2011-10881
-
Federal Register, Volume 76 Issue 92 (Thursday, May 12, 2011)[Federal Register Volume 76, Number 92 (Thursday, May 12, 2011)]
[Proposed Rules]
[Pages 27802-27841]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-10881]
[[Page 27801]]
Vol. 76
Thursday,
No. 92
May 12, 2011
Part III
Commodity Futures Trading Commission
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17 CFR Parts 1, 23, and 140
Capital Requirements of Swap Dealers and Major Swap Participants;
Proposed Rule
Federal Register / Vol. 76 , No. 92 / Thursday, May 12, 2011 /
Proposed Rules
[[Page 27802]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 23, and 140
RIN 3038-AD54
Capital Requirements of 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 regulations that would implement the new statutory
framework in the Commodity Exchange Act (CEA), added by the Wall Street
Reform and Consumer Protection Act (Dodd-Frank Act). These new
provisions of the CEA require, among other things, the Commission to
adopt capital requirements for certain swap dealers (SDs) and major
swap participants (MSPs). The proposed rules also provide for related
financial condition reporting and recordkeeping by SDs and MSPs. The
Commission further proposes to amend existing capital and financial
reporting regulations for futures commission merchants (FCMs) that also
register as SDs or MSPs. The proposed regulations also include
requirements for supplemental FCM financial reporting to reflect
section 724 of the Dodd-Frank Act. In order to align the comment
periods for this proposed rule and the Commission's earlier proposed
rulemaking on margin requirements for uncleared swaps,\1\ the comment
period for the proposed margin rulemaking is being extended elsewhere
in the Federal Register today, so that commenters will have the
opportunity to review the proposed capital and margin rules together
before the expiration of the comment periods for either proposed rule.
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\1\ See 76 FR 23732 (April 28, 2011).
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DATES: Comments must be received on or before July 11, 2011.
ADDRESSES: You may submit comments, identified by RIN 3038-AD54, by any
of the following methods:
Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: Send to David A. Stawick, Secretary, Commodity
Futures Trading Commission, 1155 21st Street, NW., Washington, DC
20581.
Hand delivery/Courier: Same as Mail above.
Federal eRulemaking Portal: http://www.regulations.gov/search/index.jsp. Follow the instructions for submitting comments.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that is exempt from disclosure under the Freedom of
Information Act, a petition for confidential treatment of the exempt
information may be submitted according to the procedures set forth in
Sec. 145.9 of the Commission's regulations.\2\
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\2\ Commission regulations referred to herein are found at 17
CFR Ch. 1 (2010). Commission regulations are accessible on the
Commission's Web site, http://www.cftc.gov.
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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 http://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the Freedom of Information Act.
FOR FURTHER INFORMATION CONTACT: Thomas Smith, Deputy Director, Thelma
Diaz, Associate Director, or Jennifer Bauer, Special Counsel, Division
of Clearing and Intermediary Oversight, 1155 21st Street, NW.,
Washington, DC 20581. Telephone number: 202-418-5137 and electronic
mail: tsmith@cftc.gov; tdiaz@cftc.gov; or jbauer@cftc.gov.
SUPPLEMENTARY INFORMATION:
I. Background
A. Legislation Requiring Rulemaking for Capital Requirements of SDs and
MSPs
On July 21, 2010, President Obama signed the Dodd-Frank Act.\3\
Title VII of the Dodd-Frank Act amended the CEA \4\ to establish a
comprehensive regulatory framework to reduce risk, increase
transparency, and promote market integrity within the financial system
by, among other things: (1) Providing for the registration and
comprehensive regulation of SDs and MSPs; (2) imposing clearing and
trade execution requirements on standardized derivative products; (3)
creating rigorous recordkeeping and real-time reporting regimes; and
(4) enhancing the Commission's rulemaking and enforcement authorities
with respect to all registered entities and intermediaries subject to
the Commission's oversight.
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\3\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
\4\ 7 U.S.C. 1 et seq.
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The legislative mandate to establish registration and regulatory
requirements for SDs and MSPs appears in section 731 of the Dodd-Frank
Act, which adds a new section 4s to the CEA. Section 4s(e) explicitly
requires the adoption of rules establishing capital and margin
requirements for SDs and MSPs, and applies a bifurcated approach that
requires each SD and MSP for which there is a prudential regulator to
meet the capital and margin requirements established by the applicable
prudential regulator, and each SD and MSP for which there is no
prudential regulator to comply with Commission's capital and margin
regulations.
The term ``prudential regulator'' is defined in a new paragraph 39
of the definitions set forth in section 1a of the CEA, as amended by
section 721 of the Dodd-Frank Act. This definition includes the Board
of Governors of the Federal Reserve System (Federal Reserve Board); the
Office of the Comptroller of the Currency (OCC); the Federal Deposit
Insurance Corporation (FDIC); the Farm Credit Administration; and the
Federal Housing Finance Agency (FHFA). The definition also specifies
the entities for which these agencies act as prudential regulators, and
these consist generally of federally insured deposit institutions; farm
credit banks; federal home loan banks; and the Federal Home Loan
Mortgage Corporation and the Federal National Mortgage Association. In
the case of the Federal Reserve Board, it is the prudential regulator
not only for certain banks, but also for bank holding companies and any
foreign banks treated as bank holding companies. The Federal Reserve
Board also is the prudential regulator for subsidiaries of these bank
holding companies and foreign banks, but excluding their nonbank
subsidiaries that are required to be registered with the Commission as
SDs or MSPs.
In general, therefore, the Commission is required to establish
capital requirements for all registered SDs and MSPs that are not
banks, including nonbank subsidiaries of bank holding companies
regulated by the Federal Reserve Board. In addition, certain swap
activities currently engaged in by banks may be conducted in such
nonbank subsidiaries and affiliates as a result of the prohibition on
Federal assistance to swap entities under section 716 of the
[[Page 27803]]
Dodd-Frank Act. Generally, insured depository institutions (IDIs) that
are required to register as SDs may be required to comply with section
716 by ``pushing-out'' to an affiliate all swap trading activities with
the exception of: (1) The IDI's hedging or other similar risk
mitigating activities directly related to the IDI's activities; and (2)
the IDI acting as a SD for swaps involving rates or reference assets
that are permissible for investment under banking law.
The Commission is further required to adopt other regulations that
implement provisions in section 4s related to financial reporting and
recordkeeping by SDs and MSPs. Section 4s(f)(2) of the CEA specifically
directs the Commission to adopt rules governing financial condition
reporting and recordkeeping for SDs and MSPs, and section 4s(f)(1)(A)
expressly requires each registered SD and MSP to make such reports as
are required by Commission rule or regulation regarding the SD's or
MSP's financial condition. The Commission also is authorized to propose
record retention and inspection requirements consistent with the
provisions of section 4s(f)(1)(B).\5\
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\5\ The Commission previously has proposed certain record
retention requirements for SDs and MSPs regarding their swap
activities. See 75 FR 76666 (Dec. 9, 2010).
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B. Consultation With U.S. Securities and Exchange Commission and
Prudential Regulators
Section 4s(e)(3)(D) of the CEA calls for comparability of the
capital requirements that the Commission, United States Securities and
Exchange Commission (SEC) and prudential regulators (together, referred
to as ``Agencies'') adopt for SDs, MSPs, security-based swap dealers
(SSDs) and major security-based swap participants (MSSPs) (together,
referred to as ``swap registrants''). Section 4s further specifies the
expected scope and frequency of consultation by the Agencies regarding
the capital requirements of swap registrants. Section 4s(e)(3)(D)
requires the Agencies to establish and to maintain, to the maximum
extent practicable, comparable minimum capital requirements. Section
4s(e)(3)(D) also requires the Agencies to periodically, but not less
frequently than annually, consult on minimum capital requirements for
swap registrants.
As directed by Dodd-Frank, and consistent with precedent for
harmonizing where practicable the minimum capital and financial
condition and related reporting requirements of dual registrants, staff
from each of the Agencies has had the opportunity to provide oral and/
or written comments to the regulations for SDs and MSPs in this
proposing release, and the proposed regulations incorporate elements of
the comments provided. The Commission will continue its discussions
with the Agencies in the development of their respective capital
regulations to implement the Dodd-Frank Act.
The Commission is relying to a great extent on existing regulatory
requirements in proposing capital requirements for SDs and MSPs.
Specifically, under this proposal, any SD or MSP that is required to
register as an FCM would be required to comply with the Commission's
existing capital requirements set forth in Sec. 1.17 for FCMs.
Furthermore, any SD or MSP that is neither a registered FCM nor a bank,
but is part of a U.S. bank holding company, would be required to comply
with the applicable bank capital requirements that are established by
the Federal Reserve Board for bank holding companies. Lastly, any SD or
MSP that was not required to register as an FCM and is not part of a
U.S. bank holding company would compute its capital in accordance with
proposed regulations summarized in part II of this release.
C. Considerations for SD and MSP Rulemaking Specified in Section 4(s)
Section 4s(e)(2)(C) of the CEA requires the Commission, in setting
capital requirements for a person designated as a swap registrant for a
single type or single class or category of swap or activities, to take
into account the risks associated with other types/classes/categories
of swap and other activities conducted by that person that are not
otherwise subject to regulation by virtue of their status as an SD or
MSP. Section 4s(e)(3)(A) also refers to the need to offset the greater
risk that swaps that are not cleared pose to SDs, MSPs, and the
financial system, and the Commission, SEC, and prudential regulators
are directed to adopt capital requirements that: (1) Help ensure the
safety and soundness of the registrant; and (2) are appropriate for the
risk associated with the uncleared swaps held by the registrants.
D. Other Considerations Under the CEA for FCM Financial Responsibility
Requirements
Entities that register as SDs and MSPs may include entities that
also are registered as FCMs.\6\ FCM registrants are subject to existing
Commission regulations establishing capital, segregation, and financial
reporting requirements under the CEA.\7\ Two primary financial
safeguards under the CEA are: (1) The requirement under section
4d(a)(2) that FCMs segregate from their own assets all money and
property belonging to their customers trading on U.S. markets; \8\ and
(2) the requirement under section 4f(b) for compliance with minimum
capital requirements for FCMs.\9\ The capital requirements for FCMs are
set forth in Commission Sec. 1.17, and reporting requirements related
to capital and the FCM's protection of customer funds are set forth in
Sec. Sec. 1.10, 1.12, and 1.16 of the Commission's regulations.\10\
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\6\ An FCM is defined as an individual, association,
partnership, corporation, or trust that engages in soliciting or in
accepting orders for: (1) The purchase or sale of a commodity for
future delivery, (2) a security futures product, (3) a swap, (4) any
commodity option authorized under Section 4c of the CEA, or (5) any
leverage transaction authorized under section 19 of the CEA, or that
is engaged in soliciting or accepting orders to act as a
counterparty in any agreement, contract, or transaction described in
sections 2(c)(2)(C)(i) or 2(c)(2)(D)(i) of the CEA, and in
connection with such activities, accepts any money, securities or
property (or extends credit) to margin, guarantee, or secure trades
or contracts.
\7\ The Commission's regulatory responsibilities include
monitoring the financial integrity of the commodity futures and
options markets and intermediaries, such as FCMs, that market
participants employ in their trading activities. The Commission's
financial and related recordkeeping and reporting rules are part of
a system of financial safeguards that also includes exchange and
clearinghouse risk management and financial surveillance systems,
exchange and clearinghouse rules and policies on clearing and
settlements, and financial and operational controls and risk
management employed by market intermediaries themselves.
\8\ The requirement that FCMs segregate customer funds is set
forth in section 4d(a)(2) of the CEA. Section 4d(a)(2) requires,
among other things, that an FCM segregate from its own assets all
money, securities, and other property held for customers as margin
for their commodity futures and option contracts, as well as any
gains accruing to such customers from open futures and option
positions. Part 30 of the Commission's regulations also requires
FCMs to hold ``secured amount'' funds for U.S. customers trading in
non-U.S. futures markets separate from the firms' proprietary funds.
\9\ Section 4f(b) of the CEA provides that FCMs must meet the
minimum financial requirements that the Commission ``may by
regulation prescribe as necessary to insure'' that FCMs meet their
obligations as registrants.
\10\ Regulation 1.10 includes a requirement for FCMs to file
annual financial statements that have been certified by an
independent public accountant in accordance with Sec. 1.16.
Regulation 1.10 also requires generally that FCMs file with the
Commission non-certified Form 1-FR-FCM financial reports each month.
Regulation 1.12 requires FCMs to provide notice of a variety of
predefined events as or before they occur. Such notice is intended
to provide the Commission with the opportunity to assess the FCM's
ability to meet its financial requirements on an ongoing basis.
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1. Background on FCM Capital Requirements in Sec. 1.17
FCM capital requirements in Sec. 1.17 are designed to require a
minimum level
[[Page 27804]]
of liquid assets in excess of the FCM's liabilities to provide
resources for the FCM to meet its financial obligations as a market
intermediary in the regulated futures and options market. The capital
requirements also are intended to ensure that an FCM maintains
sufficient liquid assets to wind-down its operations by transferring
customer accounts in the event that the FCM decides, or is forced, to
cease operations as an FCM.
