Phase 5 entities to begin 
compliance on September 1, 2020, and Phase 6 entities on September 1, 
2021. On May 28, 2020, the Commission adopted an interim final rule 
delaying the compliance date for Phase 5 entities until September 1, 
2021, to address the operational challenges faced by these entities as 
a result of the COVID-19 pandemic.

[[Page 59704]]

Because it was unclear what the impact of the pandemic would be on 
Phase 6 entities, the Commission did not deem appropriate to postpone 
these entities' September 1, 2021 compliance date through the interim 
final rule process. As a result, Phase 5 and Phase 6 entities are now 
required to begin compliance on September 1, 2021.
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    \15\ 17 CFR 23.161(a)(6).
    \16\ The term ``covered counterparty'' is defined in Commission 
regulation 23.151 as a financial end user with MSE or a swap entity, 
including an SD or MSP, that enters into swaps with a CSE. See 17 
CFR 23.151.
    \17\ Commission regulation 23.151 provides that MSE for an 
entity means that the entity and its margin 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, or 
August of the previous calendar year that exceeds $8 billion, where 
such amount is calculated only for business days. A company is a 
``margin affiliate'' of another company if: (i) Either company 
consolidates the other on a financial statement prepared in 
accordance with U.S. Generally Accepted Accounting Principles, the 
International Financial Reporting Standards, or other similar 
standards; (ii) both companies are consolidated with a third company 
on a financial statement prepared in accordance with such principles 
or standards; or (iii) for a company that is not subject to such 
principles or standards, if consolidation as described in paragraph 
(i) or (ii) of this definition would have occurred if such 
principles or standards had applied. 17 CFR 23.151.
    \18\ 17 CFR 23.161(a)(7).
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    Under the Commission's margin requirements, the method for 
determining when Phase 6 entities are required to comply with the 
CFTC's IM requirements beginning with the last phase of compliance 
differs from the method set out in the BCBS/IOSCO Framework.\19\ More 
specifically, the BCBS/IOSCO Framework requires--beginning on September 
1, 2022, which starts the last phase of implementation for the margin 
requirements under the framework--entities with [euro]8 billion \20\ in 
AANA during the period of March, April, and May of the current year, 
based on an average of month-end dates, to exchange IM beginning 
September 1 of each year.
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    \19\ See generally BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (July 2019), https://www.bis.org/bcbs/publ/d475.pdf (``2019 BCBS/IOSCO Framework'').
    \20\ The U.S. adopted the BCBS/IOSCO threshold, but replaced the 
8 billion euro figure with a dollar amount of $8 billion. As a 
result, there is a small disparity in the threshold amounts given 
the continuing fluctuation of the dollar-euro exchange rate. This 
rule proposal does not address this issue.
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    In contrast, in the last phase of compliance under the phased 
compliance schedule, under the Commission's margin requirements, Phase 
6 entities (i.e., CSEs and FEUs with more than $8 billion in AANA, or 
MSE) are required to begin exchanging IM on September 1, 2021. The MSE 
for an FEU must be determined on September 1, 2021, based on daily AANA 
(accounting only for business days) \21\ during the period of June, 
July, and August of the prior year. After the last phase of compliance, 
the determination of MSE for an FEU, which triggers the applicability 
of the IM requirements, must be conducted on January 1 of each calendar 
year based on daily AANA during the June, July, and August period of 
the prior year, with application of the IM requirements, if the FEU has 
MSE, required to begin on January 1 of each year.
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    \21\ The determination of MSE requires accounting for the 
average daily aggregate notional amount of uncleared swaps, 
uncleared security-based swaps, foreign exchange forwards, and 
foreign exchange swaps for June, July and August of the previous 
calendar year that exceeds $8 billion, where such amount is 
calculated only for business days. See definition of MSE supra note 
17. For simplicity purposes, this formulation will be referred to 
hereinafter as ``daily AANA.''
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    The BCBS/IOSCO Framework was originally promulgated in September 
2013,\22\ and then revised in 2015.\23\ The 2015 version of the BCBS/
IOSCO Framework changed the calculation period of June, July, and 
August, with an annual implementation date of December 1, to March, 
April, and May of each calendar year, with an annual implementation 
date of September 1. The CFTC Margin Rule incorporated the earlier 2013 
version of the BCBS/IOSCO Framework by adopting the June, July, and 
August calculation period for the annual calculation of MSE. As a 
result, the Commission's existing regulations do not reflect the 
calculation period of March, April, and May set forth in the revised 
BCBS/IOSCO Framework published in March 2015.
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    \22\ See generally BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (Sept. 2013), https://www.bis.org/publ/bcbs261.htm.
    \23\ See generally BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (March 2015), available at https://www.bis.org/bcbs/publ/d317.htm.
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    The Commission also departed from BCBS/IOSCO's month-end date 
calculation of AANA for determining whether an entity is subject to the 
IM requirements. In the preamble to the CFTC Margin Rule, the 
Commission stated that it decided to adopt a daily AANA calculation 
method for determining whether an FEU has MSE, the finding of which 
requires a CSE to exchange IM with the FEU, ``to gather a more 
comprehensive assessment of the [FEU]'s participation in the swaps 
market, and to address the possibility that a market participant might 
`window dress' its exposure on an as-of date such as year-end, in order 
to avoid the Commission's margin requirements.'' \24\
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    \24\ 81 FR at 645.
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    As a result, the Commission's current method for the annual 
calculation of MSE, which was adopted in coordination with the U.S. 
prudential regulators and is similar to the U.S. prudential regulators' 
method of calculation, is not consistent with the most recent version 
of the BCBS/IOSCO Framework. Nor is it consistent with requirements in 
other major market jurisdictions, most of which adopted the 2015 BCBS/
IOSCO Framework's month-end date calculation of AANA using the period 
of March, April, and May for the purposes of determining whether an 
entity is subject to the IM requirements beginning in the last phase of 
implementation.\25\
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    \25\ See, e.g., Commission Delegated Regulation (EU) 2016/2251 
Supplementing Regulation (EU) No. 648/2012 of the European 
Parliament and of the Council of July 4, 2012 on OTC Derivatives, 
Central Counterparties and Trade Repositories with Regard to 
Regulatory Technical Standards for Risk-Mitigation Techniques for 
OTC Derivative Contracts Not Cleared by a Central Counterparty (Oct. 
4, 2016), Article 28(1), https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R2251&from=EN. Financial Services Agency of 
Japan (JFSA) Cabinet Office Ordinance on Financial Instruments 
Business (Cabinet Office Ordinance No. 52 of August 6, 2007), as 
amended (March 31, 2016), Article 123(11)(iv)(c); Office of the 
Superintendent of Financial Institutions Canada (OSFI) Guideline No. 
E-22, Margin Requirements for Non-Centrally Cleared Derivatives 
(April 2020), Section 5, 71, https://www.osfi-bsif.gc.ca/Eng/Docs/e22.pdf.
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    Market participants have stated that these differences in the 
methods for determining when an entity comes within the scope of the IM 
requirements and the timing for compliance after the last phase of 
compliance may impose an undue burden on their efforts to comply with 
the CFTC's margin requirements.\26\ Entities have to account for 
different compliance schedules and set up and maintain separate 
processes for determining when they meet the thresholds for IM 
compliance.\27\
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    \26\ See Recommendations to Improve Scoping and Implementation 
of Initial Margin Requirements for Non-Cleared Swaps, Report to the 
CFTC's Global Markets Advisory Committee by the Subcommittee on 
Margin Requirements for Non-Cleared Swaps, April 2020 at, 48-54, 
https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download (``Margin Subcommittee Report'' or ``Report'').
    \27\ See id.
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B. No-Action Letter Concerning the Calculation of IM

    The Commission's Division of Swap Dealer and Intermediary Oversight 
(``DSIO'') issued CFTC No-Action Letter 19-29 in July 2019 in response 
to a request for relief submitted by Cargill Incorporated 
(``Cargill''), a CFTC-registered SD and CSE.\28\ DSIO stated that it 
would not recommend enforcement action if Cargill used the risk-based 
model calculation of IM of a counterparty that is a CFTC-registered SD 
as the amount of IM that Cargill is required to collect from the SD and 
to determine whether the IM threshold amount of $50 million (``IM 
threshold amount'') \29\ has been exceeded, which would trigger the 
requirement for

[[Page 59705]]

documentation concerning the posting, collection, and custody of IM 
collateral.
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    \28\ CFTC Letter No. 19-29, Request for No-Action Relief 
Concerning Calculation of Initial Margin (Dec.19, 2019) (``Letter 
19-29''), http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/19-29.pdf.
    \29\ Under Commission regulation 23.154(a)(3), SDs and MSPs 
subject to the Commission's regulations are not required to post or 
collect IM until the initial margin threshold amount has been 
exceeded. See 17 CFR 23.154(a)(3). The term ``initial margin 
threshold amount'' is defined in Commission regulation 23.151 to 
mean an aggregate credit exposure of $50 million resulting from all 
uncleared swaps between an SD and its margin affiliates (or an MSP 
and its margin affiliates) on the one hand, and the SD's (or MSP's) 
counterparty and its margin affiliates on the other. See 17 CFR 
23.151.
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C. Market Participant Feedback

    The CFTC's Global Markets Advisory Committee (``GMAC'') established 
a subcommittee in January 2020 to consider issues raised by the 
implementation of margin requirements for non-cleared swaps, to 
identify challenges associated with forthcoming implementation phases, 
and to make recommendations through a report for the GMAC to consider 
in advising the Commission. The subcommittee submitted the Margin 
Subcommittee Report to the GMAC with its recommendations.\30\ The GMAC 
adopted the Report and recommended to the Commission that it consider 
adopting the Report's recommendations.
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    \30\ See supra note 26.
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    Among other things, the Margin Subcommittee Report recommended 
alignment of the CFTC Margin Rule with the BCBS/IOSCO Framework with 
respect to the method for calculating AANA for determining whether an 
entity comes within the scope of the IM requirements and the timing of 
compliance after the end of the phased compliance schedule.\31\ The 
Report also recommended the codification of Letter 19-29.\32\
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    \31\ See Margin Subcommittee Report at 48-54.
    \32\ See Margin Subcommittee Report at 34-36.
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    The Commission believes that alignment with BCBS/IOSCO, the global 
standard setter for margin requirements for non-cleared derivatives, 
would promote harmonization in the application of the IM requirements. 
Moreover, the Commission does not believe that the disjunction between 
the CFTC and BCBS/IOSCO regarding the AANA calculation method and the 
timing of compliance furthers any regulatory purpose. In fact, the 
Commission notes the foreseeable possibility of calculation errors 
resulting from differences in the calculation methods.\33\
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    \33\ The possibility of calculation errors may be mitigated by 
substituted compliance, as described in Commission regulation 
23.160, if the parties are non-U.S. entities and substituted 
compliance is available, as the parties would be able to avail 
themselves of the rules in the foreign jurisdiction and would 
therefore not face the concern about different calculation methods. 
However, while the proposed changes to the method of calculation of 
AANA would align the CFTC's method of calculation with BCBS/IOSCO's 
approach, the Commission acknowledges that the changes would result 
in a divergence from the U.S. prudential regulators' approach, which 
may increase the potential for calculation errors for entities 
located in the United States.
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    The Commission also believes that adopting regulations along the 
lines of narrowly-tailored no-action letters, such as Letter 19-29, 
could promote certainty and clarity, facilitating efforts by market 
participants to take the application of the Commission's regulations 
into account in their planning, without undermining the effectiveness 
of the CFTC Margin Rule. Moreover, the proposed amendment would promote 
efficient risk hedging by smaller CSEs that offer swaps services to 
smaller entities that are neither SDs nor MSPs, with some of those 
risk-taking transactions requiring the exchange of regulatory margin 
and some, at the option of the parties, requiring the exchange of 
contractually-agreed margin. The CSEs might then enter into offsetting 
swaps with SDs and MSPs to hedge the risk associated with the risk-
taking transactions. Due to their size and limited swap business and 
resources, the CSEs may find it uneconomical to develop and maintain a 
margin model, and would therefore benefit from the option to rely on 
their SD or MSP counterparties' IM model calculations.