Paragraph (a) of Sec. 1.17 addresses the first component of the
FCM capital rule by specifying the minimum amount of adjusted net
capital that a registered FCM is required to maintain. Specifically,
Sec. 1.17 sets the minimum adjusted net capital requirement as the
greatest of: (1) $1,000,000; (2) for an FCM that engages in off-
exchange foreign currency transactions with persons that are not
eligible contract participants as defined in section 1a(12) of the CEA
(i.e. retail participants), $20,000,000, plus 5 percent of the FCM's
liabilities to the retail forex participants that exceeds $10,000,000;
(3) 8 percent of the risk margin (as defined in Sec. 1.17(b)(8)) of
customer and non-customer exchange-traded futures positions and over-
the-counter (OTC) swap positions that are cleared by a clearing
organization and carried by the FCM; (4) the amount of adjusted net
capital required by a registered futures association of which the FCM
is a member; and (5) for an FCM that also is registered as securities
broker or dealer, the amount of net capital required by rules of the
SEC.
The requirements for the calculation of the FCM's adjusted net
capital represent the second component of the FCM capital rule.
Regulation 1.17(c)(5) generally defines the term ``adjusted net
capital'' as an FCM's ``current assets'', i.e., generally liquid
assets, less all of its liabilities (except certain qualifying
subordinated debt), and further reduced by certain capital charges (or
haircuts) to reflect potential market and credit risk of the firm's
current assets.
2. Capital Required for Uncleared Swaps Under Sec. 1.17
FCMs historically have not engaged in significant OTC derivatives
transactions. The capital treatment of such transactions under Sec.
1.17 is one of the factors that has resulted in OTC transactions being
conducted in affiliated entities. Specifically, an FCM in computing its
adjusted net capital is required to mark its OTC derivatives position
to market, and to reflect any unrealized gain or loss in its statement
of income. If the FCM experiences an unrealized loss on its OTC
derivatives position, the unrealized loss is recorded as a liability to
the counterparty and results in a reduction of the firm's adjusted net
capital. If the FCM experiences an unrealized gain on the OTC
derivatives position, the FCM would record a receivable from the
counterparty. If the receivable was not secured through the receipt of
readily marketable financial collateral, the FCM would be required to
exclude the receivable from the calculation of its current assets under
Sec. 1.17(c)(2)(ii).
An FCM, in computing its adjusted net capital, is further required
to compute a capital charge to reflect the potential market risk
associated with its OTC derivatives positions. Regulation 1.17(c)(5)
establishes specific capital charges for market risk for an FCM's
proprietary positions in physical inventory, forward contracts, fixed
price commitments, and securities. Historically, the Commission has
required an FCM to use the capital charge provisions specified in Sec.
1.17(c)(5)(ii), or capital charges established by the SEC for
securities brokers or dealers, for its OTC derivatives positions.
3. Capital and Reporting Requirements for FCMs That Also Are SDs or
MSPs
Section 4s(e)(3)(B)(i) of the CEA recognizes that the requirements
applicable to SDs and MSPs under section 4s do not limit the
Commission's authority with respect to FCM regulatory requirements.
Furthermore, with respect to cleared swaps, section 724 of the Dodd-
Frank Act provides that if a SD or MSP accepts any money, securities,
or property (or extends credit in lieu of money, securities, or
property) from, or on behalf of, a swaps customer to margin, guarantee,
or secure a swap position cleared by or through a derivatives clearing
organization, the SD or MSP must register with the Commission as an
FCM.\11\ Therefore, the requirement to comply with CFTC FCM capital
requirements extends to SDs and MSPs that are required to register as
FCMs as a result of carrying customer accounts containing cleared swap
positions. This would include SDs and MSPs that are subject to
regulation by prudential regulators, and are required to register as
FCMs. In part II.B of this release, the Commission proposes specific
capital and financial reporting requirements applicable to FCMs that
also are registered as SDs or MSPs.
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\11\ Section 724 of the Dodd-Frank Act amends Section 4d of the
CEA by adding a new provision, Section 4d(f)(1), which provides that
it is unlawful for any person to accept money, securities, or other
property from or on behalf of a swap customer to margin, guarantee
or secure a swap cleared by or through a derivatives clearing
organization unless the person is registered as an FCM under the
CEA. See, also, Section 4s(e)(3)(B)(i)(I) of the CEA, as amended by
Section 731 of the Dodd-Frank Act, which provides the Commission
with authority to impose capital requirements upon SDs and MSPs that
are registered as FCMs.
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E. Structure and Approach
Consistent with the objectives set forth above, part II of this
release summarizes regulations that the Commission proposes in order to
establish minimum capital and financial reporting requirements for SDs
and MSPs that are not banks. As noted in previous proposed rulemaking
issued by the Commission, the Commission intends, where practicable, to
consolidate regulations implementing section 4s of the CEA in a new
part 23.\12\ By this Federal Register release, the Commission is
proposing to adopt the capital requirements and related financial
condition reporting requirements of SDs and MSPs under subpart E of
part 23 of the Commission's regulations.
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\12\ See 75 FR 71379, 71383 (November 23, 2010).
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In addition to the amendments being proposed for subpart E of part
23, the Commission also is proposing certain other amendments to FCM
regulations contained in part 1. The proposed regulations for SD and
MSP capital and financial reporting, as well as capital and financial
reporting requirements for FCMs, are discussed in part II of this
release. Additional amendments for part 140 of the Commission's
regulations are discussed in part III of this release.
II. Proposed Capital and Financial Reporting Regulations Under Part 23
for SDs and MSPs and Part 1 for FCMs
Proposed Sec. 23.101 would specify capital requirements applicable
to SDs and MSPs. Regulation 23.101 includes language specifying
exemptions from the Commission's proposed SD-MSP capital rules,
however, for any SD or MSP that is: (1) Subject to regulation by a
prudential regulator; (2) designated by the Financial Stability
Oversight Council as a systemically important financial institution
(SIFI) and subject to supervision by the Federal Reserve Board; or (3)
registered as an FCM.
The capital requirements of SDs and MSPs that are subject to
regulation by a prudential regulator would be established by the
prudential regulator. As identified by the prudential regulators,
applicable capital regulations for the entities they regulate include
the following: (1) In the case of insured depository institutions, the
capital adequacy guidelines adopted under 12
[[Page 27805]]
U.S.C. 1831o; (2) in the case of a bank holding company or savings and
loan holding company, the capital adequacy guidelines applicable to
bank holding companies under 12 CFR part 225; (3) in the case of a
foreign bank or the U.S. branch or agency of a foreign bank, the
applicable capital rules pursuant to 12 CFR 225.2(r)(3)(i); (4) in the
case of ``Edge corporations'' or ``Agreement corporations'', the
applicable capital adequacy guidelines pursuant to 12 CFR 211.12(c)(2);
(5) in the case of any regulated entity under the Federal Housing
Enterprises Financial Safety and Soundness Act of 1992 (i.e., Fannie
Mae and its affiliates, Freddie Mac and its affiliates, and the Federal
Home Loan Banks), the risk-based capital level or such other amount as
required by the Director of FHFA pursuant to 12 U.S.C. 4611; (6) in the
case of the Federal Agricultural Mortgage Corporation, the capital
adequacy regulations set forth in 12 CFR part 652; and (7) in the case
of any farm credit institution (other than the Federal Agricultural
Mortgage Corporation), the capital regulations set forth in 12 CFR part
615.\13\
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\13\ See joint proposed rulemaking issued by the prudential
regulators on April 12, 2011, titled ``Margin and Capital
Requirements for Covered Swap Entities.''
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Any SD or MSP that was determined to be a SIFI by the Financial
Stability Oversight Council would be subject to supervision by the
Federal Reserve Board.\14\ In this proposal, the Commission is electing
not to impose an additional capital requirement on a SD or MSP that is
designated a SIFI and subject to regulation of the Federal Reserve
Board. As part of the application process (and similar to FCM
application requirements under Sec. 1.17), proposed Sec. 23.101 would
require an applicant for registration as an SD or MSP to demonstrate
its compliance with the applicable Commission-imposed regulatory
capital requirements, or to demonstrate instead that it is supervised
by a prudential regulator or is designated as a SIFI.
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\14\ Section 113 of the Dodd-Frank Act sets forth the process by
which U.S. nonbank financial companies (as defined in section
102(a)(4)(B) of the Dodd-Frank Act) may be designated as
systemically important. Accordingly, a company that is registered as
a SD or MSP with the Commission may be designated as a SIFI by the
Financial Stability Oversight Council under a process laid out in
Title I of the Dodd-Frank Act. Entities that are designated as SIFIs
under Title I of the Dodd-Frank Act are considered to be supervised
by the Federal Reserve Board.
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While the Commission is not proposing to impose capital
requirements on a registered SD or MSP that is subject to prudential
regulation or is designated as a SIFI, the Commission is proposing to
require such an entity to file capital information with the Commission
upon request. Proposed Sec. 23.105(c)(2) provides that, upon the
request of the Commission, each SD or MSP subject to prudential
supervision or designated as a SIFI must provide the Commission with
copies of its capital computations and accompanying schedules and other
supporting documentation. The capital computations must be in
accordance with the regulations of the applicable prudential regulator
with jurisdiction over the SD or MSP.
Furthermore, any SD or MSP that is required to register as an FCM,
including an SD or MSP that is subject to supervision by a prudential
regulator or is designated a SIFI and subject to regulation by the
Federal Reserve Board, would be subject to the capital requirements set
forth in Sec. 1.17 for FCMs. Part II.B.2 of this release discusses the
applicable requirements for FCMs that also are registered as SDs or
MSPs.
A. Proposed Minimum Capital Requirements for SDs and MSPs That Are Not
FCMs
1. Subsidiaries of Bank Holding Companies
The requirements for SDs and MSPs under proposed Sec. 23.101
reflect the fact that these firms may include subsidiaries of U.S. bank
holding companies that are required by section 716 of Dodd-Frank to
``push out'' to an affiliate certain swap trading activities. The
prudential regulators for the banks that may be required to comply with
section 716 include the Federal Reserve Board, the FDIC, and the OCC.
The capital rules of these banking agencies have addressed OTC
derivatives since 1989, when the banking agencies implemented their
risk based capital adequacy standards under the first Basel Accord.\15\
As noted by these banking agencies, they have amended and supplemented
their capital rules over time to take into account developments in the
derivatives markets, including through the addition of market risk
amendments which required banks and bank holding companies meeting
certain thresholds to calculate their capital requirements for trading
positions through models approved by the appropriate banking regulator.
The banks affected by the provisions of Section 716 also may include
certain large, complex banks, which together with certain bank holding
companies are subject to other requirements for computing credit risk
requirements under Basel II capital standards that have been
implemented by these banking agencies.\16\ The Federal Reserve, OCC,
and FDIC also have stated their intention to implement requirements
under recent Basel III proposals, which would establish additional
capital requirements for the banks and bank holding companies for which
these banking agencies are the prudential regulator.
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\15\ The Basel Committee on Banking Supervision is a committee
of banking supervisory authorities established in 1974 by the
central-bank Governors of the Group of Ten countries. In 1988, the
Basel Committee published a document titled the ``International
Convergence of Capital Measurement and Capital Standards'' (the
``Basel Capital Accord''), which set forth an agreed framework for
measuring capital adequacy and the minimum requirements for capital
for banking institutions. There have been several amendments to the
Basel Capital Accord in the intervening years, including, in January
of 1996, the ``Amendment to the Capital Accord to Incorporate Market
Risks.'' The Basel Committee issued a revised framework in June of
2004 (``Basel II''), and has continued to propose additional
amendments thereafter. In 2010, the Basel Committee issued further
requirements for internationally active banks that are set forth in
``Basel III: A Global Regulatory Framework for More Resilient Banks
and Banking Systems.''
\16\ The advanced approaches rules are codified at 12 CFR part
325, appendix D (FDIC); 12 CFR part 3, appendix C (OCC); and 12 CFR
part 208, appendix F and 12 CFR part 225, appendix G (Federal
Reserve Board).
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Described in very general terms, the capital rules adopted by these
banking agencies establish the required minimum amount of regulatory
capital in terms of a ``minimum ratio of qualifying total capital to
weighted risk assets of 8 percent, of which at least 4.0 percentage
points should be in the form of Tier 1 capital.'' \17\ For purposes of
this requirement, the assets and off-balance sheet items of the bank or
bank holding company are weighted relative to their risk (primarily
credit risk): The greater the risk, the greater the weighting. Large,
complex banks must make further adjustments to these risk-weighted
assets for the additional capital they must hold to reflect the market
risk of their trading assets. The bank or bank holding company's total
capital must equal or exceed at least 8 percent of its risk-weighted
assets, and at least half of its total capital must meet the more
restrictive requirements of the definition of Tier 1 capital. For
example, a bank's total capital, but not its Tier 1 capital, may
include certain mandatory convertible debt.\18\
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\17\ See, 12 CFR part 225, appendix A, Sec. II.A.