II. Proposed Amendments

    The Commission is proposing to revise the method for calculating 
AANA for determining whether an FEU has MSE and the timing for 
compliance with the IM requirements after the end of the last phase of 
compliance to align these aspects of the CFTC Margin Rule with the 
BCBS/IOSCO Framework. The Commission is also proposing to amend 
Commission regulation 23.154(a) in a manner similar to the terms of 
Letter 19-29, and thus allow CSEs to use the risk-based model 
calculation of IM of counterparties that are CFTC-registered SDs or 
MSPs (``swap entities'') \34\ to determine the amount of IM that must 
be collected from such counterparties.
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    \34\ Commission regulation 23.151 defines the term ``swap 
entity'' as a person that is registered with the Commission as an SD 
or MSP under the CEA.
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A. Commission Regulation 23.151--Amendments to MSE Definition

    As noted above, the exchange of IM with respect to uncleared swaps 
between a CSE and a counterparty that is an FEU with MSE (together, 
Phase 6 entities) is required in the last phase of compliance, which is 
scheduled to begin on September 1, 2021.\35\ Commission regulation 
23.151 provides that an entity has MSE if it has more than $8 billion 
in average daily AANA during June, July, and August of the prior 
year.\36\ An FEU that has MSE based on its calculation of AANA over 
June, July, and August of 2020 will come within the scope of the IM 
requirements beginning on September 1, 2021. After September 1, 2021, 
however, because the base year for calculating AANA is the prior year, 
the annual determination of MSE, which triggers the applicability of 
the IM requirements, would be on January 1 of each year,\37\ using the 
AANA for June, July, and August of the prior year. If the FEU has MSE 
on January 1 of a given year, the FEU would come within the scope of 
the IM requirements on January 1 of such year. As such, a CSE would be 
required to exchange regulatory IM beginning on such January 1 for its 
uncleared swaps with such FEU.
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    \35\ See 17 CFR 23.161(a)(7), which requires that a CSE must 
comply with the CFTC IM requirements with respect to their uncleared 
swaps with counterparties that are FEUs with MSE beginning on 
September 1, 2021.
    \36\ 17 CFR 23.151.
    \37\ January 1 is not explicitly set out in the Commission's 
regulations as the determination date for MSE after the last phase 
of compliance. However, Commission regulation 23.161(a)(7) 
(addressing the last phase of compliance and the timing of 
compliance going forward) and the definition of MSE in Commission 
regulation 23.151 can be reasonably read together to set January 1 
as the determination date. See 17 CFR 23.151; 17 CFR 23.161(a)(7).
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    The Commission proposes to amend the definition of MSE in 
Commission regulation 23.151 by replacing ``June, July and August of 
the previous calendar year'' with ``March, April and May of that 
year.'' The period for calculating AANA for determining whether an FEU 
has MSE would thus be March, April, and May of ``that year.'' ``That 
year'' would be understood to mean the year the MSE is calculated for 
determining whether the IM requirements apply. The calculation of MSE 
is precipitated by Commission 23.161(a)(7), which requires a CSE to 
exchange IM with a counterparty that is an FEU with MSE beginning on 
September 1, 2021, and thereafter.
    The Commission is also proposing to amend the definition of MSE to 
set ``September 1 of any year'' as the determination date for MSE. 
Under the current requirements, the MSE for an FEU must be determined 
beginning on September 1, 2021, and subsequently, after the last phase 
of compliance, on January 1 of each year. The proposed amendment would 
change the date of determination of MSE, applicable after the last 
phase of compliance, from January 1 to September 1. Because having MSE 
triggers the applicability of the IM requirements for an FEU, requiring 
the CSE to post and collect IM with its FEU counterparty, the proposed 
amendment would effectively set the timing for compliance with the IM 
requirements on September 1 after the last phase of compliance with 
respect to

[[Page 59706]]

uncleared swaps entered into by a CSE and an FEU with MSE.
    The proposed shift of the MSE determination date from January 1 to 
September 1 could have the effect of deferring for nine months for 2022 
\38\ the obligation to exchange IM with a firm that was not in scope on 
September 1, 2021, but would be subject to the IM requirements on 
January 1, 2022. As a result, in 2022, less collateral would be 
collected for uncleared swaps during the nine-month period, which could 
render uncleared swap positions riskier and increase the risk of 
contagion and systemic risk. The Commission, however, notes that 
because the deferral period would affect entities with lower AANAs than 
entities brought into scope in earlier phases, the potential 
uncollateralized risk would be mitigated, becoming a lesser concern, 
particularly because the proposed change in the MSE determination date 
would draw the Commission's rules closer to BCBS/IOSCO's approach, 
promoting international harmonization.
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    \38\ If the July 2020 Proposal becomes final prior to this 
notice of proposed rulemaking, all references to 2022 for the 
purpose of referring to the period after the end of the last phase 
of compliance under the phased compliance schedule should be deemed 
automatically superseded and replaced with 2023.
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    Conversely, the change in the MSE determination date could also 
result in requiring certain entities to post and collect IM that would 
not otherwise be required to do so. This could occur when an FEU meets 
the MSE threshold in the last phase of compliance beginning on 
September 1, 2021, but falls below the threshold by January 1, 2022, 
because the AANA for June, July, and August of the prior year (i.e., 
2021) has declined below $8 billion. In such case, under the current 
rule, a CSE would no longer be subject to the IM requirements with 
respect to such FEU beginning January 1, 2022. However, under the 
proposed amendment, the CSE would continue to be subject to the IM 
requirements with respect to such FEU through September 1, 2022, and, 
as a result, the CSE would be required to exchange IM with the FEU for 
nine months longer than the January 1, 2022 MSE determination date 
would have required.
    These proposed amendments to the definition of MSE would have the 
effect of reducing the time frame that FEUs and their CSE 
counterparties would have to prepare for compliance with the IM 
requirements. Under the current rule, exchange of regulatory IM is 
required with respect to Phase 6 entities beginning on September 1, 
2021, which starts the last phase of the phased compliance 
schedule.\39\ The MSE for the FEU must be determined using the AANA for 
the June, July, and August period of the prior year (i.e., 2020). As a 
result, for the last phase of compliance in 2021, a CSE and FEU will 
have at least twelve months to prepare in anticipation of compliance 
with the IM requirements. Under the proposed amendment, however, for 
the last phase of compliance in 2021, the CSE and FEU would have only 3 
months because MSE would be determined using the AANA for the March, 
April, and May period of the current year (i.e., 2021).
    Also, after the last phase of compliance under the phased 
compliance schedule, as proposed, the date for determining MSE for an 
FEU would be September 1 of each year, and the AANA calculation period 
for determining whether an FEU has MSE would be March, April, and May 
of such year. As a result, under the proposed amendment, an FEU with 
MSE and its CSE counterparty would have three months to prepare in 
advance of compliance with the IM requirements, whereas under the 
current rule, such parties have four months because MSE must be 
determined on January 1 based on the AANA for June, July, and August of 
the prior year.
    Market participants recognize the effects of the proposed changes 
on the time frame for preparing for compliance with the IM 
requirements, with greater impact on Phase 6 entities that are coming 
into scope in the last phase of compliance, compared to those entities 
subject to compliance after the end of the last compliance phase. 
Nevertheless, the Margin Subcommittee Report, which the GMAC has 
adopted and recommended to the Commission, supported the changes 
because they would reconcile the CFTC's margin requirements with the 
BCBS/IOSCO Framework.\40\ The proposed changes would eliminate the need 
to maintain separate schedules and processes for the computation of 
AANA and reduce the burden and cost of compliance with the IM 
requirements.\41\ For the reasons set forth above, and taking account 
of Section 752 of the Dodd-Frank Act that calls on the CFTC to 
``consult and coordinate'' with respect to the establishment of 
consistent international standards,\42\ the Commission preliminarily 
believes that amending the definition of MSE by replacing ``June, July 
and August of the previous calendar year'' with ``March, April and May 
of that year'' and by prescribing September 1 of each year as the MSE 
determination date is appropriate to harmonize its compliance schedule 
with that of the BCBS/IOSCO Framework and eliminate a disjunction that 
risks calculation errors and may hinder compliance with the IM 
requirements.
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    \40\ See Margin Subcommittee Report at 49 (Members of the Margin 
Subcommittee stated that the divergence between the U.S. and 
international requirements ``creates complexity and confusion, and 
leads to additional effort, cost and compliance challenges for 
smaller market participants that are generally subject to margin 
requirements in multiple global jurisdictions.'').
    \41\ The Commission acknowledges that the burdens on market 
participants would not be fully eliminated, and in fact, may 
increase, for those entities that enter into uncleared swaps with 
SDs and MSPs that are subject to the prudential regulators' margin 
requirements for uncleared swaps and come within the scope the 
prudential regulators' margin regime, as the prudential regulators 
have not revised their rules consistent with the amendments proposed 
herein.
    \42\ See section 752 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).
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    The Commission is also proposing to amend the requirement to use 
daily average AANA during the three-month calculation period for 
determining MSE (``daily AANA calculation method''). The proposed 
amendment would instead require the use of average month-end AANA 
during the three-month calculation period (``month-end AANA calculation 
method''). In adopting the CFTC Margin Rule, the Commission 
acknowledged that the use of the month-end AANA calculation method 
would be consistent with BCBS/IOSCO's approach. Nonetheless, the CFTC, 
along with the U.S prudential regulators, adopted the daily AANA 
calculation method. In the preamble to the CFTC Margin Rule, the 
Commission explained that a daily average AANA calculation would 
provide a more comprehensive assessment of an FEU's participation in 
the swaps market in determining whether the FEU has MSE and would 
address the possibility of window dressing of exposures by market 
participants that might seek to avoid the CFTC's margin 
requirements.\43\
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    \43\ See supra note 24.
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    In the Margin Subcommittee Report, the GMAC subcommittee stated 
that the daily AANA calculation method entails more work for smaller 
counterparties and that the method is only used in the United States, 
noting that in the United States, daily AANA calculations over the 
three-month calculation period for Phase 5 required 64 observations 
while global determinations based on month-end AANA calculations 
required only three observations.\44\ The Report further stated that a 
month-end AANA calculation, by accounting for three periodic dates on 
which AANA would

[[Page 59707]]