\18\ Mandatory convertible debt securities are subordinated debt
instruments that require the issuer to convert such instruments into
common or perpetual preferred stock by a date at or before the
maturity of the debt instruments.
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The terms of proposed Sec. 23.101 have been drafted to maintain
consistent capital requirements among bank and nonbank subsidiaries
(other than FCM
[[Page 27806]]
subsidiaries) of a U.S. bank holding company. By meeting requirements
in the specified banking regulations, the SD or MSP will be subject to
comparable capital regulations applicable to their parent U.S. bank
holding companies, including the same credit risk and market risk
capital requirements. Establishing a regime that imposes consistent
capital requirements on nonbank subsidiaries, bank holding companies,
and banks with respect to their swap activities further enhances the
regulatory regime by attempting to remove incentives for registrants to
engage in regulatory arbitrage.
The Commission has determined that it is appropriate to defer to
the Federal Reserve Board's existing capital requirements for SDs and
MSPs that are nonbank subsidiaries of a U.S. bank holding company
because the existing capital requirements encompass the scope of the
swaps activity and related hedging activity contemplated under the
Dodd-Frank Act; the existing requirements sufficiently account for
certain risk exposures, including credit and market risks; and the
existing requirements meet the statutory requirement of ensuring the
safety and soundness of the SD or MSP and are appropriate for the risk
associated with the non-cleared swaps held by the SD or MSP.\19\
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\19\ Section 4s(e)(3)(A)(i) and (ii) of the CEA.
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The proposed regulation provides that a SD or MSP that is a nonbank
subsidiary of a U.S. bank holding company would have to comply with a
regulatory capital requirement specified by the Federal Reserve Board
as if the subsidiary itself were a U.S. bank holding company. The scope
of such a regulatory capital requirement would include the swap
transactions and related hedge positions that are part of the SD's or
MSP's swap activities. Specifically, the SD or MSP would be required to
comply with a regulatory capital requirement equal to or in excess of
the greater of: (1) $20 million of Tier 1 capital as defined in 12 CFR
part 225, appendix A, Sec. II.A; \20\ (2) the SD's or MSP's minimum
risk-based ratio requirements, as if the subsidiary itself were a U.S.
bank holding company subject to 12 CFR part 225, and any appendices
thereto; or (3) the capital required by a registered futures
association of which the SD or MSP is a member.
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\20\ The Federal Reserve Board regulations governing bank
holding companies are set forth in at 12 CFR part 225. These
regulations establish a minimum ratio of qualifying total capital to
weighted risk assets of 8 percent, of which at least 4.0 percentage
points should be in the form of Tier 1 capital.
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The proposed $20 million minimum Tier 1 capital requirement is
consistent with the minimum adjusted net capital requirement that
Congress established for Commission registrants engaging in bilateral
off-exchange foreign currency transactions with retail
participants.\21\ The Commission believes that SDs and MSPs that engage
in bilateral swap transactions should be subject to a minimum capital
requirement that is at least equal to the minimum level of capital
Congress established for registrants engaged in retail bilateral off-
exchange foreign currency transactions.
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\21\ See sections 2(c)(2)(B)(i) and (ii) of the CEA.
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The additional proposed minimum capital requirement based on
membership requirements of a registered futures association is similar
to FCM requirements under Sec. 1.17, and is appropriate in light of
proposed Commission rules that would require each SD and MSP to be a
member of a registered futures association. Currently, the National
Futures Association (NFA) is the only registered futures association.
The proposal recognizes that NFA may adopt SD and MSP capital rules at
some later date, and would incorporate such requirements into the
Commission's regulation.
2. Commercial and Other Firms That Are Not Part of Bank Holding
Companies
Certain SDs and MSPs subject to proposed regulation Sec. 23.101
may be commercial firms or other entities with no affiliations to U.S.
bank holding companies. For such SDs and MSPs, the proposed rule would
require that their regulatory capital requirement as measured by
``tangible net equity'' meet or exceed: (1) $20 million of ``tangible
net equity,'' plus the amount of the SD's or MSP's over-the-counter
derivatives credit risk requirement and additional market risk exposure
requirement (as defined below), or (2) the capital required by a
registered futures association of which the SD or MSP is a member.
For purposes of the proposed capital requirement, the term
``tangible net equity'' is defined in proposed Sec. 23.102 as a SD's
or MSP's equity as computed under generally accepted accounting
principles as established in the United States, less goodwill and other
intangible assets.\22\ The proposal would further require an SD or MSP
in computing its tangible net equity to consolidate the assets and
liabilities of any subsidiary or affiliate for which the SD or MSP
guarantees the obligations or liabilities. In accordance with similar
provisions in existing capital rules for FCMs, the proposal further
provides that the SD or MSP may consolidate the assets and liabilities
of a subsidiary or affiliate of which the SD or MSP has not guaranteed
the obligations or liabilities, provided that the SD or MSP has
obtained an opinion of counsel stating that the net asset value of the
subsidiary or affiliate, or the portion of the net asset value
attributable to the SD or MSP, may be distributed to the SD or MSP
within 30 calendar days. Lastly, the proposal would further require
that each SD or MSP included within the consolidation shall at all
times be in compliance with its respective minimum regulatory capital
requirements. The requirement for the SD or MSP to calculate its
tangible net equity on a consolidated basis is consistent with the
requirements in Sec. 1.17 for FCMs, and ensures that the SD's or MSP's
tangible net equity reflects any liabilities and other obligations for
which the SD or MSP may be directly or indirectly responsible.
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\22\ The Commission is explicitly requesting comment on whether
certain intangible assets, such as royalties, should be permitted in
the SD's or MSP's calculation of tangible net equity.
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The term ``over-the-counter derivatives credit risk requirement''
is defined in proposed Sec. 23.100 and refers to the capital that the
SD or MSP must maintain to cover potential counterparty credit
exposures for receivables arising from OTC swap positions that are not
cleared by or through a clearing organization. The term ``additional
market risk exposure requirement'' is defined in proposed Sec. 23.100
and refers to the additional amount of capital the SD or MSP must
maintain for the total potential market risk associated with such swaps
and any product used to hedge such swaps, including futures, options,
other swaps or security-based swaps, debt or equity securities, foreign
currency, physical commodities, and other derivatives. The Commission
is proposing to include swap transactions and related hedge positions
that are part of the SD's swap activities in the over-the-counter
derivatives credit risk requirement and market risk exposure
requirement, and not swap positions or related hedges that are part of
the SD's commercial operations.\23\ MSPs would
[[Page 27807]]
include all swap positions in the market risk and over-the-counter
derivatives credit exposure requirement. A discussion of the
methodology for computing the over-the-counter derivatives credit risk
requirement and the market risk exposure requirement is set forth in
part II.C. of this release.
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\23\ For example, if an SD entered into a swap transaction with
a counterparty as part of its swap dealing activities, the over-the-
counter derivatives credit risk requirement and market risk exposure
requirement associated with the swap position and any positions
hedging or otherwise related to the swap position would be included
in the SD's calculation of its minimum capital requirement. If,
however, an SD entered into a swap transaction to mitigate risk
associated with its commercial activities, the swap position and any
related positions would not be included in the SD's calculation of
its minimum capital requirement.
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The computation of regulatory capital based upon an SD's or MSP's
tangible net equity is a significant, but necessary, departure from the
Commission's traditional adjusted net capital rule for FCMs. A primary
distinction between the tangible net equity and adjusted net capital
methods is that the tangible net equity approach does not require that
a registrant maintain the same degree of highly liquid assets as the
traditional FCM adjusted net capital computation. The proposed tangible
net equity computation would allow SDs and MSPs to include in their
minimum capital computation assets that would not qualify as current
assets under FCM adjusted net capital requirements, such as property,
plant and equipment, and other potentially-illiquid assets.
The Commission is proposing a capital requirement based upon a SD's
or MSP's tangible net equity based upon its understanding that
potential SD and MSP registrants do not conduct their business
operations in a manner comparable to traditional FCMs. For example,
certain entities that are extensively or primarily engaged in the
energy or agricultural business may be required to register as SDs or
MSPs. Although these SDs and MSPs may have significant amounts of
balance sheet equity, it may also be the case that significant portions
of their equity is comprised of physical and other non-current assets,
which would preclude the firms from meeting FCM capital requirements
without engaging in significant corporate restructuring and incurring
potentially undue costs.
The Commission believes that setting a capital requirement that is
different from the traditional FCM adjusted net capital approach is
acceptable for SDs and MSPs that are not acting as market
intermediaries in the same manner as FCMs. Readily available liquid
assets are essential for FCMs to meet their key financial obligations.
FCMs have core obligations for the funds they hold for and on behalf of
their customers, and FCMs further guarantee their customers' financial
obligations with derivatives clearing organizations, including
obligations to make appropriate initial and variation margin payments
to derivatives clearing organizations. SDs and MSPs, however, do not
interact with derivatives clearing organizations to clear customer
transactions and cannot engage in transactions with customers trading
on designated contract markets without registering as FCMs.
B. Proposed Minimum Capital Requirements for SDs and MSPs That Are FCMs
The Commission is proposing to essentially impose the current FCM
capital regime on SDs and MSPs that also are registered as FCMs. FCMs
currently are required, pursuant to Sec. 1.17, to maintain a minimum
level of adjusted net capital that is equal to or greater than the
greatest of: (1) $1,000,000; (2) $20,000,000 for an FCM engaged in off-
exchange foreign currency transactions with retail participants, plus
an additional 5 percent of the total liabilities to the retail foreign
currency customers that exceeds $10,000,000; (3) the sum of 8 percent
of the risk margin on cleared futures and cleared swap positions
carried in customer and non-customer accounts; (4) the amount of
adjusted net capital required by a registered futures association of
which the FCM is a member; and (5) for an FCM that also is registered
as a securities broker-dealer, the amount of net capital required by
rules of the SEC.\24\
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\24\ FCMs that register as security-based swap dealers also will
be subject to minimum capital requirements established by the SEC
for security-based swap dealers.
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The Commission is proposing amendments to Sec. 1.17 that would
impose a minimum $20 million adjusted net capital requirement if the
FCM also is an SD or MSP. The $20 million minimum requirement is
consistent with the Commission's proposal to adopt a $20 million
minimum capital requirement for SDs and MSPs that are not FCMs, and is
further consistent with the Commission's recent adoption of a $20
million minimum capital requirement for FCMs that engage in off-
exchange foreign currency transactions with retail participants.
Furthermore, the Commission notes that the current capital
regulations would impose a risk-based capital requirement on SDs and
MSPs that are required to register as FCMs as a result of their
carrying and clearing of customer swap or futures transactions with a
clearing organization. As noted above, the current regulation requires
an FCM to maintain adjusted net capital that is equal to or greater
than 8 percent of the risk margin associated with cleared futures and
swap transactions carried by the FCM in customer and non-customer
accounts. The 8 percent of margin, or risk-based capital rule, is
intended to require FCMs to maintain a minimum level of capital that is
associated with the level of risk associated with the customer
positions that the FCM carries.
C. Required Calculations for Credit Risk and Market Risk Requirements
The proposed regulations include an application process by which
certain SDs and MSPs may apply to the Commission for approval to use
proprietary internal models for their capital calculations required by
part 23. For those SDs and MSPs whose calculations are not permitted to
be based upon such models, the proposed regulations sets forth other
specified requirements for the SD's or MSP's required market and credit
risk calculations.
1. Request for Approval of Calculations Using Internal Models
The Commission recognizes that internal models, including value-at-
risk (VaR) models, can provide a more effective means of recognizing
the potential economic risks or exposures from complex trading
strategies involving OTC derivatives and other investment instruments.
In this connection, the Commission has previously adopted Sec.
1.17(c)(6), which allows certain FCMs that are dually-registered with
the SEC to elect to use internally developed models to compute market
risk deductions for proprietary positions in securities, forward
contracts, foreign currency, and futures contracts, and credit risk
deductions for unsecured receivables from counterparties in OTC
transactions (the ``Alternative Capital Computation'') in lieu of the
standard deductions set forth in Sec. 1.17(c). A precondition of using
the Alternative Capital Computation is the SEC's review and written
approval of the firm's application to use internal models in computing
its capital under SEC regulations, and the requirement that the model
and the firm's risk management meet certain qualitative and
quantitative requirements set forth in SEC Rule 15c3-1e. The firm also
was required to maintain at least $1 billion of tentative net capital
and $500 million in net capital.\25\ The firm further was obligated to
report to the SEC and to the
[[Page 27808]]
CFTC if its tentative net capital fell below $5 billion.\26\
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\25\ See 17 CFR 15c3-1(a)(7).
\26\ See 17 CFR 15c3-1e(e)(1).
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Significant resources, however, are necessary for regulators to
effectively assess and to periodically review proprietary internal
models. Absent concerns regarding future Commission resources to
implement an adequate program for the effective direct supervision of
internal models used by SDs and MSPs, the Commission would propose
regulations to establish a framework by which FCMs that are registered
as SDs or MSPs could submit internal models to the Commission for
review and approval for use in their required capital calculations.