be calculated, would mitigate the risk that market participants would 
adjust exposures to avoid the CFTC's margin requirements, and that it 
would be neither practicable nor financially desirable for parties to 
tear-up their positions on a recurring basis prior to each month-end 
AANA calculation, as it would interfere with their hedging strategies 
and cause them to incur realized profit and loss.\45\
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    \44\ Margin Subcommittee Report at 52.
    \45\ Id.
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    The Commission believes that it is appropriate to propose the 
month-end AANA calculation method to determine whether an FEU has MSE 
because such method of calculation would align the CFTC's approach with 
the BCBS/IOSCO Framework and that of other major market jurisdictions. 
The Commission notes that there is the risk that market participants 
that are counterparties to CSEs may ``window dress'' their exposures by 
adjusting their exposures as they approach the month-end date for the 
calculation of AANA. In doing so, an FEU would no longer have to post 
and collect IM with all CSEs for all its uncleared swaps for at least 
twelve months from the date on which compliance with the IM 
requirements would have been initially required.\46\ The Commission 
believes that it has sufficient tools at its disposal to address the 
``window dressing'' concern. In particular, the Commission notes that 
Commission regulation 23.402(a)(ii) requires CSEs to have written 
policies and procedures to prevent their evasion, or participation in 
or facilitation of an evasion, of any provision of the CEA or the 
Commission regulations.\47\ The Commission also reminds market 
participants that are counterparties to CSEs that section 4b of the CEA 
prohibits any person entering into a swap with another person from 
cheating or defrauding or willfully deceiving or attempting to deceive 
the other person.\48\
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    \46\ As proposed, the MSE calculation would be made annually on 
September 1 of each year and would be in effect for the next twelve 
months after that date.
    \47\ 17 CFR 23.402(a)(ii).
    \48\ 7 U.S.C. 6b.
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    The Commission acknowledges that replacing the daily AANA 
calculation method with the month-end AANA calculation method for 
determining MSE could result in an AANA calculation that is not fully 
representative of an entity's participation in the swap markets. The 
current definition of MSE provides that AANA must be calculated 
counting uncleared swaps, uncleared security-based swaps, foreign 
exchange forwards, or foreign exchange swaps. Some of these financial 
products because of their terms, such as tenure and time of execution, 
may be undercounted or excluded from the AANA calculation if month-end 
dates are used to determine MSE.\49\ The proposed month-end AANA 
calculation method therefore may not account for products that are 
required to be included in the calculation.
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    \49\ For example, the Commission observes that certain physical 
commodity swaps such as electricity and natural gas swaps are 
products for which a month-end AANA calculation might not provide a 
comprehensive assessment of the full scope of an FEU's exposure to 
those products.
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    The Commission preliminarily believes that the notional amounts 
associated with products that may be excluded from the AANA calculation 
may be relatively low and that their contribution to the AANA 
calculation for the purpose of determining MSE may be insignificant. In 
this regard, in an exercise undertaken by the Commission's Office of 
the Chief Economist (``OCE'') on a sample of days, the OCE estimated 
(setting aside the window dressing issue) that calculations based on 
end-of-month AANA would yield fairly similar results as calculations 
based on the current daily AANA approach. Based on 2020 swap data, the 
OCE estimated that 492 entities of the 514 entities that would come 
into scope during Phase 6 based on the current methodology would also 
come into scope in the event that the Commission were to adopt the 
proposed methodology. Put differently, all but 22 of the entities that 
are above MSE under the current methodology would also be above MSE 
under the proposed methodology. In addition, there are 20 entities that 
would be in scope under the proposed methodology, but would not be in 
scope under the current methodology, so that the aggregate number of 
Phase 6 entities under the current and proposed methodologies differs 
only by two. In aggregate, the two methodologies would capture quite 
similar sets of entities. In addition, the entities that fall out of 
scope applying the month-end methodology tend to be among the smallest 
of the Phase 6 entities. That is, entities that are in-scope under the 
current methodology but not the proposed methodology average $6.95 
billion in AANA, compared to $20 billion for all Phase 6 entities.\50\
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    \50\ Note that the OCE calculation excludes commodity swaps, and 
the examples of products for which end-of-month calculations may be 
undercounting tend to be in commodity swaps like natural gas and 
electricity swaps. Overall, commodity swaps tend to represent less 
than 1% of all swap trades. See BIS Statistic Explorer, Global OTC 
derivatives market (July 30, 2020), https://stats.bis.org/statx/srs/table/d5.1?f=pdf.
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    In the Commission's preliminary view, based on the OCE analysis 
discussed above, switching from daily AANA calculations to month-end 
calculations for the purpose of determining MSE would likely have a 
limited impact on the protections provided by the CFTC Margin Rule. The 
Commission also preliminary believes that the benefits of aligning with 
the BCBS/IOSCO Framework and the approach of other major market 
jurisdictions outweigh the window dressing concerns.\51\
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    \51\ The prudential regulators have not indicated whether they 
intend to amend their margin requirements consistent with the BCBS/
IOSCO Framework and the proposed amendments to the definition of MSE 
discussed herein. Below, the Commission requests comment on the 
impact of this potential regulatory divergence on market 
participants. Also of note, the U.S. Securities and Exchange 
Commission (``SEC'') has adopted a different approach that does not 
use MSE for identifying entities that come within the scope of the 
SEC margin requirements. See Capital, Margin, and Segregation 
Requirements for Security-Based Swap Dealers and Major Security-
Based Swap Participants and Capital and Segregation Requirements for 
Broker-Dealers, 84 FR 43872 (Aug. 22, 2019).
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    The Commission requests comments regarding the general approach 
proposed for changes to Commission regulation 23.151. The Commission 
also specifically requests comment on the following questions:
     Are the proposed amendments appropriate in light of the 
CFTC's overall approach to uncleared margin requirements and the manner 
in which firms currently undertake the calculation of AANA to determine 
MSE? Should the Commission consider any alternative to aligning with 
the BCBS/IOSCO Framework with respect to the methodology for the AANA 
calculation and the timing for compliance after the last phase of 
compliance?
     Should the Commission proceed to adopt the proposed 
amendments if the U.S. prudential regulators do not adopt similar 
regulatory changes? Would this divergence between the CFTC and the 
prudential regulators' margin requirements for uncleared swaps affect 
market participants? Is there a potential for industry confusion if 
that were to be the case?
     In adopting the CFTC Margin Rule, the Commission stated 
that the daily AANA calculation method was intended to provide a more 
comprehensive assessment of an FEU's participation in the swaps 
markets. Would the proposed month-end AANA calculation method requiring 
the averaging of month-end dates during the three-month calculation 
period be representative of a market participant's participation in the 
swaps markets? Is it

[[Page 59708]]

possible that the proposed month-end calculation would result in the 
exclusion or undercounting of certain products because of their terms, 
such as tenure and time of execution, or for any other reason, that are 
required to be included in the AANA calculation? Could the calculation 
lead to skewed results for entities that have an AANA calculation on 
the three end-of-month dates that is uncharacteristically high compared 
to their typical positions?
     How likely and significant is the risk that market 
participants may ``window dress'' their exposures to avoid the CFTC's 
margin requirements? In the event that this is a significant impediment 
to an accurate calculation of AANA over a three month period, are the 
existing tools at the Commission's disposal sufficient to address this 
concern? Are there additional steps the Commission should consider if 
the Commission were to implement the month-end calculation methodology?

B. Commission Regulation 23.154--Alternative Method of Calculation of 
IM

    The CFTC Margin Rule requires CSEs to collect and post IM with 
covered counterparties.\52\ Commission regulation 23.154(a) directs 
CSEs to calculate, on a daily basis, the IM amount to be collected from 
covered counterparties and to be posted to FEU counterparties with 
MSE.\53\ CSEs have the option to calculate the IM amount by using 
either a risk-based model or the standardized IM table set forth in 
Commission regulation 23.154(c)(1).\54\ For a CSE that elects to use a 
risk-based model to calculate IM, Commission regulation 23.154(b)(1) 
requires the CSE to obtain the written approval of the Commission or a 
registered futures association \55\ to use the model to calculate IM 
required by the Commission's margin requirements for uncleared 
swaps.\56\
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    \52\ See 17 CFR 23.152.
    \53\ See 17 CFR 23.154(a).
    \54\ See id.
    \55\ See 17 CFR 23.154(b)(1)(i). In this context, the term 
``registered futures association'' refers to the National Futures 
Association (``NFA''), which is the only futures association 
registered with the Commission.
    \56\ See 17 CFR 23.154(b)(1)(i).
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    The Commission is proposing to amend Commission regulation 
23.154(a) along the lines of Letter 19-29 by adding proposed paragraph 
(a)(5). The proposed paragraph would permit a CSE that enters into 
uncleared swaps with a swap entity to use the swap entity's risk-based 
model calculation of IM in lieu of its own IM calculation. The risk-
based model used for the calculation of IM would need to satisfy the 
requirements set out in Commission regulation 23.154(b) or would need 
to be approved by the swap entity's prudential regulator.
    Letter 19-29 sets out certain situations in which DSIO would not 
recommend an enforcement action under Commission regulation 
23.154(a)(1), which requires CSEs to calculate, on a daily basis, IM to 
be collected from a covered counterparty, including swap entities and 
FEUs with MSE. Letter 19-29 conveyed the staff's view that Cargill, the 
requester for relief, could use the risk-based model calculation of IM 
of a counterparty that is a swap entity to determine the amount of IM 
to be collected from that counterparty and to determine whether the IM 
threshold amount has been exceeded, which would require the parties to 
have documentation addressing the collection, posting, and custody of 
IM. The proposed amendment, consistent with Letter 19-29, would modify 
the requirement that CSEs calculate the IM to be collected from a swap 
entity counterparty and would give CSEs the option to use such 
counterparty's risk-based IM calculation to determine the amount of IM 
to be collected from the counterparty.
    The Commission acknowledges that expanding the use of the 
alternative method in Letter 19-29 to a wider group of CSEs could raise 
some concerns. Being able to rely on the IM risk-based calculation of a 
swap entity counterparty, as would be permitted under the proposal, 
CSEs may forgo altogether the adoption of a risk-based model and may be 
less incentivized to monitor IM exposures on a regular basis. Without a 
model to compute its own IM, a CSE may lack reasonable means to verify 
the IM provided by its counterparty or recognize any shortfalls in the 
IM calculation or flaws in the counterparty's risk-based model. As a 
result, the CSE may collect insufficient amounts of IM to offset 
counterparty risk. There is also the concern that the swap entity 
calculating the IM for the CSE may be conflicted,\57\ as it may have a 
bias in favor of calculating and posting lower amounts of IM to its CSE 
counterparty.
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    \57\ The Commission notes, however, that the potential for 
conflict may be reduced as the swap entity, as a CFTC-registered SD 
or MSP, would be subject to Commission regulation 23.600, which 
requires SDs and MSPs to establish a risk management program for the 
management and monitoring of risk, including credit and legal risk, 
associated with their swaps activities. See 17 CFR 23.600.
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    In light of these concerns, Letter 19-29 imposed certain conditions 
for the application of the relief.\58\ The Commission believes that it 
is appropriate that the proposed amendment incorporate in the rule text 
two conditions set forth in the no-action letter. Other conditions from 
the no-action letter would not be reflected in the rule text, because 
the Commission believes that the conditions are adequately addressed by 
existing requirements under the Commission's regulations, as explained 
below. In addition, if the proposed amendment is adopted, the 
Commission notes that it will monitor its implementation by CSEs and 
may consider further rulemaking as appropriate.
---------------------------------------------------------------------------

    \58\ Letter 19-29 at 4.
---------------------------------------------------------------------------

    First, consistent with Letter 19-29, the proposed rule text would 
require that the applicable model meet the requirements of Commission 
regulation 23.154(b) (requiring the approval of the use of the model by 
either the Commission or the NFA), or that it be approved by a 
prudential regulator.\59\
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    \59\ The prudential regulators have not amended their margin 
requirements for uncleared swaps consistent with the proposed 
amendment to Commission regulation 23.154(b) discussed herein. As 
such, the CFTC's margin requirements would diverge from the 
prudential regulators' approach. Below, the Commission seeks comment 
on how this regulatory divergence may impact market participants.
---------------------------------------------------------------------------

    Second, the proposed rule text would provide that the CSE would be 
able to use the risk-based model calculation of IM of a swap entity 
counterparty only if the uncleared swaps for which IM is calculated are 
entered into for the purpose of hedging the CSE's own risk. In this 
context, the risk to be hedged would be the risk that the CSE would 
incur when entering into swaps with non-swap entity counterparties. By 
proposing to limit the application of this alternative method of 
calculation of IM only to uncleared swaps entered into for the purpose 
of hedging risk arising from swaps entered into with non-swap entities, 
the Commission would ensure its narrow application.
    The Commission contrasts the risk of customer-facing swaps with the 
risk that CSEs incur when entering into a swap in a dealing capacity 
``to accommodate the demand'' of a swap entity counterparty.\60\ The 
Commission believes that it would be inappropriate to allow a CSE to 
use the IM calculation of the swap entity counterparty in this latter 
case. The Commission notes that the latter case (i.e., where the CSE is 
acting in a dealing capacity for a

[[Page 59709]]