Such a program would include the continuous and direct review by
Commission staff of the policies and procedures applicable to, and
output of, such proprietary models.
In view, however, of current Commission resources which does not
support the development of a program to conduct the initial review and
ongoing assessment of internal models, and the uncertainty of future
funding levels for the necessary staffing resources, this release
provides for an application process for approval of SD and MSP capital
calculations using internal models, but limits the initial pool of
applicants to those whose internal models are subject to review by the
Federal Reserve Board or the SEC. Specifically, proposed Sec. 23.103
would permit a nonbank SD or MSP that also is part of a U.S. bank
holding company subject to oversight by the Federal Reserve Board to
apply to the Commission for approval by written order to use
proprietary internal models to compute market risk and credit risk
capital requirements under the applicable U.S. bank holding company
regulations. The SD or MSP also may apply for such approval if it also
is registered as an SSD or MSSP, and the internal models for which it
seeks approval have been reviewed and are subject to the regular
assessment by the SEC.
a. Application Process and Requirements for Internal Models
As set forth in the proposed regulation, the application must
address several factors including: (1) Identifying the categories of
positions that the SD or MSP holds in its proprietary accounts; (2)
describing the methods that the SD or MSP will use to calculate its
market risk and credit risk capital requirements; (3) describing the
internal models; and (4) describing how the SD or MSP will calculate
current exposure and potential future exposure. The SD or MSP also must
explain the extent to which the internal models have been reviewed and
approved by the Federal Reserve Board, or, as applicable, the SEC.
The proposal would further provide that the internal models must
meet such requirements as are adopted by U.S. regulators under the
Basel Accord, including requirements implemented as part of Basel III.
In particular, the internal models must meet the requirements that are
set forth in regulations of the Federal Reserve Board at 12 CFR part
225, appendix E and appendix G applicable to market risk and OTC
counterparty credit risk; or, as applicable to SSDs or MSSPs, the
requirements set forth in SEC regulations. Such requirements include,
but are not limited to, the requirements in these regulations to assess
the effectiveness of such models by conducting appropriate backtesting
and for the application of multipliers to the model outputs that would
be based on the results of such backtesting.
The proposed regulation further specifies that the application
shall be in writing and filed with the regional office of the
Commission having jurisdiction over the SD or MSP as set forth in Sec.
140.2 of the Commission's regulations. The application may be filed
electronically in accordance with instructions approved by the
Commission and specified on the Commission's Web site. A petition for
confidential treatment of information within the application may be
submitted according to procedures set forth in Sec. 145.9. The
proposed rule further provides that the SD or MSP must promptly, upon
the request of the Commission at any time, provide any other
explanatory information as the Commission may require at its discretion
regarding the SD's or MSP's internal models and related capital
computations.
As set forth in proposed Sec. 23.103, upon recommendation by
Commission staff, the Commission may approve the application, or
approve an amendment to the application, in whole or in part, subject
to any conditions or limitations the Commission may require, if the
Commission finds the approval to be necessary or appropriate in the
public interest or for the protection of investors, after determining,
among other things, whether the applicant has met the requirements of
this section and is in compliance with other applicable rules
promulgated under the Act and by self-regulatory organizations. The
proposed rule also specifies the following conditions under which such
Commission approval may be terminated: (1) Internal models that were
previously approved are no longer approved or periodically reviewed by
the Federal Reserve Board or the SEC; (2) the SD or MSP has changed
materially a mathematical model described in the application or changed
materially its internal risk management control system without first
submitting amendments identifying such changes and obtaining Commission
approval for such changes; (3) the Commission in its own discretion
determines that as a result of changes in the operations of the SD or
MSP the internal models are no longer sufficient for purposes of the
capital calculations of the SD or MSP; (4) the SD or MSP fails to come
into compliance with its requirements under the terms of the
Commission's approval under Sec. 23.103, after having received from
the Commission's designee written notification that the firm is not in
compliance with its requirements, and must come into compliance by a
date specified in the notice; or (5) upon any other condition specified
in the Commission approval order.
b. Approval Criteria if SD or MSP Also Is an FCM
If the application made under proposed part 23 is from an SD or MSP
that also is an FCM, proposed Sec. 23.103 provides that the
application shall specify that the firm requests approval to calculate
its adjusted net capital (not tangible net equity or other regulatory
capital) using proprietary internal models. The Commission also is
proposing to provide in Sec. 1.17(c)(7) that any FCM that also is
registered as an SD or MSP, or also is registered as an SSD or MSSP,
and which has received approval of its application to the Commission
under Sec. 23.103 for capital computations using the firm's internal
models, shall calculate its adjusted net capital in accordance with the
terms and conditions of such Commission approval. The Commission
further is proposing to amend Sec. 1.17(c)(6)(i) to recognize the
possibility that FCMs that have been authorized to elect to use the
Alternative Capital Computation may be SDs or MSPs and required to
register as such with the Commission. The amended Sec. 1.17(c)(6)(i)
would permit these FCMs to continue to apply the Alternative Capital
Computation pending the Commission's determination of the application
that such FCMs must file under proposed part 23.
[[Page 27809]]
2. Calculations by SDs and MSPs That Are Not Using Internal Models and
Are Not FCMs
As noted earlier, the internal models that may be approved for use
in the capital calculations of SDs and MSPs must meet qualifying
standards under the Basel Accord. In addition to specifying qualifying
criteria for internal models, the Basel Accord also includes other
requirements for capital calculations that do not incorporate
measurements from the firm's internal models.
a. OTC Derivatives Credit Risk
Proposed Sec. 23.104 sets forth capital calculations for OTC
derivatives credit risk that are based on Basel requirements that do
not incorporate internal models. The proposed required credit risk
deduction also includes a concentration charge specified in SEC Rule
15c3-1e. The charge as proposed would equal the sum of (1) a
counterparty exposure charge (summarized below) and (2) a counterparty
concentration charge, which would equal 50 percent of the amount of the
current exposure to any counterparty in excess of 5 percent of the SD's
or MSP's applicable minimum capital requirement, plus a portfolio
concentration charge of 100 percent of the amount of the SD's or MSP's
aggregate current exposure for all counterparties in excess of 50
percent of the SD's or MSP's applicable minimum capital requirement.
The counterparty exposure charge would equal the sum of the net
replacement values in the accounts of insolvent or bankrupt
counterparties plus the ``credit equivalent amount'' of the SD's or
MSP's exposure to its other counterparties. The SD or MSP would be
permitted to offset the net replacement value and the credit equivalent
amount by the value of collateral submitted by the counterparty, as
specified and subject to certain haircuts in the proposed rule. The
resultant calculation would be multiplied by a credit risk factor of 8
percent.
For purposes of this computation, the credit equivalent amount
would equal the sum of the SD's or MSP's current exposure and potential
future exposure to each of its counterparties that is not insolvent or
bankrupt. The current exposure for multiple OTC positions would equal
the greater of (i) the net sum of all positive and negative mark-to-
market values of the individual OTC positions, subject to permitted
netting pursuant to a qualifying master netting agreement; or (ii)
zero.\27\ The potential future exposure for multiple OTC positions that
are subject to a qualifying master netting agreement is calculated in
accordance with the following formula: Anet = (0.4 x Agross) + (0.6 x
NGR x Agross), where: (i) Agross equals the sum of the potential future
exposure for each individual OTC position \28\ subject to the swap
trading relationship documentation that permits netting; \29\ and (ii)
NGR equals the ratio of the net current credit exposure to the gross
current credit exposure. In calculating the NGR, the gross current
credit exposure equals the sum of the positive current credit exposures
of all individual OTC derivative contracts subject to any netting
provisions of the swap trading relationship documentation, which must
be legally enforceable in each relevant jurisdiction, including in
insolvency proceedings. The proposed rule also requires that the gross
receivables and gross payables subject to the netting agreement can be
determined at any time; and that the SD or MSP, for internal risk
management purposes, monitors and controls its exposure to the
counterparty on a net basis. The credit risk equivalent amount may be
reduced to the extent of the market value of collateral pledged to and
held by the swap dealer or major swap participant to secure an over-
the-counter position. The collateral would be subject to the following
requirements:
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\27\ For a single OTC position, the current exposure is the
greater of the mark-to-market value of the over-the-counter position
or zero.
\28\ For a single over-the-counter position, the potential
future exposure, including an over-the-counter position with a
negative mark-to-market value, is calculated by multiplying the
notional principal amount of the position by the appropriate
conversion factor in Table E of the proposed rules. Table E is the
same as the table proposed as ``Table to 1.3(sss)'' in proposed
rulemaking issued jointly by the CFTC and SEC for purposes of the
further definition of the term ``major swap participant.'' See 75 FR
80174, 80214 (December 21, 2010). Both tables remove any references
to credit ratings and require the same charge to be applied to all
corporate debt regardless of rating.
\29\ 76 FR 6715.
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The collateral must be in the swap dealer or major swap
participant's physical possession or control; Provided, However,
collateral may include collateral held in independent third party
accounts as provided under part 23;
The collateral must meet the requirements specified in a
credit support agreement meeting the requirements of Sec. 23.151;
If the counterparty is a swap dealer, major swap
participant or financial entity as defined in Sec. 23.150, certain
additional requirements apply as described in the proposed rule at
Sec. 23.104(j); and
Applicable haircuts must be applied to the market value of
the collateral.
Once the credit equivalent amount is computed as described above,
the SD or MSP would be required to apply a credit risk factor of 50
percent, regardless of any credit rating of the counterparty by any
credit rating agency.\30\ However, the SD or MSP also may apply to the
Commission for approval to assign internal individual ratings to each
of its counterparties, or for an affiliated bank or affiliated broker-
dealer to do so. The application will specify which internal ratings
will result in application of a 20 percent risk weight, 50 percent risk
weight, or 150 percent risk weight. Based on the strength of the
applicant's internal credit risk management system, the Commission may
approve the application. The SD or MSP must make and keep current a
record of the basis for the credit rating for each counterparty, and
the records must be maintained in accordance with Sec. 1.31 of the
Commission's regulations.
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\30\ The Basel credit risk factors are determined for
counterparties based on credit ratings assigned by credit rating
agencies to such counterparties. Section 939A of the Dodd-Frank Act
requires the Commission to review and modify regulations that place
reliance on credit rating agencies. Accordingly, the Commission is
proposing a 50 percent credit risk factor in lieu of assigning a
credit risk factor based on ratings issued by credit rating
agencies.
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b. Additional Market Risk Exposure
Proposed Sec. 23.103 specifies required calculations for market
risk that are based on Basel ``standardized'' measurement procedures
for assessing market risk arising from positions in traded debt and
equity and in commodities and foreign currencies. The Basel
standardized approach also includes market risk exposure requirements
for options that have debt instruments, equities, foreign currency, or
commodities as the underlying positions. Although proposing
requirements based on the Basel standardized approach for market risk
calculations, Commission staff recognizes that the Basel Accord
expressly supports capital requirements based on internal risk
measurement models as the better approach for a bank that has a
significant business in options or commodities.\31\ However, as
discussed above, absent a program for the review and approval of
internal
[[Page 27810]]
models, the Commission believes that this established approach is the
most appropriate method for computing market risk charges.
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\31\ See ``Basel II: International Convergence of Capital
Measurement and Capital Standards: A Revised Framework--
Comprehensive Version,'' issued by the Basel Committee on Banking
Supervision in June 2006.
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The Basel standardized charges seek to address ``general market
risk,'' meaning the risk of changes in the market value of transactions
that arise from broad market movements, such as changing levels of
market interest rates, broad equity indices, or currency exchange
rates. Where applicable, the Basel standardized charges also seek to
address ``specific'' risk, which is defined as changes in the market
value of a position due to factors other than broad market movements.
Such specific risk may include default risk,\32\ event risk (the risk
of loss on a position that could result from sudden and unexpected
large changes in market prices or specific events other than the
default of the issuer), and idiosyncratic risk (the risk of loss in the
value of a position that arises from changes in risk factors unique to
that position).
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\32\ Default risk is the risk of loss on a position that could
result from the failure of an obligor to make timely payments of
principal or interest on its debt obligation, and the risk of loss
that could result from bankruptcy, insolvency, or similar
proceeding. For credit derivatives, default risk means the risk of
loss on a position that could result from the default of the
reference exposure(s).
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Applying the Basel standardized approach, the proposed rules
require the calculation of separate charges for general and specific
market risk for positions in equities and debt instruments (including
options with underlying instruments in these categories), which are
summed to determine the total charge required with respect to such
positions. Only general market charges are calculated for positions in
commodities and foreign currencies (including options with underlying
instruments in these categories). For purposes of computing such
specific and general market risk charges, off-balance sheet positions
are included. For example, swaps are included in the calculation as two
positions, with a receiving side treated as a long position and a
paying side treated as a short position, and using market values of the
notional position in the underlying debt or equity instrument, or index
portfolio. The required calculations for specific risk and general
market risk charges are described in more detail below.
i. Specific Risk
For positions in equities, the proposed specific risk charge equals
8 percent of the firm's gross equity positions, i.e., the absolute sum
of all long equity positions and of all short equity positions, with
netting allowed when the SD or MSP has long and short positions in
exactly the same instrument.