counterparty that is itself calculating IM) would occur in the inter-
dealer market for swaps. The Commission believes that a CSE 
participating in the inter-dealer market in a dealing capacity should 
have the capacity to develop, implement, and use an approved risk-based 
model.
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    \60\ See Further Definition of ``Swap Dealer,'' ``Security-Based 
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based 
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR 
30596, 30608 (May 23, 2012) (noting that a distinguishing 
characteristic of swap dealers is being known in the industry as 
being available to accommodate demand for swaps.).
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    The Commission expects that the alternative method of calculation 
would be used primarily by CSEs that are not obtaining approval to use 
a risk-based model for the calculation of IM but rather elect to use 
the table-based calculation described in Commission regulation 
23.154(c) for swaps with non-swap entity counterparties. The Commission 
anticipates that such CSEs would enter into uncleared swaps mostly with 
end-user, non-swap entity counterparties, and would then hedge the risk 
of those swaps with uncleared swaps entered into with a few swap entity 
counterparties. The CSEs and their swap entity counterparties would be 
required to exchange IM for the uncleared swaps entered into for the 
purpose of hedging. Because maintaining a model would impose a 
disproportionate burden on the CSEs relative to the discrete and 
limited nature of their uncleared swap activities, the CSEs may not 
have a risk-based model for the calculation of IM and may opt to use 
instead the risk-based model calculation of their swap entity 
counterparties.
    To obtain relief under Letter 19-29, Cargill, prior to using the 
risk-based model calculation of IM of a swap entity counterparty, must 
agree with the counterparty in writing that the IM calculation will be 
provided to Cargill in a manner and time frame that would allow Cargill 
to comply with the CFTC Margin Rule and other applicable Commission 
regulations, and that the calculation will be used to determine the 
amount of IM to be collected from the counterparty and to determine 
whether the IM threshold amount has been exceeded, which would require 
documentation addressing the posting, collection, and custody of IM. 
The Commission preliminarily believes that the documentation 
requirements in Commission regulations 23.158 and 23.504 address this 
no-action letter condition.
    Commission regulation 23.158(a) requires CSEs to comply with the 
documentation requirements set forth in Commission regulation 
23.504.\61\ In turn, Commission regulation 23.504(b)(4)(i) requires 
CSEs to have written documentation reflecting the agreement with a 
counterparty concerning methods, procedures, rules, and inputs, for 
determining the value of each swap at any time from execution to the 
termination, maturity, or expiration of such swap for the purposes of 
complying with the margin requirements under section 4s(e) of the Act 
and regulations under this part.\62\ Regulation 23.504(b)(3)(i) also 
provides that the documentation shall include credit support 
arrangements, including initial and variation margin requirements, if 
any.\63\
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    \61\ 17 CFR 23.158(a).
    \62\ 17 CFR 23.504(b)(4)(i).
    \63\ Commission regulation 23.504(b)(1) further provides that 
the documentation shall include all terms governing the trading 
relationship between the swap dealer or major swap participant and 
its counterparty, including without limitation terms addressing 
payment obligations calculation of obligations upon termination 
valuation, and dispute resolution. 17 CFR 23.504(b)(1).
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    The last two conditions of Letter 19-29 \64\ were designed to 
ensure that Cargill would undertake adequate risk management of its 
uncleared swaps, notwithstanding the lack of a proprietary risk-based 
model and hence the inability to calculate IM, which is representative 
of potential future exposure of uncleared swaps.\65\ The Commission 
believes that these conditions are addressed by CSEs' risk management 
obligations under the CEA and the Commission's regulations. Section 
4s(j)(2) of the CEA requires SDs and MSPs, including CSEs, to establish 
robust and professional risk management systems adequate for the 
management of their day-to-day swap business.\66\ In addition, 
Commission regulation 23.600 requires SDs and MSPs to establish and 
maintain a risk management program to monitor and manage risk 
associated with their swap activities.\67\
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    \64\ Letter 19-29 at 4. The last two conditions in Letter 19-29 
(which refers to Cargill's swap dealer as ``CRM SD'') read as 
follows:
    4. To the extent CRM SD uses an SD counterparty's IM calculation 
generated pursuant to an Approved IM Calculation Method, CRM SD must 
monitor the Approved IM Calculation Method's output, in particular, 
to ensure the sufficiency of the calculated IM amounts. CRM SD must 
keep track of exceedances, that is, price movements above the 
amounts of IM generated pursuant to an Approved IM Calculation 
Method. If the exceedances indicate that the Approved IM Calculation 
Method being used fails to meet the relevant regulators' standards, 
CRM SD must take appropriate steps to ensure compliance with its 
risk management obligations and address the exceedances with its SD 
counterparty. If any adjustments or enhancements are applied to the 
amount of IM calculated pursuant to the Approved IM Calculation 
Method to ensure CRM SD's collection of adequate amounts of IM, CRM 
SD must provide written notice by email to NFA and Commission staff 
at [email protected] and [email protected], 
respectively. CRM SD must also have an independent risk management 
unit, as prescribed in Commission regulation 23.600, perform an 
annual review of the Approved IM Calculation Method's output. CRM SD 
should be prepared to produce, upon request, records relating to the 
monitoring of the Approved IM Calculation Method output and any 
other records demonstrating CRM SD's ongoing monitoring.
    5. As part of its risk management program pursuant to Commission 
regulation 23.600, CRM SD must independently monitor on an ongoing 
basis credit risk, including potential future exposure associated 
with uncleared swaps subject to the CFTC Margin Rule, to determine, 
among other things, whether CRM SD is approaching the $50 million IM 
Threshold with respect to a counterparty.
    \65\ See 17 CFR 23.154(b)(2) (explaining that IM is equal to the 
potential future exposure of the uncleared swap or netting portfolio 
of uncleared swaps covered by an eligible master netting 
agreement.).
    \66\ 7 U.S.C. 6s(j)(2).
    \67\ See 17 CFR 23.600.
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    To obtain relief under Letter 19-29, Cargill also must ``keep track 
of exceedances'' and ``[if] the exceedances indicate that the Approved 
IM Calculation Method fails to meet the relevant regulators' standards, 
[Cargill] must take appropriate steps to ensure compliance with its 
risk management obligations and address exceedances with its SD 
counterparty.'' \68\ The purpose of this requirement is to ensure that 
Cargill monitors, identifies, and addresses potential shortfalls in the 
amount of IM generated by the counterparty. Cargill must also report to 
the CFTC ``any adjustments and enhancements . . . applied to the amount 
of IM calculated pursuant to the Approved IM Calculation Method to 
ensure [Cargill's] collection of adequate amounts of IM.''
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    \68\ Letter 19-29 at 4.
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    The Commission preliminarily believes that Commission regulation 
23.600 addresses these concerns by requiring SDs and MSPs to account 
for credit risk in conducting their risk oversight and to ensure 
compliance with the CFTC margin requirements. In the case of a CSE 
relying on the provisions of proposed paragraph (a)(5), adequate risk 
oversight would include steps by the CSE to monitor, identify, and 
address potential shortfalls in the amounts of IM generated by the 
counterparty on whose IM model the CSE is relying. While the Commission 
does not propose to prescribe the CSE's oversight process, it believes 
that a risk management program that is unable to identify or to address 
shortfalls in IM would be insufficient to comply with Regulation 
23.600.
    Moreover, Commission regulation 23.600 requires SDs and MSPs to 
furnish to the Commission risk exposure reports setting forth credit 
risk exposures and any other applicable risk exposures relating to 
their swap activities. Here again, the Commission believes that an 
adequate risk exposure

[[Page 59710]]

report pursuant to Regulation 23.600 would require a CSE to identify 
any adjustments and enhancements to the amount of IM calculated 
pursuant to the risk-based model of its swap entity counterparty to 
ensure the CSE's collection of adequate amounts of IM.
    The Commission requests comment regarding the proposed amendment to 
Commission regulation 23.154(a). The Commission also specifically 
requests comment on the following questions:
     The proposed amendment to Regulation 23.154(a) would allow 
a CSE to use the risk-based model calculation of IM of a swap entity 
counterparty to comply with Regulation 23.154(a)(1), which requires 
CSEs to calculate IM to be collected from counterparties. The 
alternative method of IM calculation would be available only with 
respect to uncleared swaps entered into for the purpose of hedging. 
Should this restriction be eliminated, narrowed, or expanded? If the 
restriction should be narrowed or expanded, please describe any 
appropriate modifications to the restriction. If it should be 
eliminated, please explain why.
     The proposed amendment to Regulation 23.154(a) intends to 
provide an alternative method for the calculation of IM for CSEs with 
highly specialized and discrete swap business models that primarily 
enter into swaps with non-SDs or MSPs but, enter into offsetting swaps 
with SDs and MSPs to hedge the risk of such customer-facing swaps, and 
opt to use the standardized IM table set forth in Commission regulation 
23.154(c) rather than adopt and maintain a risk-based model for the 
calculation of IM. As such, the use of the alternative method of 
calculation is not expected to be widespread. Is this a reasonable 
expectation, or would this alternative method of IM calculation be 
likely to be used by all CSEs or a larger subset of CSEs than 
anticipated under the proposed rule? If a larger subset, please 
describe the characteristics of this wider group. Should the 
availability of this alternative method of IM calculation include all 
classes of swaps, or only a subset (e.g., commodity swaps)?
     How many CSEs would likely take advantage of this 
amendment? How many of these CSEs do not trade uncleared swaps 
currently? How many use the standardized IM table? How many use a model 
developed by a third-party vendor? How many of the Phase 5 entities are 
likely to take advantage of this amendment? What might they do for IM 
calculation absent the amendment? To the extent possible, please 
provide a basis for these estimates.
     The Commission believes that the requirement to furnish 
risk exposure reports under Commission regulation 23.600, while not 
matching exactly all the terms of the CFTC notification required by 
Letter 19-29, addresses the overall purpose of the requirement. Should 
the Commission include a more tailored reporting requirement in the 
proposed amendment?
     Does the proposed amendment to effectively codify Letter 
19-29 include sufficient risk management tools in place to guard 
against any potential conflict of interest arising from the fact that a 
CSE will rely on its swap entity counterparty's IM calculation to 
determine the amount of IM to be collected from such counterparty?
     Should the Commission proceed to adopt the proposed 
amendment to effectively codify Letter 19-29 if the U.S. prudential 
regulators do not adopt similar regulatory changes? Would this 
divergence between the CFTC and the prudential regulators' margin 
requirements for uncleared swaps impact market participants? Is there a 
potential for industry confusion if that were to be the case?

III. Administrative Compliance

    The Regulatory Flexibility Act (``RFA'') requires Federal agencies 
to consider whether the rules they propose will have a significant 
economic impact on a substantial number of small entities and, if so, 
provide a regulatory flexibility analysis respecting the impact.\69\ 
Whenever an agency publishes a general notice of proposed rulemaking 
for any rule, pursuant to the notice-and-comment provisions of the 
Administrative Procedure Act,\70\ a regulatory flexibility analysis or 
certification typically is required.\71\ 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.\72\ The proposed amendments only affect 
certain SDs and MSPs and their counterparties, which must be eligible 
contract participants (``ECPs'').\73\ The Commission has previously 
established that SDs, MSPs and ECPs are not small entities for purposes 
of the RFA.\74\
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    \69\ 5 U.S.C. 601 et seq.
    \70\ 5 U.S.C. 553. The Administrative Procedure Act is found at 
5 U.S.C. 500 et seq.
    \71\ See 5 U.S.C. 601(2), 603, 604, and 605.
    \72\ See Registration of Swap Dealers and Major Swap 
Participants, 77 FR 2613 (Jan. 19, 2012).
    \73\ Pursuant to section 2(e) of the CEA, 7 U.S.C. 2(e), each 
counterparty to an uncleared swap must be an ECP, as defined in 
section 1a(18) of the CEA, 7 U.S.C. 1a(18).
    \74\ See Further Definition of ``Swap Dealer,'' ``Security-Based 
Swap Dealer,'' `` `Major Swap Participant,'' ``Major Security-Based 
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR 
30596, 30701 (May 23, 2012).
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    Accordingly, the Chairman, on behalf of the Commission, hereby 
certifies pursuant to 5 U.S.C. 605(b) that the proposed amendments will 
not have a significant economic impact on a substantial number of small 
entities.

A. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \75\ 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. The Commission may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid Office of Management 
and Budget control number. The proposed amendments contain no 
requirements subject to the PRA.
---------------------------------------------------------------------------

    \75\ 44 U.S.C. 3501 et seq.
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B. Cost-Benefit Considerations

    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.\76\ Section 15(a) further specifies that the costs and 
benefits shall be evaluated in light of the following 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) considerations, and 
seeks comments from interested persons regarding the nature and extent 
of such costs and benefits.
---------------------------------------------------------------------------

    \76\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    The Commission is proposing to amend the CFTC Margin Rule to revise 
the method for calculating AANA for determining whether an FEU has MSE 
and the timing for determining whether an FEU has MSE after the end of 
the phased compliance schedule (``timing of post-phase-in 
compliance''). These amendments would align the CFTC Margin Rule with 
the BCBS/IOSCO Framework with respect to these matters.
    The Commission is also proposing to amend Commission regulation 
23.154(a) along the lines of Letter 19-29, and thus allow CSEs to use 
the risk-based model calculation of IM of a counterparty that

[[Page 59711]]

is a swap entity.\77\ The proposed rule would make this accommodation 
available only with respect to uncleared swaps entered into for the 
purpose of hedging swap risk.
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    \77\ For the definition of the term ``swap entity,'' see supra 
note 34.
---------------------------------------------------------------------------

    The baseline against which the benefits and costs associated with 
the proposed amendments are compared is the uncleared swaps markets as 
they exist today and the currently applicable timing for compliance 
with the IM requirements after the expiration of the phased compliance 
schedule. Concerning the amendment of Commission regulation 23.154(a), 
the Commission believes that to the extent market participants may have 
relied on Letter 19-29, the actual costs and benefits of the proposed 
amendment, as realized by the market, may not be as significant at a 
practical level. With respect to the proposed amendment to align 
aspects of the CFTC Margin Rule with the BCBS/IOSCO Framework, the 
Commission acknowledges that the Dodd-Frank Act calls on the CFTC to 
``consult and coordinate on the establishment of consistent 
international standards'' with respect to the regulation of swaps.\78\ 
The proposed rule therefore would advance the Congressional mandate to 
harmonize the CFTC's requirements with international standards, thereby 
removing a regulatory impediment that might hinder the competitiveness 
of the U.S. swaps industry.\79\
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    \78\ See supra note 42.
    \79\ A starting point in determining the potential benefit of 
alignment with the BCBS/IOSCO Framework is various statutory 
provisions where the U.S. Congress has called on the CFTC and other 
financial regulators to align U.S. regulatory requirements with 
international standards. For example, the Commodity Futures 
Modernization Act of 2000 (``CFMA'') focused on the potential threat 
to competitiveness for U.S. industry where there is divergence with 
international standards. In particular, section 126 of the CFMA 
provides that regulatory impediments to the operation of global 
business interests can compromise the competitiveness of United 
States businesses. See CFMA section 126(a), Appendix E of Public Law 
106-554, 114 Stat. 2763 (2000).
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    The Commission notes that the consideration of costs and benefits 
below is based on the understanding that the markets function 
internationally, with many transactions involving U.S. firms taking 
place across international boundaries; with some Commission registrants 
being organized outside of the United States; with leading industry 
members typically conducting operations both within and outside the 
United States; and with industry members commonly following 
substantially similar business practices wherever located. Where the 
Commission does not specifically refer to matters of location, the 
below discussion of costs and benefits refers to the effects of these 
proposed amendments on all activity subject to the proposed amended 
regulations, whether by virtue of the activity's physical location in 
the United States or by virtue of the activity's connection with 
activities in, or effect on, U.S. commerce under section 2(i) of the 
CEA.\80\
---------------------------------------------------------------------------