The specific risk charge required for debt instruments is based on
risk-weight factors applied to the debt instrument positions of the SD
or MSP. The applicable required risk weight factor is based in part on
the identity of the obligor. For example, all positions in debt
instruments of national governments of the Organization of Economic Co-
operation and Development (``OECD'') countries are assigned zero
specific risk. Other debt securities issued by ``qualifying'' borrowers
are assigned risk weights that vary by maturity; specifically, 0.25
percent (6 months or less); 1 percent (6 to 24 months); or 1.6 percent
(over 24 months). Qualifying debt instruments include those issued by
U.S. government-sponsored agencies; general obligation debt instruments
issued by states and other political subdivisions of OECD countries and
multilateral development banks; and debt instruments issued by U.S.
depository institutions or OECD-banks that do not qualify as capital of
the issuing institution.
The Basel standardized approach also permits certain rated
corporate debt securities to be included as qualifying debt. However,
given the legislative directive to eliminate the use of credit ratings
in Commission regulations, the proposed rules do not permit any
differentiation among the charges applied to corporate debt securities.
As a result, the proposed rule would apply the same haircut to highly-
rated debt as to debt that is not highly-rated, i.e., the maximum
specific risk weight of 8 percent. The total proposed specific risk
charge for debt instruments would equal the sum of the risk-weighted
positions, with netting allowed for long and short positions (including
derivatives) in identical debt issues or indices.
In drafting the terms of proposed Sec. 23.103, the Commission has
taken into consideration Basel provisions relating to specific risk
that have been incorporated into banking regulations of the Federal
Reserve Board, FDIC, and OCC.\33\ These agencies have recently,
however, proposed revisions to their general market risk and specific
risk rules in light of certain amendments to the Basel Accord developed
in 2005 and 2009.\34\ The revisions proposed by these banking agencies
include requirements applicable to the treatment of credit derivatives
in the calculation of standardized specific risk charges, and the
proposed rules also set forth other offsetting permitted under the
Basel Accord for positions in a credit derivative and its corresponding
underlying instrument. The Commission's proposed requirements for
credit derivatives include text that is based on the banking agencies'
proposed rules. In particular, the text in proposed Sec. 23.104(c)(5)
is the same as the text proposed by the proposed banking agencies.
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\33\ The market risk capital rules of the OCC, Federal Reserve
Board, and FDIC appear respectively at 12 CFR part 3, appendix B; 12
CFR part 208, appendix E and part 225, appendix E, and 12 CFR part
325, appendix C.
\34\ See 76 FR 1890 (January 11, 2011)(proposing amendments that
include revisions to standardized specific risk charges). This
proposed rulemaking refers to Basel Accord revisions set forth in
``The Application of Basel II to Trading Activities and the
Treatment of Double Default Effects'', issued by the Basel Committee
on Banking Supervision and the International Organization of
Securities Commissions (IOSCO) in July 2005, and to the ``Revisions
to the Basel II Market Risk Framework, Guidelines for Computing
Capital for Incremental Risk in the Trading Book'' and ``
Enhancements to the Basel II Framework'' issued by the Basel
Committee on Banking Supervision in July of 2009.
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ii. General Market Risk Charges
In contrast to the Basel standardized approach to specific risk
charges, the federal banking agencies have not adopted the Basel
standardized approach for computing general market risk capital
charges.\35\ In 1995, U.S. banking regulators considered proposed rules
to implement two approaches under the Basel Accord for the capital
treatment of market risk: the internal models approach and the
standardized approach. These agencies subsequently determined, however,
that only the internal models approach would apply to general market
risk capital charges, noting that ``an institution with significant
exposure to market risk can most accurately measure that risk using
detailed information available to the institution about its particular
portfolio processed by its own risk measurement model.'' \36\ The
Commission, however, is proposing the Basel standardized approach since
such an approach does not rely upon proprietary internal models. The
terms in the proposed Sec. 23.104 for general market risk therefore
take into consideration the terms originally contemplated by these
banking agencies in the 1995 proposed
[[Page 27811]]
rules. Proposed Sec. 23.104 requires the calculation of separate
charges for general market risk for positions in equities, debt
instruments, commodities and foreign currency (including options with
underlying instruments in these categories), which are summed to
determine the total general market risk requirement with respect to
such positions.
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\35\ With permission by its federal banking regulator, a bank
also may use internal models for calculating specific risk charges.
See 76 FR 1890, 1893 (January 11, 2011) (discussion of specific risk
requirements currently applicable to banks).
\36\ See 60 FR 38082 (July 25, 1995) (release proposing market
risk capital charges) and 61 FR 47358, 47359 (September 6, 1996)
(release adopting internal models approach).
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Equities
The standardized measure of market risk for equities applies to
direct holdings of equity securities, equity derivatives and off-
balance-sheet positions whose market values are directly affected by
equity prices. The required charge is the sum of the specific risk
charge, calculated as described above, and of the general market risk
charge, which is equal to 8.0 percent of the difference between the sum
of the firm's long and the sum of the firm's short positions. The net
long or short position must be calculated separately for each national
market. Thus, for example, a long position in U.S. companies traded on
the New York Stock Exchange cannot be netted against a short position
in Japanese companies traded on the Tokyo Stock Exchange. Long and
short equity positions (including derivatives) in identical equity
issues or equity indices in the same market may be netted.
Debt Instruments
Applying the ``maturity'' method under the Basel standardized
approach, on and off-balance-sheet debt positions are distributed among
a range of time-bands and zones that are specified by the Basel Accord,
which are designed to take into account differences in price
sensitivities and interest rate volatilities across various maturities.
The time-band into which a position is distributed is determined by its
maturity (fixed rate instruments) or the nearest interest rate reset
date of the instrument (floating rates). Long positions are treated as
positive amounts and short positions are treated as negative amounts.
The net long or short position for each time-band is multiplied by the
risk weight specified in a table set forth in the Basel Accord.\37\ The
resulting risk-weighted position represents the amount by which the
market value of that debt position is expected to change for a
specified movement in interest rates. The sum of all risk-weighted
positions (long or short) across all time-bands is the base capital
charge for general market risk.
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\37\ The risk-weights provided in the table approximate the
price sensitivity of various instruments. The price sensitivity of
zero coupon and low coupon instruments can be materially greater
than that of instruments with higher coupons, and the table
therefore assigns higher risk weights to low coupon instruments.
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The standardized approach also requires a ``time-band
disallowance'' to address the basis risk that exists between
instruments with the same or similar maturities and also the possibly
different price movements that may be experienced by different
instruments within the same time-band due to the range of maturities
(or repricing periods) that may exist within a time-band. To capture
this risk, a disallowance of 10 percent is applied to the smaller of
the offsetting (long or short) positions within a time-band.\38\ This
amount would be added to the SD's or MSP's base capital charge.
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\38\ For example, if the sum of weighted long positions within a
time-band equals $100 million and the sum of weighted short
positions equals $90 million, the disallowance for the time-band
would be 10 percent of $90 million, or $9 million. Also, if the
offsetting amounts (long and short) are equal, the disallowance can
be applied to either figure.
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Additional disallowances address the risk that interest rates along
the yield curve are not perfectly correlated and that the risk-weighted
positions may not be offset fully. The required disallowances, which
apply to the smaller of the offsetting positions, are specified in a
table provided under the Basel Accord, and range from 30 percent to 100
percent. The amount of each disallowance varies in size by zone:
Greater netting is allowed for positions in different time bands but
within the same zone than is allowed for positions that are in
different zones. The firm must first determine ``intra-zone''
disallowance amounts, and then the required ``inter-zone''
disallowances across zones. An SD's or MSP's general market risk
requirement for debt instruments within a given currency would be the
sum of (1) the value of its net risk-weighted position and (2) all of
its time-band, intra-zone and inter-zone disallowances.\39\ The capital
charges would be separately computed for each currency in which an SD
or MSP has significant positions.
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\39\ The Basel standardized approach includes another maturity
ladder approach for interest rate products, the ``duration method,''
which is not included in the proposed Appendix as it requires
computations that are less standardized.
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Certain debt securities would not be included in the charges
described above, but would instead be subject to the capital treatment
under applicable provisions in the SEC's capital regulation at 17 CFR
240. 15c3-1. For example, municipal securities would be subject to
capital requirements in the SEC rule.\40\ All collateralized debt
obligations, asset-backed securities or mortgage-backed securities,
except pass-through mortgage-backed securities issued or guaranteed as
to principal or interest by the United States or any agency thereof,
would also be governed by the SEC rule.\41\
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\40\ This proposed separate treatment is consistent with the
SEC's analysis when considering, in 1997, capital provisions similar
to the Basel standardized approach for debt instruments. Although
the proposed rules were not adopted, the proposing release included
pertinent analysis that the market price of municipal securities
``depends on tax issues to a much greater extent than other debt
instruments,'' and that the price movements of non-investment grade
debt securities ``tend to be based primarily on issuer-specific
factors.'' See 62 FR 67996 (December 30, 1997).
\41\ Id. at 68002.
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Commodities
The market risk capital requirement for commodities risk applies to
holdings or positions taken in commodities, including precious metals,
but excluding gold (which is treated as a foreign currency because of
its market liquidity). The required charge addresses directional risk,
which is the risk that a commodity's spot price will increase or
decrease, as well as other important risks such as basis risk, interest
rate risk, and forward gap risk.
For purposes of determining the charge, the firm is required to
calculate its net position in each commodity on the basis of spot
rates. Long and short positions in the same commodity may be netted,
and different categories of commodities may be netted if deliverable
against each other. Under the ``simple'' approach under the Basel
Accord, the firm's capital charge for directional risk would equal 15
percent of its net position, long or short, in each commodity, and a
supplemental charge of 3.0 percent of the gross position in each
commodity is added to cover basis, interest rate and forward gap
risk.\42\
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\42\ The standardized approach will in certain instances offer
more than one measurement technique, of increasing degrees of
complexity. The ``simplified'' method for calculating general market
risk charges for positions in commodities has been included in the
proposed rules.
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Foreign Exchange
The market risk capital requirement for foreign exchange covers the
risk of holding or taking positions in foreign currencies (including
gold). The charge is determined by the firm's net positions in a given
currency, including its net spot and forward positions; any guarantees
that are certain to be called and likely to be irrecoverable; its net
future income and expenses that are not yet accrued, but that are
already fully hedged; and any other items
[[Page 27812]]
representing a profit or loss in foreign currencies. For purposes of
the calculation, forward and future positions are converted into the
reporting currency at spot market rates.
The standardized approach assumes the same volatility for all
currencies and requires an SD or MSP to take capital charge equal to
8.0 percent of the sum of (a) its net position in gold and (b) the
greater of the sum of the net short positions or the sum of the net
long positions in each foreign currency.
Options
The proposed rule is based on the ``delta-plus method'' under the
Basel standardized approach, which includes capital charges related to
the option's delta (its price sensitivity relative to price changes in
the underlying security, rate, or index); gamma (the change in delta
for a given change in the underlying); and vega (the effect of changes
in the volatility of the underlying).\43\ The three separate capital
charges are computed as follows:
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\43\ Two other methods under the Basel standardized approach for
options are not included in the Appendix, as the ``simplified''
method applies only to purchased options, and the ``scenario''
method incorporates measurements that must meet the same qualitative
requirements applicable to the internal models approach. See 60 FR
at 38091 (discussing restrictions on use of simplified and scenario
methods).
---------------------------------------------------------------------------
Delta risk charge--This charge is determined by incorporating
options positions in the calculations (including specific risk if
applicable) that are required elsewhere in the proposed rule for
positions in commodities, foreign currencies, equities, and debt
instruments. Specifically, options are included as positions equal to
the market value of the underlying instrument multiplied by the delta.
To determine the delta, and also gamma and vega, sensitivities of the
options, the firm will use option pricing models that will be subject
to Commission review.
Total gamma risk charge--This charge requires the following steps:
(1) For each option, perform a ``gamma impact'' calculation that is
based on a Taylor series expansion and expressed in the Basel Accord
as: Gamma impact = .05 x Gamma x VU\2\. In this formula, VU refers to
the variation of the underlying of the option and is computed by
multiplying the market value of the underlying by percentages derived
from those specified elsewhere in the proposal for commodities, foreign
currencies, equities and debt instruments.\44\
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\44\ Applying the required percentages, VU would be determined
for a commodity option by multiplying the market value of the
underlying commodity by 15 percent; for a foreign currency by
multiplying the market value of the underlying by 8 percent; for an
equity or index by multiplying the market value of the underlying by
12 percent or 8 percent respectively, and for options on debt
instruments or interest rates, the market value of the underlying
multiplied by the risk weights for the appropriate time band as
derived from Table A. The text of the rules for the gamma risk
charge simplifies the required computation for options with debt
instruments or interest rates as the underlying, by providing a
table of specific risks weights to be used.