    \80\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------

1. Benefits
    By harmonizing the method for calculating AANA for determining MSE 
and the timing of post-phase-in compliance with the BCBS/IOSCO 
Framework, the proposed amendment would create a benefit because it 
would reduce complexity--for example, the proposed AANA month-end 
calculation would require consideration of only three observation dates 
rather than daily AANAs over the three-month calculation period--and 
the potential for confusion in the application of the margin 
requirements. Firms would no longer need to undertake separate AANA 
calculations using different calculation periods, nor would they need 
to conform to two separate compliance timings, varying according to the 
location of their swap counterparties and jurisdictional requirements 
applicable to the counterparties.
    The proposed amendment would impact FEUs with average AANA between 
$8 billion and $50 billion (Phase 6 entities) that come into the scope 
of compliance with the IM requirements under the CFTC Margin Rule in 
the last compliance phase beginning on September 1, 2021, as well as 
those entities that come into scope after the end of the last 
compliance phase. The Commission believes that the proposed amendment 
would benefit these entities, which, given their level of swap 
activity, pose a lower risk to the uncleared swaps market and the U.S 
financial system in general than entities who came into scope in 
earlier phases. The OCE has estimated that there are approximately 514 
of such entities representing 4% of total AANA across all phases.\81\ 
This means that the proposed amendment addresses entities that tend to 
engage in less uncleared swap trading activity and, and in the 
aggregate, pose less systemic risk than entities in previous phases. 
Because these entities are smaller, they presumably have fewer 
resources to devote to IM compliance and hence would benefit from the 
alignment of the method of calculation of AANA across jurisdictions 
without contributing substantially to systemic risk.
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    \81\ Using March-May of 2020 as the calculation period. The 
methodology for calculating AANA is described in Richard Haynes, 
Madison Lau, & Bruce Tuckman, Initial Margin Phase 5, at 4 (Oct. 24, 
2018), https://www.cftc.gov/sites/default/files/About/Economic%20Analysis/Initial%20Margin%20Phase%205%20v5_ada.pdf.
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    For Phase 6 entities with average AANA between $8 billion and $50 
billion that will begin collecting initial margin on September 1, 2021, 
moving the calculation period from June, July, and August 2020 to 
March, April, and May 2021 would better align with current practices. 
While the Commission cannot anticipate exactly how the second quarter 
of 2021 will differ from the third quarter of 2020, based on comparable 
past experience, the OCE estimates that approximately 75-100 entities 
would come into scope, and a similar number would fall below the 
threshold by virtue of moving the calculation period. The adjusted 
calculation period would reduce the regulatory burden for firms that 
have reduced their MSE below the $8 billion threshold while requiring 
the collection of margin for those firms that have increased their 
swaps business above the threshold. While aggregate AANA for firms that 
fall into or out of scope is small relative to the overall market (less 
than one percent of total aggregate AANA), moving the calculation 
period close to the compliance date may have a significant impact on 
the entities that have reduced their MSE.
    The Commission also notes that the benefits of alignment with the 
BCBS/IOSCO Framework will continue to accrue in future years, as the 
determination of MSE for an FEU under the CFTC Margin Rule is an annual 
undertaking, triggered by the entry into an uncleared swap between the 
FEU and a CSE counterparty and the need to determine whether the FEU 
has MSE, which triggers the application of the IM requirements and the 
exchange of regulatory IM between a CSE and a FEU for their uncleared 
swap transactions.
    With respect to the amendment of Commission regulation 23.154(a), 
the Commission believes that the uncleared swap markets would benefit 
from the extension of the targeted relief provided to Cargill, the 
requester in Letter 19-29, to a wider group of CSEs with similar unique 
swap business models. In taking a no-action position, DSIO took account 
of Cargill's representation that its swap trading activity primarily 
involved physical agricultural commodities and certain other asset 
classes and that it ``may maintain positions that require collection of 
IM from SDs.'' Cargill

[[Page 59712]]

further stated that given the highly specialized and discrete nature of 
its swap business, risk-based modeling would impose a disproportionate 
burden.
    The more widespread availability of the alternative method of 
calculation of IM provided by regulation 23.154(a), as proposed to be 
amended, may incentivize some market participants to expand their swap 
business. In particular, given that certain market participants would 
have the option to forgo the cost of risk-based modeling, this 
potential reduction in compliance costs may encourage certain entities 
to increase their swaps trading. This may be especially true after 
September 1, 2021, as a large number of entities will be newly-subject 
to mandatory margin.\82\ By increasing the pool of potential swap 
counterparties, the proposed amendment could enhance competition, 
increase overall liquidity, and facilitate price discovery in the 
uncleared swaps markets.
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    \82\ Margin Requirements for Uncleared Swaps for Swap Dealers 
and Major Swap Participants, 85 FR 41346 (July 10, 2020).
---------------------------------------------------------------------------

2. Costs
    While the proposed changes to the CFTC Margin Rule would have the 
effect of creating efficiencies for market participants, the Commission 
acknowledges that the changes would also result in some costs. Among 
other things, the proposed revision of the AANA calculation period for 
determining MSE to align it with the BCBS/IOSCO AANA calculation period 
would reduce the time frame for determining whether an FEU is subject 
to the IM requirements and for preparing for compliance with the 
requirements during the final phase-in period of 2021.
    Under the current margin requirements, in the period leading to the 
final phase-in date of September 1, 2021, FEUs would have a full year 
to prepare, as MSE for an FEU would be determined by using the AANA for 
June, July and August of the prior year. However, the proposed 
amendment to the period of calculation of AANA for determining MSE 
would result in entities only having a three-month advance notice in 
2021, as AANA would be calculated using the March, April and May period 
of that year. Entities would have a shorter time frame to engage in 
preparations to comply with IM requirements, including, among other 
things, procuring rule-compliant documentation, establishing processes 
for the exchange of regulatory IM, and setting up IM custodial 
arrangements. Because the proposed amendment would align the AANA 
calculation for determining MSE with BCBS/IOSCO's AANA calculation and 
the compliance date would remain unchanged, the Commission believes 
that the cost would be mitigated. In particular, the Commission notes 
market participants' statements indicating that the differences in the 
U.S. regulations could create complexity and confusion and lead to 
additional effort, cost and compliance challenges for smaller market 
participants that are generally subject to margin requirements in 
multiple global jurisdictions.\83\
---------------------------------------------------------------------------

    \83\ Margin Subcommittee Report at 49.
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    The Commission further notes that the proposed amendment to the 
timing of post-phase-in compliance would defer compliance with the IM 
requirements with respect to uncleared swaps entered into by a CSE with 
an FEU that comes into the scope of IM compliance after the end of the 
last compliance phase. Under the current rule, FEUs with MSE as 
measured in June, July, and August 2021 would come into the scope of 
compliance post-phase-in beginning on January 1, 2022. On the other 
hand, under the proposed amendment, FEUs with MSE as measured in March, 
April, and May 2022 would be subject to compliance beginning on 
September 1, 2022. As a result, for FEUs with MSE in both periods, less 
collateral for uncleared swaps may be collected between January 1, 
2022, and September 1, 2022, rendering uncleared swap positions entered 
into during the nine-month period riskier, which could increase the 
risk of contagion and the potential for systemic risk. Conversely, 
under the proposed amendment, a CSE would be required to exchange IM 
with a previously in-scope FEU that fell below the MSE level by January 
1, 2022, for nine months longer than the otherwise required.
    With respect to changing the daily AANA calculation method to a 
month-end calculation method for determining MSE, the Commission 
acknowledges that there are potential costs. The utilization of a 
month-end calculation method could result in an AANA calculation that 
is not representative of a market participant's participation in the 
swaps markets. As previously discussed, the proposed AANA month-end 
calculation may result in the exclusion or undercounting of certain 
financial contracts that are required to be included in the calculation 
(e.g., uncleared swaps, uncleared security-based swaps, foreign 
exchange forwards, or foreign exchange swaps) because of certain 
combinations of tenure and time of execution, such as those often 
present in some intra-month natural gas and electricity swaps.\84\ The 
Commission also notes the potential that market participants might 
``window dress'' their exposures to avoid MSE status and compliance 
with the CFTC's margin requirements. At the same time, it is possible 
that the month-end methodology, which uses only three data points, 
could result in some entities having an AANA calculation on the three 
end-of-month dates that is uncharacteristically high relative to their 
typical positions.
---------------------------------------------------------------------------

    \84\ See supra note 49.
---------------------------------------------------------------------------

    If products are excluded from the AANA calculation, or if exposures 
are ``window dressed,'' the month-end calculation may have the effect 
of deferring the time by which market participants meet the MSE 
classification resulting in additional swaps between market 
participants and CSEs being deemed legacy swaps that are not subject to 
the IM requirements.\85\ This may increase the level of counterparty 
credit risk to the financial system. While potentially meaningful, this 
risk would be mitigated because the legacy swap portfolios would be 
entered into with FEUs that engage in lower levels of notional trading.
---------------------------------------------------------------------------

    \85\ Pursuant to Commission regulation 23.161, the compliance 
dates for the IM and VM requirements under the CFTC Margin Rule are 
staggered across a phased schedule that extends from September 1, 
2016, to September 1, 2021. The compliance period for the VM 
requirements ended on March 1, 2017 (though the CFTC and other 
regulators provided guidance permitting a six-month grace period to 
implement the requirements following the implementation date), while 
the IM requirements continue to phase in through September 1, 2021. 
An uncleared swap entered into prior to an entity's IM compliance 
date is a ``legacy swap'' that is not subject to IM requirements. 
See CFTC Margin Rule, 81 FR at 651 and Commission regulation 23.161. 
17 CFR 23.161.
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    Finally, given the possibility that the U.S. prudential regulators 
may not adopt the changes to the method of calculation of AANA proposed 
in this rulemaking, there is the potential that firms that engage in 
swaps transactions with both CSEs and swaps dealers subject to the 
margin requirements of the U.S. prudential regulators may incur 
additional costs by continuing to have to undertake their AANA 
calculations under two different methods of calculation.
    However, the Commission preliminarily is of the view that the 
benefits of aligning with the BCBS/IOSCO Framework outweigh these 
potential costs. In this regard, in the aforementioned OCE exercise 
utilizing a sample of days, the OCE estimated that calculations based 
on end-of-month

[[Page 59713]]

AANA would yield fairly similar results as the calculations based on 
the current daily AANA approach (setting aside the window dressing 
issue). Based on 2020 swap data, the OCE estimated that approximately 
492 entities of 514 entities that would come into scope during Phase 6 
based on the current methodology would also come into scope based on 
the proposed methodology. Put differently, all but 22 of the entities 
that are above MSE under the current methodology would also be above 
MSE under the proposed methodology. In addition, there are 20 entities 
that would be in scope under the proposed methodology, but would not be 
under the current methodology, so that the aggregate number of Phase 6 
entities differs only by two. In aggregate, the two methodologies would 
capture quite similar sets of entities. In addition, the entities that 
fall out of scope when one changes methodology tend to be among the 
smallest of the Phase 6 entities. That is, entities that are in-scope 
under the current methodology but not the proposed methodology average 
$6.95 billion in AANA, compared to $20 billion for all Phase 6 
entities.\86\
---------------------------------------------------------------------------

    \86\ See supra note 50.
---------------------------------------------------------------------------

    Taking account of the small number of FEUs that would therefore 
have MSE and thus be subject to the Commission's IM requirements, the 
Commission believes that the potential exclusion of certain financial 
products in determining MSE would have a limited impact on the 
effectiveness of the CFTC Margin Rule. In addition, with respect to the 
potential that a market participant might ``window dress'' its 
exposure, the Commission has sufficient regulatory authority, including 
anti-fraud powers under section 4b of the CEA,\87\ to take appropriate 
enforcement actions against any market participant that may engage in 
deceptive conduct with respect to the AANA calculation, and CSEs must 
also have written policies and procedures in place to prevent evasion 
or the facilitation of an evasion by an FEU counterparty.\88\
---------------------------------------------------------------------------

    \87\ 7 U.S.C. 6b.
    \88\ See 17 CFR 23.402(a)(ii).
---------------------------------------------------------------------------