---------------------------------------------------------------------------
(2) The gamma impact for each option will be positive or negative,
and for options on the same underlying, the individual gamma impacts
will be summed, resulting in a net gamma impact for each underlying
that is either positive or negative.
(3) Net positive gamma impacts amounts are disregarded, and the
capital charge equals the absolute value of the sum of all of the net
negative gamma impact amounts.
Total vega risk charge--This charge requires the following steps:
(1) Sum the vegas for all options on the same underlying, and multiply
by a proportional shift in volatility of 25 percent; \45\
and (2) The total capital charge for vega risk will be the sum of the
absolute value of the individual capital charges computed for options
positions in the same underlying.
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\45\ Vega is quoted to show the theoretical price change for
every 1 percentage point change in implied volatility. Assuming a
European short call option with volatility of 20 percent, for
purposes of the required calculation the volatility has to be
increased by a relative shift of 25 percent (only an increase in
volatility carries a risk of loss for a short call option.) Thus, in
this example, the vega capital charge should be calculated on the
basis of a change in volatility of 5 percentage points from 20
percent to 25 percent. Assuming vega in this example equals 168, a 1
percent increase in volatility increases the value of the option by
1.68. Accordingly, the capital charge for vega risk is calculated as
follows: 5 x 1.68 = 8.4
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3. Calculations by SDs and MSPs That Are Not Using Internal Models and
Are FCMs
The existing capital treatment under Sec. 1.17 for those FCMs that
are not approved to use internal models would remain the same under the
proposed rules. Thus, SDs and MSPs that are also FCMs and not approved
to use internal models for their capital calculations would be required
to deduct 100 percent of the receivables associated with their
uncleared swaps, except the extent of the market value, minus specified
haircuts, of acceptable collateral that secure such receivables. The
margin rules that have been proposed may result in fewer unsecured
receivables for the FCM's uncleared swaps, especially as the Commission
also is proposing to amend Sec. 1.17(c)(2)(ii)(G) to provide that
receivables from third-party custodians that arise from initial and/or
variation margin deposits associated with bilateral swap transactions
pursuant to proposed Sec. 23.158 will be included in the FCM's current
assets.
The Commission also is proposing to provide greater clarity and
transparency to the market risk haircut charges under Sec. 1.17 for
OTC derivatives positions, by adding new paragraphs (iii) and (iv) to
Sec. 1.17(c)(5) that would address proprietary OTC swap transactions
that are not cleared by or through a clearing organization. The
proposal is intended to codify existing guidance provided by the
Commission and SEC regarding the computation of capital charges for OTC
derivative transactions.
As proposed, Sec. 1.17(c)(5)(iii)(A) would require a capital
charge equal to the notional amount of an interest rate swap multiplied
by the applicable percentages of the underlying securities specified in
SEC Rule 15c3-1(c)(2)(vi)(A)(1), as if such notional amount was the
market value of a security issued or guaranteed as to principal or
interest by the United States, if the interest rate swap position was
not hedged with U.S. Treasury securities of corresponding maturities or
matched with offsetting interest rate swap positions with corresponding
terms and maturities.\46\ Proposed Sec. 1.17(c)(5)(iii)(B) would
address uncleared swaps maturing in 10 years or less that are hedged
with U.S. Treasury securities of corresponding maturities, or matched
with offsetting interest rate swap positions with corresponding terms
and maturities, and would require a capital charge of 1 percent of the
notional amount of such interest rate swaps. Proposed Sec.
1.17(c)(5)(iii)(C) would require a capital charge of 3 percent of the
notional amount of the interest rate swap, if the swap was hedged with
U.S. Treasury securities of corresponding maturities or matched with
offsetting interest rate swap positions with corresponding terms and
maturities, and such interest rate swap positions were maturing in more
than10 years.
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\46\ SEC Rule 15c3-1(c)(2)(vi)(A)(1) lists haircut percentages
between 0 percent and 6 percent based upon the time to maturity of
the security.
---------------------------------------------------------------------------
Proposed Sec. 1.17(c)(5)(iv) addresses the capital charges on
proprietary OTC swap positions in credit default swaps, equity swaps,
or commodity swaps that are not cleared by or through a clearing
organization. Credit default swaps that are not hedged by the same
securities underlying the swap are subject to a capital charge computed
by multiplying the notional principal amount of the
[[Page 27813]]
swap by the applicable percentages as determined by the underlying
securities under SEC Rule 15c3-1(c)(2)(vi) and taking into account the
remaining maturity of the swap agreement.
Equity swaps would be subject to a capital charge equal to 15
percent of the net notional principal amount of the swap transaction.
Commodity swaps would be subject to a capital charge equal to 20
percent of the net market value of the notional amount of the
commodities underlying the swap transaction.
D. Failure To Meet Minimum Capital Requirements
Regulation 1.17(a)(4) currently provides that any FCM that fails to
meet, or is unable to demonstrate compliance with, the minimum capital
requirement must transfer all customer accounts and immediately cease
doing business as an FCM until it is capable of demonstrating
compliance with the capital requirements. The FCM may continue to trade
for liquidation purposes only unless the Commission or the FCM's
designated self-regulatory organization (DSRO) provides otherwise.\47\
The Commission and the FCM's DSRO also have the authority to grant the
FCM up to a maximum of 10 business days to come back into compliance
with the capital regulations without having to transfer customer
accounts if the FCM can immediately demonstrate the capability of
achieving capital compliance.
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\47\ The term ``designated self-regulatory organization'' is
defined at Sec. 1.3(ff) as the self-regulatory organization of an
FCM that has been delegated the responsibility of reviewing such
FCM's compliance with minimum financial requirements and financial
reports under a plan approved by the Commission pursuant to Sec.
1.52.
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The Commission is not proposing to amend Sec. 1.17(a)(4).
Accordingly, if an FCM that also is registered as an SD or MSP fails to
maintain the minimum level of capital, it would have to cease operating
as an FCM and transfer the customer futures and cleared swap accounts
that it carries to another FCM. The FCM also could request that the
Commission or DSRO grant the firm up to 10 business days to come back
into compliance with the minimum capital requirements if the FCM could
demonstrate an immediate plan to achieve compliance.
The Commission recognizes that an FCM that is an SD or MSP and has
open uncleared bilateral swap transactions cannot transfer the
uncleared bilateral swap transactions in a manner similar to customer
futures and cleared swap transactions. In such situations, the
agreements between the SD or MSP and its counterparties should dictate
the process. As previously proposed by the Commission, each SD or MSP
would be required to establish written policies and procedures
reasonably designed to ensure that each SD or MSP and its
counterparties have agreed in writing to all of the terms governing
their swap trading relationship. The Commission further has proposed
that the swap trading relationship documentation include a written
agreement by the parties on terms relating to events of default or
other termination events, and dispute resolution procedures. Therefore,
the SD's or MSP's written agreements with its counterparties should
address the possible undercapitalization of the SD or MSP and the
parties' rights in such a situation.\48\
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\48\ See 76 FR 6715 (Feb. 8, 2011). Proposed Sec. 23.504 would
require each SD or MSP to execute with its counterparties swap
trading relationship documentation that address, among other things,
the events of default or other termination events.
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Proposed Sec. 23.105(a) requires an SD or MSP to provide the
Commission with immediate notice if the SD or MSP fails to maintain
compliance with the minimum capital requirements. FCMs also are
required to provide the Commission with immediate notice under Sec.
1.12(a). Upon receipt of an undercapitalization notice, the Commission
would engage the SD or MSP to assess the situation and to determine
whether the SD or MSP would be able to take reasonable actions to bring
itself back into compliance with the minimum capital requirements. The
Commission would further assess what other actions were necessary
depending on the facts and circumstance of each situation, including
the need for providing immediate notice to the SD's or MSP's swap
counterparties.
E. SD and MSP Financial Reporting Requirements
1. SD and MSP Financial Statement Requirements
Section 4s(f)(1)(A) of the CEA, as amended by section 731 of the
Dodd-Frank Act, expressly requires each registered SD and MSP to make
such reports as are required by Commission rule or regulation regarding
the SD's or MSP's financial condition. The Commission is proposing new
Sec. 23.106, which would require certain SDs and MSPs to file monthly
unaudited financial statements and annual audited financial statements
with the Commission and with any registered futures association of
which they are members.
Proposed Sec. 23.106 would apply to SDs and MSPs, except any SDs
or MSPs that are subject to the capital requirements of a prudential
regulator, or designated by the Financial Stability Oversight Council
as a SIFI. SDs and MSPs that are subject to regulation by a prudential
regulator would comply with the applicable financial reporting
obligations imposed by such prudential regulator. SDs and MSPs that are
designated as SIFIs would comply with any financial reporting
obligations imposed by the Federal Reserve Board. Registered SDs or
MSPs that are subject to prudential regulation or designated as SIFIs,
however, would be required pursuant to proposed Sec. 23.105(d) to
provide the Commission with copies of their capital computations and
supporting documentation upon the Commission's request. In addition,
SDs and MSPs that are required to register with the Commission as FCMs
would not be required to file financial reports under Sec. 23.106, and
would continue to comply with the FCM financial reporting obligations
set forth in Sec. 1.10 of the Commission's regulations.
The proposed financial statements under part 23 would include a
statement of financial condition; a statement of income or loss; a
statement of cash flows; and a statement of changes in stockholders',
members', partners', or sole proprietor's equity. The financial
statements also would include a schedule reconciling the firm's equity,
as set forth in the statement of financial condition, to the firm's
regulatory capital by detailing any goodwill or other intangible assets
that are required to be deducted from the SD's or MSP's equity in order
to compute its net tangible equity as required under proposed Sec.
23.101. The schedule would further disclose the firm's minimum required
capital under Sec. 23.101 as of the end of the month or end of its
fiscal year, as applicable, and the amount of regulatory capital it
held at such date.
The proposed financial statements would be required to be prepared
in accordance with generally accepted accounting principles as
established in the United States, using the English language, and in
U.S dollars. The unaudited financial statements would be required to be
filed within 17 business days of the end of each month and the annual
audited financial statements would be required to be filed within 90
days of the end of the SD's or MSP's fiscal year.
Proposed Sec. 23.106 also would authorize the Commission to
require a SD or MSP that was not subject to regulation by a prudential
regulator to
[[Page 27814]]
file with the Commission additional financial or operational
information, and to prepare and to keep current ledgers or other
similar records which show or summarize each transaction affecting the
SD's or MSP's asset, liability, income, expense and capital accounts.
These accounts would be required to be classified in accordance with
United States generally accepted accounting principles. Proposed Sec.
23.106 also would provide that the comprehensive data records
supporting the information contained in the SD's or MSP's unaudited and
annual audited financial reports must be maintained and retained for a
period of five years pursuant to Sec. 1.31 of the Commission's
regulations.
2. SD and MSP Notice Filing Requirements
Proposed Sec. 23.105 would require SDs and MSPs to provide the
Commission, and the registered futures association of which the SDs or
MSPs are members, with written notice in the event of certain
enumerated financial or operational issues. The proposal is intended to
provide the Commission and the appropriate registered futures
association with timely notice of potentially adverse financial or
operational issues that may warrant immediate attention and ongoing
surveillance. The proposed notice requirements are comparable to the
notice requirements currently existing for FCMs under Sec. 1.12 of the
Commission's regulations. Proposed Sec. 23.105 would not be applicable
to SDs and MSPs that are registered as FCMs. Such SDs and MSPs would be
subject to the FCM notice requirements set forth in Sec. 1.12 and, as
noted above, such requirements are comparable to the proposed SD and
MSP notice requirements set forth in Sec. 23.105.
Proposed Sec. 23.105 also would not be applicable to SDs or MSPs
that are subject to the capital requirements of a prudential regulator,
with the exception of two provisions that are discussed below. SDs and
MSPs that are subject to capital requirements imposed by a prudential
regulator would be subject to the applicable financial surveillance
program of its prudential regulator. The first exception is the
proposed requirement in Sec. 23.105(c) that a SD or MSP that is
subject to the capital rules of a prudential regulator file notice with
the Commission and with a registered futures association if the SD or
MSP fails to maintain compliance with the minimum capital requirements
established by its prudential regulator. The second exception is set
forth in proposed Sec. 23.105(e) which requires an SD or MSP to
provide the Commission with notice if it fails to maintain current
books and records.
While the prudential regulator will be assessing such an SD's or
MSP's financial condition, the Commission believes that notice of a
CFTC registrant's failure to maintain compliance with applicable
minimum capital requirements is critical information that may impact
the Commission's assessment and monitoring of the SD's or MSP's ongoing
compliance with applicable non-capital CFTC regulations and the SD's or
MSP's potential adverse impact on counterparties, including other
Commission registered SDs and MSPs.
The proposed notice provisions would require a SD or MSP to give
telephonic notice to the Commission, followed by a written notice,
whenever it knows or should know that the firm does not maintain
tangible net equity in excess of its minimum requirement under Sec.