    Roughly 514 entities, as estimated by the OCE, would come into the 
scope of the IM requirements beginning on September 1, 2021, and would 
be affected by the foregoing proposed amendments. In advance of the 
September 1, 2021 compliance date, many of these entities may engage in 
planning and preparations relating to the exchange of regulatory IM. 
With the revision of the AANA method of calculation, these entities may 
need to adjust their systems to reflect changes in the calculation and 
update related financial infrastructure arrangements. While requesting 
comments on this issue, the Commission believes that the cost of 
shifting the MSE calculation period to the new time frame would be 
negligible, and the adoption of the month-end AANA calculation method 
would likely be cost-reducing for impacted firms.
    Regarding the amendment of Commission regulation 23.154(a), there 
may be associated costs, as CSEs would be allowed to rely on the risk-
based model calculation of IM computed by a swap entity counterparty. 
Specifically, the safeguard of requiring both the CSE and its SD 
counterparty to maintain a margin model for any swap transaction that 
does not utilize the table-based method would be eliminated. A CSE that 
relies on a counterparty's risk-based model calculations would thus 
avoid rigorous Commission requirements relating to risk-based 
modeling,\89\ which may undercut the effectiveness of the CSE's risk 
oversight.\90\
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    \89\ See generally 17 CFR 23.154(b).
    \90\ But cf. 17 CFR 23.600 (requiring SDs and MSP to establish a 
robust risk management program for the monitoring and management of 
their swaps activities).
---------------------------------------------------------------------------

    In addition, the safeguard of private market discipline that is 
inherent in having each counterparty develop its own IM model, and 
therefore the ability for the parties to scrutinize each other's IM 
model and output, will not be present given that under the proposed 
rule, a CSE would be permitted to rely on the risk-based model 
calculation of a swap entity counterparty. As a result, there is the 
potential that insufficient amounts of IM would be generated by the 
swap entity counterparty, which may be attributable to a deficiency in 
the model or the fact that the swap entity may be inherently conflicted 
and interested in generating lower amounts of IM collectable by the 
CSE.\91\ Given that the CSE without a model may lack adequate means to 
verify the amount of IM produced by the swap entity counterparty, the 
CSE may not be capable to contest it. As a result, insufficient amounts 
of IM may be collected by the CSE to protect itself against the risk of 
default by the swap entity counterparty, increasing the risk of 
contagion and the potential for systemic risk.
---------------------------------------------------------------------------

    \91\ But cf. 17 CFR 23.600 (requiring swap entities to have a 
risk management program for the management and monitoring of risk 
associated with their swaps, which may reduce the risk that such 
entities may act in a conflicted manner).
---------------------------------------------------------------------------

    The Commission, however, believes that these costs are mitigated by 
the proposed rule, which would be narrowly tailored to make available 
the alternative method of IM calculation set forth in Letter 19-29 only 
with respect to uncleared swaps entered into for the purpose of 
hedging. In addition, the Commission notes that there are other 
requirements in the Commission's regulations that address the 
monitoring of exposures and swap risk.
3. Section 15(a) Considerations
    In light of the foregoing, the CFTC has evaluated the costs and 
benefits of the proposal pursuant to the five considerations identified 
in section 15(a) of the CEA as follows:
(a) Protection of Market Participants and the Public
    The proposed rule would align the CFTC Margin Rule's method for 
calculating AANA for determining MSE and the timing of post-phase-in 
compliance with the BCBS/IOSCO Framework. By aligning these 
requirements with the international standard, the proposed rule would 
reduce the potential for complexity and confusion that can result from 
using different AANA calculation methods and different compliance 
schedules for market participants that may be subject to margin 
requirements in multiple jurisdictions. At the same time, the 
Commission recognizes that some firms may have already begun 
preparations to undertake AANA calculations under the existing 
requirements. The proposed rule may require them to adjust their 
calculations to reflect the new proposed method for calculating AANA 
for determining MSE and to update infrastructure arrangements, 
increasing the overall cost of compliance with the margin requirements.
    Under the existing CFTC Margin Rule, firms that are FEUs, beginning 
in Phase 6, which starts on September 1, 2021, would look back to the 
2020 June-August period to determine whether they have MSE. As such, 
the firms would have no less than twelve months to engage in 
preparations for the exchange of regulatory IM, by, among other things, 
procuring rule-compliant documentation, establishing processes and 
systems for the calculation, collection and posting of IM collateral, 
and setting up custodial arrangements. If the Commission determines to 
adopt the proposed amendment changing the AANA calculation period for 
determining MSE to March-May of the current year, such firms would have 
only a three-month window to engage in preparations to exchange IM. 
Nevertheless, the Commission notes that, under the existing 
requirements,

[[Page 59714]]

after the end of the phased compliance schedule, firms would only have 
four months in subsequent years since the calculation period for 
determining MSE status would be June through August of the prior year, 
with compliance starting January 1 of the following year. In addition, 
because the proposed amendment would require only averaging three 
month-end dates rather than averaging all business days during the 
three-month calculation period, the potential burdens of a shorter 
preparatory period for Phase 6 entities may be offset by the adoption 
of the BCBS/IOSCO Framework's less onerous calculation method.
    Moreover, the proposed amendment would shift the timing of post-
phase-in compliance to September 1 of each year. As such, entities that 
otherwise would be required to exchange IM beginning January 1, 2022, 
would be able to defer compliance to September 1, 2022.\92\ As a 
result, less collateral for uncleared swaps may be collected between 
January 1, 2022, and September 1, 2022, rendering the parties' 
positions riskier during that nine-month period, which could raise the 
risk of contagion and increase the potential for systemic risk. Firms 
that would have fallen out of scope by January 1, 2022 would also be 
subject to compliance for an additional nine months.
---------------------------------------------------------------------------

    \92\ This would apply to entities that meet the MSE level based 
on their AANA during the June, July, and August 2021 period, and 
continue to have MSE in the March, April, and May 2022 period. Of 
course, changing the calculation period to the March, April, and May 
2022 period may lead to the inclusion of entities whose AANA is 
below MSE in the June, July, and August 2021 period, but rises to 
the MSE level or above by the March, April, and May 2022 period. The 
OCE estimated that approximately 75-100 entities typically move from 
one side of the MSE threshold to the other between measurement 
periods.
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    Notwithstanding these potential costs, the Commission believes that 
the proposed changes advance the Commission's goal, pursuant to 
statutory direction, of coordination and harmonization with 
international regulators. The costs that may arise as a result of the 
proposed changes, as discussed above, would be mitigated by the overall 
cost savings, as the need to undertake separate calculations of MSE to 
address different requirements in different jurisdictions would be 
obviated with respect to most jurisdictions.
    The amendment of Commission regulation 23.154(a) would allow a CSE 
to use the risk-based model calculation of IM of a counterparty that is 
a swap entity. Without an alternative model, the CSE may not be able to 
challenge the amounts generated by the swap entity counterparty, which 
may be insufficient because of model error or malfunction or because 
the swap entity may be inherently conflicted and may be interested in 
generating low amounts of IM collectable by the CSE. In turn, 
insufficient amounts of IM may be collected by the CSE to offset the 
risk of counterparty default, increasing the risk of contagion and the 
potential for systemic risk.
    The Commission believes that these risks would be mitigated by the 
proposed rule, which would be narrowly tailored to permit reliance on a 
swap entity counterparty's risk-based model calculation only with 
respect to uncleared swaps entered into for the purpose of hedging. In 
addition, there are other requirements in the Commission's regulations 
that address the monitoring of exposures and swap risk (i.e., 
Commission regulation 23.600, which requires SDs and MSPs to adopt a 
robust risk management program for the monitoring and management of 
risk related to their swap activities).
(b) Efficiency, Competitiveness, and Financial Integrity of Markets
    The proposed rule would align the CFTC Margin Rule's AANA 
calculation method for determining MSE and the timing of post-phase-in 
compliance with the BCBS/IOSCO Framework. As such, the proposed rule 
would reduce the need, at least for entities not also undertaking swaps 
with U.S. prudentially regulated SDs, to undertake separate AANA 
calculations accounting for different calculation methods and to 
conform to separate compliance timings, varying according to the 
location of swap counterparties and jurisdictional requirements 
applicable to the counterparties. As such, the proposed changes would 
promote market efficiency and would even the playing field for market 
players, fostering competitiveness and reducing the incentive to engage 
in regulatory arbitrage by identifying more accommodating margin 
frameworks.
    The amendment of Commission regulation 23.154(a) would allow CSEs 
to rely on a swap entity counterparty's IM risk-based model 
calculations. Without a model, the CSE would lack effective means to 
verify its counterparty's IM calculations. As a result, if there are 
shortfalls in the output, the CSE may collect less IM collateral to 
offset the risk of default by the counterparty, which could increase 
the risk of contagion, threatening the integrity of the U.S. financial 
markets. The Commission, however, believes that the proposed rule is 
sufficiently targeted to mitigate these risks. The proposed amendment 
would apply only when uncleared swaps are entered into for hedging, 
thus limiting widespread use and the potential for uncollateralized 
uncleared swap risk.
    In addition, by providing an alternative to risk-based modeling and 
the associated costs, the proposed rule could encourage some market 
participants to expand their swap business. The proposed amendment 
would thus promote efficiency in the uncleared swaps market by 
increasing the pool of swap counterparties and fostering competition. 
On the other hand, the availability of an alternative less costly 
method of IM calculation may encourage entities to shift their trading 
to uncleared swaps from swaps that can be cleared, potentially reducing 
liquidity in the cleared swap markets.
(c) Price Discovery
    By aligning the CFTC Margin Rule and the BCBS/IOSCO Framework with 
respect to the AANA calculation method for determining MSE and post-
phase-in compliance timing, the proposed rule would reduce the burden 
and confusion inherent in implementing separate measures and processes 
to address compliance in different jurisdictions. The proposed rule 
could thus incentivize more firms to enter into uncleared swap 
transactions, which would increase liquidity and lead to more robust 
pricing that reflects market fundamentals.
    By amending Commission regulation 23.154(a), the Commission would 
relieve certain CSEs from having to adopt a risk-based margin model to 
calculate IM or use the standardized IM table. Being able to rely on a 
counterparty's risk-based model calculation of IM may encourage 
entities to increase trading in uncleared swaps. As a result, firms may 
take a more active role in the uncleared swap markets, which would lead 
to increase liquidity and enhance price discovery. On the other hand, 
the proposed amendment may encourage entities to shift their trading 
from swaps that can be cleared, potentially reducing liquidity and 
price discovery in those markets.
(d) Sound Risk Management
    The proposed rule would reduce the need for firms to undertake 
separate AANA calculations using different methods and to conform to 
separate compliance timing, allowing firms to engage in sound risk 
management by focusing on more substantive requirements.
    Under the current rule, after the last phase of compliance, FEUs 
would be subject to IM compliance beginning on

[[Page 59715]]

January 1, 2022. The proposed rule would defer such compliance until 
September 1, 2022. Uncleared swaps entered between January 1, 2022, and 
September 1, 2022, may be uncollateralized. As such, less collateral 
may be collected, and positions created during that nine-month period 
may be riskier, increasing the risk of contagion and systemic risk. The 
Commission notes, however, that keeping the January 1, 2022 compliance 
date could likewise result in the collection of less collateral. Some 
FEUs, after coming into scope during the last phase of compliance, may 
exit MSE status on January 1, 2022, as their AANA during the relevant 
calculation period may decline below the MSE threshold, and CSEs 
entering into uncleared swaps with these FEUs would no longer be 
required to exchange IM with the FEUs.
    Also, it is possible that under the proposed month-end method for 
calculating AANA to determine MSE, FEUs trading certain financial 
products may avoid MSE status, as month-end calculations may not 
capture certain financial products that are required to be included in 
the calculation. As result, CSEs transactions with such FEUs would not 
be subject to the IM requirements and may be insufficiently 
collateralized, increasing the risk of contagion and systemic risk. 
Conversely, because more than 96% of FEUs are unlikely to have MSE, as 
estimated by the OCE, and come within the scope of the IM requirements, 
the exclusion of such products would have a limited impact on the 
effectiveness of the Commission's IM requirements.
    Moreover, month-end AANA calculations compared to daily AANA 
calculations may be more susceptible to ``window dressing'' and less 
conducive to sound risk management. FEUs may manage their exposures as 
they approach the month-end date during the three month calculation 
period to avoid MSE status. The Commission, however, notes that it has 
sufficient regulatory authority, including anti-fraud powers under 
section 4b of the CEA, to take appropriate enforcement actions against 
any market participant that may engage in deceptive conduct with 
respect to the AANA calculation, and CSEs must also have written 
policies and procedures in place to prevent evasion or the facilitation 
of an evasion by an FEU counterparty.
    By allowing CSEs to use the risk-based model calculation of a swap 
entity counterparty consistent with Letter 19-29, CSEs may no longer be 
incentivized to adopt their own risk-based models. If a CSE uses a 
counterparty's IM model calculation without developing its own model, 
the CSE may lack reasonable means to verify the IM provided by its 
counterparty, recognize shortfalls in the IM calculation, and identify 
potential flaws in the swap entity counterparty's risk-based model. As 
a result, insufficient amounts of IM may be collected by the CSE to 
protect itself against the risk of default by the swap entity 
counterparty, increasing the risk of contagion and the potential for 
systemic risk. The Commission, however, believes that these risks are 
mitigated because, under the proposed amendment, CSEs would be able to 
use a counterparty's risk-based model IM calculation only with respect 
to uncleared swaps entered into for the purpose of hedging. In 
addition, the Commission notes that there are other requirements in the 
Commission's regulations that address the monitoring of exposures and 
swap risk.
(e) Other Public Interest Considerations
    The Commission believes that the proposed amendments to align the 
CFTC Margin Rule with the BCBS/IOSCO Framework would promote 
harmonization with international regulatory requirements and would 
reduce the potential for regulatory arbitrage. However, given that the 
U.S. prudential regulators may not amend their margin requirements in 
line with the proposed amendments, the possibility exists that the CFTC 
and U.S. prudential regulators' differing rules may induce certain 
firms to undertake swaps with particular SDs based on which U.S. 
regulatory agency is responsible for setting margin requirements for 
such SDs.
    Request for Comments on Cost-Benefit Considerations. The Commission 
invites public comment on its cost-benefit considerations, including 
the section 15(a) factors described above. Commenters are also invited 
to submit any data or other information they may have quantifying or 
qualifying the costs and benefits of the proposed amendments.