23.101. The SD or MSP also would be required to file documentation
containing a calculation of its current tangible net equity with its
notice of undercapitalization.
Proposed Sec. 23.105 also would require a SD or MSP to file a
written notice with the Commission whenever its tangible net equity
fails to exceed 110 percent of its minimum tangible net equity
requirement as computed under Sec. 23.101. The SD or MSP would be
required to file the notice within 24 hours of failing to maintain
tangible net equity at a level that is 110 percent or more above its
minimum tangible net equity requirement. Proposed Sec. 23.105 also
would require a registered SD or MSP to provide written notice of its
failure to maintain current books and records, or of a substantial
reduction in capital as previously reported to the Commission.
E. Proposed Financial Reporting and Other Amendments to FCM Regulations
Relating to Customer Cleared Swap Transactions
The Commission issued in December 2010 an advanced notice of
proposed rulemaking seeking comment on possible models to implement
section 4d(f)(2) of the CEA, as added by section 724 of the Dodd-Frank
Act, which provides that funds deposited by customers to margin a
cleared swap transaction shall not be commingled with the funds of the
FCM or used to margin, guarantee or secure the positions of any other
customer other than the customer that deposited the funds.\49\ The
Commission is proposing in this release amendments to certain FCM
financial reporting requirements in Sec. Sec. 1.10, 1.12, and 1.16 of
the Commission's regulations to address the segregation of swap
customers' funds. The proposed financial reporting requirements are
similar to the current financial reporting requirements that FCMs must
meet with respect to the segregation of customer funds deposited under
section 4d(a)(2) of the CEA as margin for futures contracts and options
on futures contracts executed on a designated contract market. The
Commission is further proposing to amend Sec. 1.17 to provide that
certain capital charges relating to undermargined customer and
noncustomer accounts extends to undermargined customer and noncustomer
accounts that carry cleared swap transactions.
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\49\ 75 FR 75162 (Dec. 2, 2010).
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1. Financial Reporting Requirements in Sec. 1.10
Regulation 1.10 currently requires each FCM to prepare and to file
unaudited financial condition reports, Form 1-FR-FCM, within 17
business days of the close of business each month. The Form 1-FR-FCM is
required to be filed with the Commission and with the FCM's DSRO. An
FCM also is required to file a Form 1-FR-FCM audited by an independent
public accountant as of the end of the FCM's fiscal year. The audited
financial Form 1-FR-FCM is required to be filed with the Commission and
with the FCM's DSRO organization within 90 calendar days of the date of
the FCM's fiscal year end.
Regulation 1.10(d) provides that each unaudited and audited Form 1-
FR-FCM must include: a Statement of Financial Condition; a Statement of
the Computation of Minimum Capital Requirements; a Statement of Income
(Loss); a Statement of Changes in Ownership Equity; a Statement of
Changes in Liabilities Subordinated to Claims of General Creditors
Pursuant to a Satisfactory Subordination Agreement; a Statement of
Segregation Requirements and Funds in Segregation for Customers Trading
on U.S. Commodity Exchanges; and a Statement of Secured Amounts and
Funds Held in Separate Accounts for Foreign Futures and Options
Customers Pursuant to Sec. 30.7.
The Commission is proposing to amend Sec. Sec. 1.10(d)(1) and (2)
to include a new Statement of Cleared Swap Customer Segregation
Requirements and Funds in Cleared Swap Customer Accounts Under 4d(f) of
the CEA in both the unaudited monthly Form 1-FR-FCM and the audited
annual Form
[[Page 27815]]
1-FR-FCM, respectively. This Statement is comparable to the statement
required for the segregation of customer funds for trading on
designated contract markets, the Statement of Segregation Requirements
and Funds in Segregation for Customers Trading on U.S. Commodity
Exchanges. The proposed swap segregation statement is intended to
provide an FCM that carries accounts for customers that maintain
cleared swap positions with a schedule to document and to demonstrate
its compliance with its obligation to treat, and deal with all money,
securities, and property of any swap customer received to margin,
guarantee, or secure a swap cleared by or through a derivates clearing
organization (including money, securities, or property accruing to swap
customers as the result of such a swap) as belonging to the FCM's swap
customers as required by section 4d of the CEA as amended by section
724 of the Dodd-Frank Act.
Pursuant to the proposal, each FCM would be required to include the
Statement of Cleared Swap Customer Segregation Requirements and Funds
in Cleared Swap Customer Accounts Under 4d(f) of the CEA in both its
unaudited monthly financial Form 1-FR-FCM filings and its annual
audited Form 1-FR-FCM filings. In addition, each FCM would be required
to include a reconciliation of any material reconciling items between
the Statement of Cleared Swap Customer Segregation Requirements and
Funds in Cleared Swap Customer Accounts Under 4d(f) of the CEA
contained in the audited annual Form 1-FR-FCM and the corresponding
unaudited monthly financial Form 1-FR-FCM filed as of the FCM's year
end date, or include a statement that there were no material
reconciling items.
The Commission also is proposing to amend Sec. 1.10(g)(2)(ii) to
provide that an FCM's Statement of Cleared Swap Customer Segregation
Requirements and Funds in Cleared Swap Customer Accounts Under 4d(f) of
the CEA will not be treated as exempt from mandatory public disclosure
under the Freedom of Information Act and the Government in the Sunshine
Act and Parts 145 and 147 of Chapter I of the Commission's regulations.
This proposed amendment would treat the public disclosure of an FCM's
financial information regarding the holding of funds for customers'
cleared swap transactions in a manner that is consistent with the
public disclosure of information regarding the segregation of customer
funds for trading on U.S. commodity exchanges, and regarding the
securing of customer funds for trading on foreign boards of trade
pursuant to Sec. 30.7 of the Commission's regulations.
The Commission is further proposing a technical amendment to Sec.
1.10(c)(1), which directs an FCM, and other registrants, to file the
reports and other information required by Sec. 1.10 with Commission's
Regional Office with jurisdiction over the registrant's principal place
of business. Commission Sec. 140.02 establishes the jurisdiction of
each Regional Office over filing requirements of registrants based upon
the geographic location of the principal business office of the
registrants. In order to clarify where a registrant should file
required financial information with the Commission, the Commission
proposes to amend Sec. 1.10(c) to include a reference to the
geographic listing in Sec. 140.02 of the Commission's regulations.
Except for the technical amendment described above, the other
proposed amendments implementing reporting requirements for funds of
cleared swap customers would not be adopted or effective unless the
Commission adopts, after issuing proposed rules for comment,
regulations establishing requirements for collateral posted by cleared
swap customers under section 4d(f) of the CEA.
2. Audited Financial Statement Requirements in Sec. 1.16
The Commission is proposing to amend Sec. 1.16 of the Commission's
regulations. Regulation 1.16 sets forth the qualifications that an
independent public accountant must meet to be qualified to conduct the
annual examinations of an FCM as required by Sec. 1.10(b)(1)(ii), and
establishes the minimum audit objectives of the independent
accountant's examination of an FCM.
Regulation 1.16(c)(2) provides that the accountant's report on the
audit of an FCM must state whether the audit was made in accordance
with generally accepted auditing standards and must designate any
auditing procedures deemed necessary by the accountant under the
circumstances of the particular case which have been omitted and the
reason for the omission of such procedures. Regulation 1.16(c)(3)
further provides that the accountant's report must clearly state the
opinion of the accountant with respect to the financial statements and
schedules covered by the report and the accounting principles and
practices reflected therein.
Regulation 1.16(d) sets forth the required audit objective of the
accountant's examination of the financial statements of an FCM and
provides, in relevant part, that the audit must be made in accordance
with generally accepted auditing standards and must include a review
and appropriate tests of the accounting systems, the internal
accounting controls, and the procedures for safeguarding customer and
firm assets in accordance with the CEA and Commission regulations,
since the last examination date. The scope of the audit and review of
the FCM's accounting systems, the internal accounting controls, and
procedures for safeguarding customer and firm assets must be sufficient
to provide reasonable assurance that any material inadequacies existing
at the dates of the examination in (1) The accounting systems, (2) the
internal accounting controls, and (3) the procedures for safeguarding
customer and firm assets (including the segregation requirements of
section 4d(a)(2) of the CEA and Commission regulations, and the secured
amount requirements of the CEA and part 30 of the Commission's
regulations) will be discovered. Regulation 1.16(d) further provides
that as specified objectives the audit must include reviews of the
practices and procedures followed by the FCM in making daily
computations of the segregation requirements of section 4d(a)(2) of the
CEA and the secured amount requirements of part 30 of the Commission's
regulations.
The proposed amendments would revise Sec. 1.16 to include the
proposed new Statement of Cleared Swap Customer Segregation
Requirements and Funds in Cleared Swap Customer Accounts Under 4d(f) of
the CEA within the explicit audit scope of the examination of an FCM.
Specifically, the Commission is proposing to amend the term
``customer'' as defined in Sec. 1.16(a)(4) to include an FCM's swap
customers that engage in cleared swap transactions. The proposed
amendment would bring cleared swap positions carried in swap customers'
accounts explicitly within the scope of the accountant's audit
objectives, as set forth in Sec. 1.16(d), which includes the review
and appropriate testing of the accounting systems, the internal
accounting control, and the procedures for safeguarding customer and
firm assets.
The Commission also proposes to amend Sec. 1.16(d)(1) to
explicitly provide that the scope of the independent accountant's
review of the accounting systems, internal accounting controls, and
procedures for safeguarding customer assets must be sufficient to
provide reasonable assurance that any
[[Page 27816]]
material inadequacy existing as of the date of the examination in (1)
the accounting system, (2) the internal accounting controls, and (3)
the procedures for safeguarding customer and firms assets will be
discovered includes the cleared swap segregation requirements as set
forth in section 4d(f) of the CEA. The Commission further proposes to
amend Sec. 1.16(d)(2) to include as a material inadequacy in the
accounting systems, internal accounting controls, and the procedures
for the safeguarding customer and firm assets that are required to be
reported to the Commission any conditions which contribute
substantially to or, if appropriate corrective action is not taken,
could reasonably be expected to result in a violation of the
requirement to segregate swap customers' funds.
The proposed amendments to Sec. 1.16 would not be adopted or
effective unless the Commission adopts, after issuing proposed rules
for comment, regulations establishing segregation requirements for
collateral posted by cleared swap customers under section 4d(f) of the
CEA. As previously noted, the Commission published an advanced notice
of proposed rulemaking on this topic on December 2, 2010.
3. Early Warning Requirements in Sec. 1.12
Regulation 1.12 requires an FCM to provide notice to the Commission
and to the FCM's DSRO of certain material financial or operational
events. The self-reporting of these financial and operational events by
an FCM is a key to the Commission's and self-regulatory organizations'
financial surveillance oversight programs as such notices may lead to
the discovery of accounting, recordkeeping, risk management, or other
regulatory failures that require prompt attention to safeguard customer
funds and to protect the clearing system.
Regulation 1.12(b) is referred to as the ``early warning capital
provisions'' and currently requires an FCM to file written notice with
the Commission and with its DSRO whenever its adjusted net capital is
less than: (1) 150 percent of the minimum dollar amount of adjusted net
capital required by Sec. 1.17(a)(1)(i)(A); (2) 150 percent of the
amount of adjusted net capital required by a registered futures
association of which the FCM is a member (except if the registered
futures association has adopted a margin-based capital rule, then the
FCM is required to file a written notice if its adjusted net capital is
less than 110 percent of its minimum adjusted net capital requirement
as computed under the registered futures association's margin-based
capital requirement); or (3) 110 percent of the FCM's margin-based
capital requirement as computed under Sec. 1.17(a)(1)(i)(B). An FCM
that also is registered with the SEC as a broker or dealer is required
to provide the Commission with written notice whenever it fails to
maintain net capital (as defined in SEC Rule 15c3-1) in an amount that
exceeds the ``early warning level'' set forth in SEC Rule 17a-11(c).
The early warning capital provisions are intended to provide the
Commission and the FCM's DSRO with prompt notice of potential adverse
financial or operational issues that may impact the FCM's ability to
meet its obligations to its customers and the clearing system, and
provide an opportunity for Commission and DSRO staff to review the
financial condition of an FCM that does not maintain a significant
amount of excess adjusted net capital prior to the firm falling under
the minimum net capital requirement.
The Commission is proposing to amend Sec. 1.12(b) by adding a new
paragraph (b)(5) to require any FCM that also is registered with the
SEC as a SSD or a MSSP to file a notice with the Commission if the SSD
or MSSP fails to maintain net capital above the minimum ``early warning
level'' established by rules or regulations of the SEC. The proposed
new paragraph (b)(5) would provide the Commission and the FCM's DSRO
with an opportunity to review the financial condition of an FCM and, if
necessary, to assess possible courses of regulatory action to protect
customer funds and to review potential financial risk presented by the
FCM to the clearing system.
The Commission also is proposing to amend Sec. 1.12(f)(4).