C. Antitrust Laws

    Section 15(b) of the CEA requires the Commission to take into 
consideration the public interest to be protected by the antitrust laws 
and endeavor to take the least anticompetitive means of achieving the 
purposes of this Act, in issuing any order or adopting any Commission 
rule or regulation (including any exemption under section 4(c) or 
4c(b)), or in requiring or approving any bylaw, rule or regulation of a 
contract market or registered futures association established pursuant 
to section 17 of this Act.\93\
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    \93\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------

    The Commission believes that the public interest to be protected by 
the antitrust laws is generally to protect competition. The Commission 
requests comment on whether the proposed amendments implicate any other 
specific public interest to be protected by the antitrust laws.
    The Commission has considered the proposed amendments to determine 
whether they are anticompetitive, and has preliminarily identified no 
anticompetitive effects. The Commission requests comment on whether 
these rule proposals are anticompetitive and, if they are, what the 
anticompetitive effects are.
    Because the Commission has preliminarily determined that the 
proposed amendments are not anticompetitive and have no anticompetitive 
effects, the Commission has not identified any less competitive means 
of achieving the purposes of the Act. The Commission requests comment 
on whether there are less anticompetitive means of achieving the 
relevant purposes of the Act that would otherwise be served by adopting 
the proposed amendments.

List of Subjects in 17 CFR Part 23

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

    For the reasons stated in the preamble, the Commodity Futures 
Trading Commission proposes to amend 17 CFR part 23 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.
    Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b), 
Pub. L. 111-203, 124 Stat. 1641 (2010).

0
2. In Sec.  23.151, revise the definition of ``Material swaps 
exposure'' to read as follows:


Sec.  23.151  Definitions applicable to margin requirements.

* * * * *
    Material swaps exposure for an entity means that, as of September 1 
of any year, the entity and its margin affiliates have an average 
month-end aggregate notional amount of uncleared swaps, uncleared 
security-based swaps, foreign exchange forwards, and foreign

[[Page 59716]]

exchange swaps with all counterparties for March, April, and May of 
that year that exceeds $8 billion, where such amount is calculated only 
for the last business day of the month. An entity shall count the 
average month-end aggregate notional amount of an uncleared swap, an 
uncleared security-based swap, a foreign exchange forward, or a foreign 
exchange swap between the entity and a margin affiliate only one time. 
For purposes of this calculation, an entity shall not count a swap that 
is exempt pursuant to Sec.  23.150(b) or a security-based swap that 
qualifies for an exemption under section 3C(g)(10) of the Securities 
Exchange Act of 1934 (15 U.S.C. 78c-3(g)(4)) and implementing 
regulations or that satisfies the criteria in section 3C(g)(1) of the 
Securities Exchange Act of 1934 (15 U.S.C. 78-c3(g)(4)) and 
implementing regulations.
* * * * *
0
3. In Sec.  23.154, add paragraph (a)(5) to read as follows:


Sec.  23.154  Calculation of initial margin.

    (a) * * *
    (5) A covered swap entity would be deemed to calculate initial 
margin as required by paragraph (a)(1) of this section if it uses the 
amount of initial margin calculated by a counterparty that is a swap 
entity and the initial margin amount is calculated using the swap 
entity's risk-based model that meets the requirements of paragraph (b) 
of this section or is approved by a prudential regulator, provided that 
initial margin calculated in such manner is used only with respect to 
uncleared swaps entered into by the covered swap entity and the swap 
entity for the purpose of hedging the covered swap entity's swaps with 
non-swap entity counterparties.
* * * * *

    Issued in Washington, DC, on August 17, 2020, by the Commission.
Robert Sidman,
Deputy 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 and 
Commissioners' Statements

Appendix 1--Commission Voting Summary

    On this matter, Chairman Tarbert and Commissioners Quintenz, 
Behnam, Stump, and Berkovitz voted in the affirmative. No 
Commissioner voted in the negative.

Appendix 2--Supporting Statement of Commissioner Dawn D. Stump Overview

    I am pleased to support the proposed rulemaking that the 
Commission is issuing with respect to the definition of ``material 
swap exposure'' and an alternative margin calculation method in 
connection with the Commission's margin requirements for uncleared 
swaps.
    This proposed rulemaking addresses recommendations that the 
Commission has received from its Global Markets Advisory Committee 
(``GMAC''), which I am proud to sponsor, and is based on a 
comprehensive report prepared by GMAC's Subcommittee on Margin 
Requirements for Non-Cleared Swaps (``GMAC Margin 
Subcommittee'').\1\ It demonstrates the value added to the 
Commission's policymaking by its Advisory Committees, in which 
market participants and other interested parties come together to 
provide us with their perspectives and potential solutions to 
practical problems.
---------------------------------------------------------------------------

    \1\ Recommendations to Improve Scoping and Implementation of 
Initial Margin Requirements for Non-Cleared Swaps, Report to the 
CFTC's Global Markets Advisory Committee by the Subcommittee on 
Margin Requirements for Non-Cleared Swaps (April 2020), available at 
https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
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    The proposed rulemaking contains two proposals, which have much 
to commend them. These proposals further objectives that I have 
commented on before:
     The imperative of harmonizing our margin requirements 
with those of our international colleagues around the world in order 
to facilitate compliance and coordinated regulatory oversight; and
     the benefits of codifying relief that has been issued 
by our Staff and re-visiting our rules, where appropriate.
    I am very appreciative of the many people whose efforts have 
contributed to bringing this proposed rulemaking to fruition. First, 
the members of the GMAC, and especially the GMAC Margin 
Subcommittee, who devoted a tremendous amount of time to quickly 
provide us with a high-quality report on complex margin issues at 
the same time they were performing their ``day jobs'' during a 
global pandemic. Second, Chairman Tarbert, for his willingness to 
include this proposed rulemaking on the busy agenda that he has laid 
out for the Commission for the rest of this year. Third, my fellow 
Commissioners, for working with me on these important issues. And 
finally, the Staff of the Division of Swap Dealer and Intermediary 
Oversight (``DSIO''), whose tireless efforts have enabled us to 
advance these initiatives to assure that our uncleared margin rules 
are workable for all and are in line with international standards, 
thereby enhancing compliance consistent with our responsibilities 
under the Commodity Exchange Act (``CEA'').

Background: A Different Universe Is Coming Into Scope of the Uncleared 
Margin Rules

    The Commission's uncleared margin rules for swap dealers, like 
the Framework of the Basel Committee on Banking Supervision and the 
Board of the International Organization of Securities Commissions 
(``BCBS/IOSCO'') \2\ on which they are based, were designed 
primarily to ensure the exchange of margin between the largest 
financial institutions for their uncleared swap transactions with 
one another. These institutions and transactions are already subject 
to uncleared margin requirements.
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    \2\ See generally BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (July 2019), available at https://www.bis.org/bcbs/publ/d475.pdf.
---------------------------------------------------------------------------

    Pursuant to the phased implementation schedule of the 
Commission's rules and the BCBS/IOSCO Framework, though, a different 
universe of market participants--presenting unique considerations--
is coming into scope of the margin rules. It is only now, as we 
enter into the final phases of the implementation schedule, that the 
Commission's uncleared margin rules will apply to a significant 
number of financial end-users, and we have a responsibility to make 
sure they are fit for that purpose. Accordingly, now is the time we 
must explore whether the regulatory parameters that we have applied 
to the largest financial institutions in the earlier phases of 
margin implementation need to be tailored to account for the 
practical operational challenges posed by the exchange of margin 
when one of the counterparties is a pension plan, endowment, 
insurance provider, mortgage service provider, or other financial 
end-user.

International Harmonization To Enhance Compliance and Coordinated 
Regulation

    The first proposal in this proposed rulemaking would revise the 
calculation method for determining whether financial end-users come 
within the scope of the initial margin (``IM'') requirements, and 
the timing for compliance with the IM requirements after the end of 
the phased compliance schedule. These changes would align certain 
timing and calculation issues under the Commission's margin rules 
with both the BCBS/IOSCO Framework and the manner in which these 
issues are handled by our regulatory colleagues in all other major 
market jurisdictions.
    Swap dealers must exchange IM with respect to uncleared swaps 
that they enter into with a financial end-user counterparty that has 
``material swap exposure'' (``MSE''). The Commission's margin rules 
provide that after the last phase of compliance, MSE is to be 
determined on January 1, and that an entity has MSE if it has more 
than $8 billion in average aggregate notional amount (``AANA'') 
during June, July, and August of the prior year. By contrast, under 
the BCBS/IOSCO Framework and in virtually every other country in the 
world, an entity is determined to come into scope of the IM 
requirement on September 1, and an entity has MSE if it has the 
equivalent of $8 billion in AANA \3\ during March, April, and May of 
that year.
---------------------------------------------------------------------------

    \3\ The MSE threshold under the BCBS/IOSCO Framework is stated 
in euros rather than dollars.
---------------------------------------------------------------------------

    The reason the United States is out-of-step with the rest of the 
world on these timing and calculation issues is not because of any

[[Page 59717]]

considered policy determination. Rather, it is simply the result of 
a quirk that the margin rules were adopted based on the BCBS/IOSCO 
Framework that was in effect at the time--but the BCBS/IOSCO 
Framework was revised two years later.
    In a further disconnect, the Commission's margin rules look to 
the daily average AANA during the three-month calculation period for 
determining MSE, whereas the BCBS/IOSCO Framework and other major 
market jurisdictions base the AANA calculation on an average of 
month-end dates during that period. Yet, the proposing release notes 
that the Commission's Office of the Chief Economist has estimated 
that calculations based on end-of-month AANA generally would yield 
similar results as calculations based on the Commission's current 
daily AANA approach.
    The Commission is proposing to amend these timing and 
calculation provisions of its uncleared margin rules to harmonize 
them with the BCBS/IOSCO Framework and the approach followed by our 
international colleagues around the world. Given the global nature 
of the derivatives markets, we should always seek international 
harmonization of our regulations unless a compelling reason exists 
not to do so--which is not the case here.
    Indeed, in the Dodd-Frank Act, Congress specifically directed 
the Commission, ``[i]n order to promote effective and consistent 
global regulation of swaps,'' to ``consult and coordinate with 
foreign regulatory authorities on the establishment of consistent 
international standards with respect to the regulation . . . of 
swaps [and] swap entities . . .'' \4\ And when the G-20 leaders met 
in Pittsburgh in the midst of the financial crisis in 2009, they, 
too, recognized that a workable solution for global derivatives 
markets demands coordinated policies and cooperation.\5\
---------------------------------------------------------------------------

    \4\ See section 752(a) of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010) 
(``Dodd-Frank Act'').
    \5\ See Leaders' Statement from the 2009 G-20 Summit in 
Pittsburgh, Pa. at 7 (September 24-25, 2009) (``We are committed to 
take action at the national and international level to raise 
standards together so that our national authorities implement global 
standards consistently in a way that ensures a level playing field 
and avoids fragmentation of markets, protectionism, and regulatory 
arbitrage''), available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
---------------------------------------------------------------------------

    The MSE proposal being issued today is true to the direction of 
Congress in the Dodd-Frank Act, and honors the commitment of the G-
20 leaders at the Pittsburgh summit. Differences between countries 
in the detailed timing and calculation requirements with respect to 
uncleared margin compel participants in these global markets to run 
multiple compliance calculations--for no particular regulatory 
reason. This not only forces market participants to bear unnecessary 
costs, but actually hinders compliance with margin requirements 
because of the entirely foreseeable prospect of calculation errors 
in applying the different rules.
    As noted above, now is the time to address this disjunction in 
MSE timing and calculation requirements because the financial end-
users to which the MSE definition applies are coming into scope of 
the margin rules. Both Congress and the G-20 leaders recognized that 
because modern swap markets are not bound by jurisdictional borders, 
they cannot function absent consistent international standards. 
Harmonization fosters both improved compliance and effectively 
regulated markets through coordinated oversight--which must always 
be our goals.
    During the unfortunate events of the financial crisis, we 
learned that coordination among global regulators, working towards a 
common objective, is essential. That lesson remains true today, and 
we are reminded that disregarding this reality has the potential to 
weaken, rather than strengthen, the effectiveness of our oversight 
and the resilience of global derivatives markets.

The Benefits of Codifying Staff Relief and Re-Visiting Our Rules

    The second proposal in the proposed rulemaking would codify 
existing DSIO no-action relief in recognition of market realities. 
Our Staff often has occasion to issue relief or take other action in 
the form of no-action letters, interpretative letters, or advisories 
on various issues and in various circumstances. This affords the 
Commission a chance to observe how the Staff action operates in 
real-time, and to evaluate lessons learned. With the benefit of this 
time and experience, the Commission should then consider whether 
codifying such staff action into rules is appropriate.\6\ As I have 
said before, ``[i]t is simply good government to re-visit our rules 
and assess whether certain rules need to be updated, evaluate 
whether rules are achieving their objectives, and identify rules 
that are falling short and should be withdrawn or improved.'' \7\
---------------------------------------------------------------------------

    \6\ See comments of Commissioner Dawn D. Stump during Open 
Commission Meeting on January 30, 2020, at 183 (noting that after 
several years of no-action relief regarding trading on swap 
execution facilities (``SEFs''), ``we have the benefit of time and 
experience and it is time to think about codifying some of that 
relief. . . . [T]he SEFs, the market participants, and the 
Commission have benefited from this time and we have an obligation 
to provide more legal certainty through codifying these provisions 
into rules.''), available at https://www.cftc.gov/sites/default/files/2020/08/1597339661/openmeeting_013020_Transcript.pdf.
    \7\ Statement of Commissioner Dawn D. Stump for CFTC Open 
Meeting on: (1) Final Rule on Position Limits and Position 
Accountability for Security Futures Products; and (2) Proposed Rule 
on Public Rulemaking Procedures (Part 13 Amendments) (September 16, 
2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement091619.
---------------------------------------------------------------------------

    The proposal we are issuing today would codify the alternative 
IM calculation method set out in DSIO no-action Letter No. 19-29.\8\ 
It would provide that a swap dealer may use the risk-based model 
calculation of IM of a counterparty that is a CFTC-registered swap 
dealer as the amount of IM that the former must collect from the 
latter. The proposing release states the Commission's expectation 
that the proposal generally would be used by swap dealers with a 
discrete and limited swap business consisting primarily of entering 
into uncleared swaps with end-user counterparties and then hedging 
the risk of those swaps with uncleared swaps entered into with a few 
swap dealers.
---------------------------------------------------------------------------

    \8\ CFTC Letter No. 19-29, Request for No-Action Relief 
Concerning Calculation of Initial Margin (December 19, 2019), 
available at https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=&field_csl_letter_types_target_id%5B%5D=636&field_csl_divisions_target_id%5B%5D=596&field_csl_letter_year_value=2019&=Apply.
---------------------------------------------------------------------------

    This proposal is subject to conditions that: (1) The applicable 
risk-based model be approved by either the Commission, the National 
Futures Association, or a prudential regulator; and (2) the 
uncleared swaps for which a swap dealer uses the risk-based model 
calculation of IM of its swap dealer counterparty are entered into 
for the purpose of hedging the former's own risk from entering into 
swaps with non-swap dealer counterparties.
    Simply put, not all swap dealers are created equal. It is 
therefore appropriate to tailor our uncleared margin regime 
accordingly. Letter No. 19-29 recognized this reality and smoothed 
the rough edges of our otherwise one-size-fits-all uncleared margin 
rules, and I support the proposal to codify that result.

There Remains Unfinished Business

    The report of the GMAC Margin Subcommittee recommended several 
actions beyond those contained in this proposed rulemaking in order 
to address the unique challenges associated with the application of 
uncleared margin requirements to end-users. Having been present for 
the development of the Dodd-Frank Act, I recall the concerns 
expressed by many lawmakers about applying the new requirements to 
end-users. The practical challenges with respect to uncleared margin 
that caused uneasiness back in 2009-2010 are now much more immediate 
as the margin requirements are being phased in to apply to these 
end-users.
    So, while I am pleased at the steps the Commission is taking in 
this proposed rulemaking, I hope that we can continue to work 
together to address the other recommendations included in the GMAC 
Margin Subcommittee's report. The need to do so will only become 
more urgent as time marches on.

Conclusion

    To be clear, these proposals to amend the Commission's uncleared 
margin rules are not a ``roll-back'' of the margin requirements that 
apply today to the largest financial institutions in their swap 
transactions with one another. Rather, the proposals reflect a 
thoughtful refinement of our rules to align them with the rest of 
the international regulatory community, and to take account of 
specific circumstances in which they impose substantial operational 
challenges (i.e., they are not workable) when applied to other 
market participants that are coming within the scope of their 
mandates. I look forward to receiving public input on any 
improvements that can be made to the proposals to further enhance 
compliance with the Commission's uncleared margin requirements.

[[Page 59718]]

Appendix 3--Statement of Commissioner Dan M. Berkovitz

    I support issuing for public comments two notices of proposed 
rulemaking to improve the operation of the CFTC's Margin Rule.\1\ 
The Margin Rule requires certain swap dealers (``SDs'') and major 
swap participants (``MSPs'') to post and collect initial and 
variation margin for uncleared swaps.\2\ The Margin Rule is critical 
to mitigating risks in the financial system that might otherwise 
arise from uncleared swaps. I support a strong Margin Rule, and I 
look forward to public comments on the proposals, including whether 
certain elements of the proposals could increase risk to the 
financial system and how the final rule should address such risks.
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    \1\ Margin Requirements for Uncleared Swaps for Swap Dealers and 
Major Swap Participants, 81 FR 636 (Jan. 6, 2016) (``Margin Rule'').
    \2\ See also Commodity Exchange Act (``CEA'') section 4s(e). The 
CEA, as amended by the Dodd-Frank Act, requires the Commission to 
adopt rules for minimum initial and variation margin for uncleared 
swaps entered into by SDs and MSPs for which there is no prudential 
regulator. Although addressed in the rules, there are currently no 
registered MSPs.
---------------------------------------------------------------------------

    The proposals address: (1) The definition of material swap 
exposure (``MSE'') and an alternative method for calculating initial 
margin (``the MSE and Initial Margin Proposal''); and (2) the 
application of the minimum transfer amount (``MTA'') for initial and 
variation margin (``the MTA Proposal''). They build on frameworks 
developed by the Basel Committee on Banking Supervision and 
International Organization of Securities Commissions (``BCBS/
IOSCO''),\3\ existing CFTC staff no-action letters, and 
recommendations made to the CFTC's Global Markets Advisory Committee 
(``GMAC'').\4\ I thank Commissioner Stump for her leadership of the 
GMAC and her work to bring these issues forward for the Commission's 
consideration.
---------------------------------------------------------------------------

    \3\ BCBS/IOSCO, Margin requirements for non-centrally cleared 
derivatives (July 2019), https://www.bis.org/bcbs/publ/d475.pdf. The 
BCBS/IOSCO framework was originally promulgated in 2013 and later 
revised in 2015.
    \4\ Recommendations to Improve Scoping and Implementation of 
Initial Margin Requirements for Non-Cleared Swaps, Report to the 
CFTC's Global Markets Advisory Committee by the Subcommittee on 
Margin Requirements for Non-Cleared Swaps, April 2020, https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
---------------------------------------------------------------------------

    Today's proposed amendments to the Margin Rule could help 
promote liquidity and competition in swaps markets by allowing the 
counterparties of certain end-users to rely on the initial margin 
calculations of the more sophisticated SDs with whom they enter into 
transactions designed to manage their risks, subject to safeguards. 
They would also address practical challenges in the Commission's MTA 
rules that arise when an entity such as a pension plan or endowment 
retains asset managers to invest multiple separately managed 
accounts (``SMAs''). Similar operational issues are addressed with 
respect to initial and variation margin MTA calculations.
    These operational and other benefits justify publishing the MSE 
and Initial Margin Proposal and the MTA Proposal in the Federal 
Register for public comment. However, I am concerned that specific 
aspects of each of these proposed rules could weaken the Margin Rule 
and increase risk by creating a potentially larger pool of 
uncollateralized, uncleared swaps exposure. My support for 
finalizing these proposals will depend on how the potential 
increased risks are addressed.
    One potential risk in the MSE and Initial Margin Proposal arises 
from amending the definition of MSE to align it with the BCBS/IOSCO 
framework.\5\ One element of the proposal would amend the 
calculation of the average daily aggregate notional amount 
(``AANA'') of swaps. The proposed rule would greatly reduce the 
number of days used in the calculation, reducing it from an average 
of all business days in a three month period to the average of the 
last business day in each month of a three month period.\6\ The 
result would be that a value now calculated across approximately 60+ 
data points (i.e., business days) would be confined to only three 
data points, and could potentially become less representative of an 
entity's true AANA and swaps exposure. Month-end trading adjustments 
could greatly skew the AANA average for an entity.
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    \5\ 17 CFR 23.151.
    \6\ Existing Commission regulation 23.151 specifies June, July, 
and August of the prior year as the relevant calculation months. The 
proposed rule would amend this to March, April, and May of the 
current year. The proposed rule would also amend the calculation 
date from January 1 to September 1. These amendments would be 
consistent with the BCBS/IOSCO framework.
---------------------------------------------------------------------------

    When the Commission adopted the Margin Rule in 2016, it rejected 
the MSE calculation approach now under renewed consideration. U.S. 
prudential regulators also declined to follow the BCBS/IOSCO 
framework in this regard. The Commission noted in 2016 that an 
entity could ``window dress'' its exposure and artificially reduce 
its AANA during the measurement period.\7\ Even in the absence of 
window dressing, there are also concerns that short-dated swaps, 
including intra-month natural gas and electricity swaps, may not be 
captured in a month-end calculation window. While the MSE and 
Initial Margin Proposal offers some analysis addressing these 
issues, it may be difficult to extrapolate market participants' 
future behavior based on current regulatory frameworks. I look 
forward to public comment on these issues.
---------------------------------------------------------------------------

    \7\ See CFTC Margin Rule, 81 FR at 645.
---------------------------------------------------------------------------

    The MSE and Initial Margin Proposal and the MTA Proposal each 
raise additional concerns that merit public scrutiny and comment. 
The MTA Proposal, for example, would permit a minimum transfer 
amount of $50,000 for each SMA of a counterparty. In the event of 
more than 10 SMAs with a single counterparty (each with an MTA of 
$50,000), the proposal would functionally displace the existing 
aggregate limit of $500,000 on a particular counterparty's 
uncollateralized risk for uncleared swaps. The proposal would also 
state that if certain entities agree to have separate MTAs for 
initial and variation margin, the respective amounts of MTA must be 
reflected in their required margin documentation. Under certain 
scenarios, these separate MTAs could result in the exchange of less 
total margin than if initial and variation margin were aggregated.
    The MSE and Initial Margin Proposal and the MTA Proposal both 
articulate rationales why the Commission preliminarily believes that 
the risks summarized above, and others noted in the proposals, may 
not materialize. The Commission's experience with relevant staff no-
action letters may also appear to lessen concerns around the 
proposals. While each item standing on its own may not be a 
significant concern, the collective impact of the proposed rules may 
be a reduction in the strong protections afforded by the 2016 Margin 
Rule--and an increase in risk to the U.S. financial system. The 
Commission must resist the allure of apparently small, apparently 
incremental, changes that, taken together, dilute the comprehensive 
risk framework for uncleared swaps.
    I look forward to public comments and to continued deliberation 
on what changes to the MSE and Initial Margin Proposal and the MTA 
Proposal are appropriate. I thank Commissioner Stump, our fellow 
Commissioners, and staff of the Division of Swap Dealer and 
Intermediary Oversight for their extensive engagement with my office 
on these proposals.

[FR Doc. 2020-18303 Filed 9-22-20; 8:45 am]
BILLING CODE 6351-01-P