Regulation 1.12(f)(4) requires an FCM to provide immediate notice by
telephone communication, followed by immediate written confirmation,
whenever any commodity futures, options, cleared swaps, or other
Commission regulated account that the FCM carries is subject to a
margin call, or a call for other deposits required by the FCM, that
exceeds the FCM's excess adjusted net capital determined under Sec.
1.17, and the call for additional deposits has not been answered by the
close of business on the day following the issuance of the call.
The Commission intends for all of the notice provisions of Sec.
1.12 to apply, as applicable, to FCMs that carry swap customer
accounts. The Commission, however, believes it is necessary to amend
Sec. 1.12(f)(4) due to the reference in the regulation to ``commodity
interest'' accounts. The term ``commodity interest'' is defined in
Sec. 1.3(yy) as any contract for the purchase or sale of a commodity
for future delivery and any contract, agreement, or transaction
submitted under section 4c of the CEA. To avoid any confusion and to
ensure that an FCM provides the Commission and its self-regulatory
organizations with appropriate early warning notice, the Commission is
proposing to amend Sec. 1.12(f)(4) to require notice of a failure of
the owner of any commodity futures, option, swap, or other Commission
regulated account carried by the FCM to meet a margin call that exceeds
the FCM's excess adjusted net capital. The proposed amendment is
intended to ensure that an FCM is required to file a written notice if
a customer account containing cleared swap transactions fails to meet a
margin call that exceeds the FCM's excess adjusted net capital.
The Commission also is proposing to amend Sec. 1.12(h) to require
an FCM to provide the Commission and its DSRO with immediate notice by
telephone, confirmed immediately in writing, if the amount of funds on
deposit in accounts segregated for the benefit of the FCM's swap
customers is less than the amount that the FCM is required to hold in
such accounts. The proposed amendment to Sec. 1.12(h) would impose an
obligation upon the FCM that is consistent with an FCM's current
obligation to provide immediate telephone notice, confirmed by writing,
whenever the FCM fails to maintain the amount of funds in customer
segregated or secured accounts as required by Sec. 1.20 and Sec.
30.7, respectively.
4. Amendments to 1.17 for FCMs With Cleared Swaps Customers
The Commission proposes to amend Commission regulation
1.17(c)(2)(i) by adding references to cleared swap customers to this
regulation, which currently provides that FCMs must exclude from
current assets any unsecured commodity futures and options account (as
amended, this would include cleared swaps customers and other
Commission regulated accounts) containing a ledger balance and open
trades, the combination of which liquidates to a deficit or containing
a debit ledger balance only: Provided, however, Deficits or debit
ledger balances in unsecured customers', non-customers', and
proprietary accounts, which are the subject of calls for margin or
other required deposits may be included in current assets until the
close of business on the business day following the date on which such
deficit or debit ledger balance originated providing that the account
had timely satisfied, through the deposit of new funds, the previous
day's debit or deficits, if any, in its
[[Page 27817]]
entirety. The Commission is also proposing to add similar references to
cleared swap accounts of customers in Sec. Sec. 1.17(c)(5)(viii) and
(ix), which requires certain capital charges when the accounts of
customer or noncustomers are undermargined.
The Commission also is proposing to amend provisions in Sec.
1.17(c)(5)(v) that require an FCM to incur a capital charge not only on
its proprietary securities included in the FCM's calculation of
adjusted net capital, but also for securities held in customer
segregated accounts when such securities were not deposited in
segregation by a specific customer (i.e., the securities were purchased
with cash held in the customer segregated accounts). The purpose of
both of these capital requirements is to ensure that the FCM maintains
a capital cushion in order to cover potential decreases in the value of
the securities. The proposed rule would further require the FCM to
incur a capital charge for any securities purchased by the FCM using
funds belonging to the FCM's customers and held in the secured accounts
for customers trading on foreign markets pursuant to Sec. 30.7 or in
segregated accounts for cleared swap customers pursuant to section
4d(f) of the CEA.
C. Request for Comment
The Commission requests comment on all aspects of the proposed
capital and financial reporting regulations. In particular, the
Commission request comment on the following:
(1) The Commission's capital proposal for SDs and MSPs includes a
minimum dollar level of $20 million. A non-bank SD or MSP that is part
of a U.S. bank holding company would be required to maintain a minimum
of $20 million of Tier 1 capital as measured under the capital rules of
the Federal Reserve Board. An SD or MSP that also is registered as an
FCM would be required to maintain a minimum of $20 million of adjusted
net capital as defined under Sec. 1.17. In addition, an SD or MSP that
is not part of a U.S. bank holding company or registered as an FCM
would be required to maintain a minimum of $20 million of tangible net
equity, plus the amount of the SD's or MSP's market risk exposure and
OTC counterparty credit risk exposure.
The Commission requests comment on the amount of the proposed
minimum dollar amount of regulatory capital. Should the minimum dollar
amount of capital be set at a higher or lower level? Is a consistent
$20 million of minimum regulatory capital appropriate for all SDs and
MSPs?
(2) The Commission is proposing in Sec. 23.101 to incorporate bank
capital requirements into the CFTC capital requirements by requiring
non-bank SDs and MSPs that are part of a U.S. bank holding company to
meet bank capital requirements. The Commission requests comment on the
appropriateness of the proposed incorporation of banking capital
regulations in the terms of Sec. 23.101 for such SDs or MSPs.
(3) The Commission is proposing in Sec. 23.101 to establish a
regulatory capital requirement that is based upon tangible net equity
if the SD or MSP is not: (1) An FCM; (2) part of a U.S. bank holding
company; or (3) designated a SIFI. Proposed Sec. 23.102 provides that
tangible net equity shall be determined under generally accepted
accounting principles and shall exclude goodwill and other intangible
assets. The Commission requests comment on the proposed definition of
tangible net equity. Should all intangible assets be excluded?
(4) The Commission requests comment on the appropriateness of
establishing a minimum regulatory capital requirement based upon
tangible net equity for all SDs and MSPs that are not also registered
as FCMs, part of U.S. bank holding companies, or designated as SIFIs.
Specifically, is the tangible net equity method appropriate for SDs and
MSPs that are primarily engaged in non-financial operations? Is the
tangible net equity method appropriate for SDs and MSPs that are
primarily engaged in financial operations? Should minimum regulatory
capital requirements be established under a different method for SDs
and MSPs that are primarily financial or trading entities, such as
funds or trading firms? Should the Commission impose additional capital
or alternative capital requirements on financial firms that qualify to
use the tangible net equity approach? What additional or alternative
capital requirements would be appropriate for such firms?
(5) The proposed tangible net equity capital computation does not
require an SD or MSP to maintain the same level of highly liquid assets
as the Commission's current capital requirement for FCMs. Specifically,
the tangible net equity capital requirement would allow an SD or MSP to
include fixed assets and other illiquid assets in meeting its
regulatory capital requirement. Should the capital requirement for the
tangible net equity method include a liquidity component that would
effectively require an SD or MSP to hold a defined amount of highly
liquid assets? What factors should the Commission consider in adopting
a liquidity requirement?
(6) One possible approach to a minimum liquidity requirement is to
require an SD or MSP to hold unencumbered liquid assets equal to the
sum of the total amount of initial margin that the SD or MSP would have
to post with a counterparty for all uncleared swap transactions and the
total amount of any unpaid variation margin that the SD or MSP owes to
any counterparty. Liquid assets that could qualify for purposes of the
liquidity requirement could be limited to cash, obligations guaranteed
by the U.S., and obligations of government sponsored entities. Such
assets could be part of the general operating assets of the SD or MSP
and would not have to be held or ``segregated'' in any special account
by the SD or MSP. Assets posted by the SD or MSP with custodians as
margin on uncleared swap transactions could be included in meeting the
liquidity requirement. The qualifying liquid assets also could be
subject to market value haircuts set forth in the proposed margin rule
Sec. 23.157(c). The Commission request comment on this approach to the
computation of a liquidity requirement. If the Commission were to adopt
such a liquidity requirement, would it be appropriate to incorporate
minimum margin thresholds that would have to be exceeded before the SD
or MSP was subject to the liquidity requirement? For example, should
the Commission consider a rule that would impose a liquidity
requirement only if the SD's or MSP's initial and variation margin
obligations on uncleared swaps exceeded a minimum threshold? How would
such thresholds be determined? What are the appropriate market value
haircuts that should be imposed?
(7) The Commission is proposing to amend Sec. 1.17 to specify
capital charges for uncleared swap transactions held by an FCM. The
Commission request comment on the appropriateness of the proposed
calculations. Furthermore, the Commission request comment on viable
alternative methods to compute capital charges for uncleared swap
positions. Specifically, the Commission requests comment on whether
capital charges should be based upon the margin calculations that would
be required to be conducted under Part 23 of the proposed regulations.
(8) SDs and MSPs that also are registered as FCMs are required
under Sec. 1.17(c)(2)(ii) to exclude unsecured receivables from
counterparties to OTC transactions in determining their adjusted net
capital under Sec. 1.17. Certain SDs or MSPs that also are
[[Page 27818]]
registered as FCMs, however, may elect to use internal models to
compute credit risk charges under Sec. 1.17(c)(6) if they comply with
the Commission's requirements set forth in Sec. 1.17(c)(6) and have
previously obtained an order from the SEC approving the use of such
models for purpose of computing regulatory capital. In addition,
proposed Sec. 1.17(c)(7) would permit SDs and MSPs that also are
registered FCMs to seek Commission approval under Sec. 23.103 to use
internal models to compute credit risk charges for OTC derivatives
transactions in lieu of the current 100 percent capital charge for
unsecured receivables.
The Commission seeks comment on the appropriateness of allowing SDs
and MSPs that also are registered as FCMs and have received approval to
use internal models to compute their capital requirements to use such
models to reduce the 100 percent capital charge for unsecured
receivables arising from uncleared OTC swap transactions. The
Commission requests comment on this issue as it is concerned that SDs
and MSPs may have significant unsecured receivables for uncleared swap
transactions that are not subject to variation margin requirements
(e.g., bilateral swap positions entered into prior to the effective
date of the Dodd-Frank Act). If such SDs and MSPs also were to register
as FCMs, the unsecured receivables could have a significant impact on
the financial condition of the FCMs and adversely impact the FCMs'
customers if the debtor were to default.
(9) The Commission solicits comment on all of the proposed rules
related to the use of internal models for computing market risk and
counterparty credit risk for capital purposes. Specifically, comment is
requested regarding what resources, expertise, and capacity SDs and
MSPs ought to have in order to be approved to use internal models.
(10) The Commission solicits comment regarding whether it is
appropriate to permit SDs and MSPs to use internal models for computing
market risk and counterparty credit risk charges for capital purposes
if such models have been approved by a foreign regulatory authority and
are subject to periodic assessment by such foreign regulatory
authority. What criteria should the Commission consider in assessing
whether to approve or to accept a model approved by a foreign
regulatory authority?
(11) The Commission previously has proposed regulations that
require each SD and MSP to promptly report to the Commission any swap
valuation dispute not resolved within one business day if the
counterparty is SD or MSP, or five business days if the counterparty is
not an SD or MSP.\50\ The Commission requests comment on whether it is
appropriate to require an SD or MSP to take a capital charge for the
amount of any valuation dispute. Should the SD or MSP take a capital
charge immediately upon learning of a valuation dispute, or should the
capital charge be taken after one business day or five business days
depending on whether the counterparty is an SD/MSP or a non-SD/MSP,
respectively? What role should margin deposits have on the calculation
of the capital charge? Are there any other issues that the Commission
should consider?
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\50\ See, proposed Sec. 23.504(e) at 76 FR 6715 (Feb. 8, 2011).
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(12) What are the costs to counterparties resulting from the
capital requirements being proposed by the Commission?
(13) FCMs currently file monthly unaudited financial statements
with the Commission, and the Commission is proposing to extend this
monthly filing requirement to SDs and MSPs. The Commission seeks
comment regarding the frequency of the filing of SD and MSP unaudited
financial statements. Specifically, what challenges and costs are
associated with monthly financial statement filings? Would the
Commission receive adequate financial information from SDs and MSPs if
they filed on a quarterly basis? Are there other financial statements
or schedules other than, or in addition to, the proposed statements and
schedules that the Commission should require from SDs and MSPs?
(14) The Commission is proposing in Sec. 23.106(i) to make
available to the public regulatory capital information provided by each
SD and MSP in their financial statement filings with the Commission.
Specifically, the Commission would make publicly available for each SD
or MSP its minimum regulatory capital requirement, the amount of its
regulatory capital, and any excess or deficiency in its regulatory
capital. The disclosure of the regulatory capital information of SDs
and MSPs is consistent with the disclosure of FCM financial
information.
III. Conforming Amendments to Delegated Authority Provisions
Commission Sec. Sec. 1.10, 1.12, and 1.17 reserve certain
functions to the Commission, the greater part of which the Commission
has delegated to the Director of the Division of Clearing and
Intermediary Oversight through the provisions of Sec. 140.91 of the
Commission's regulations. The Commission proposes to amend Sec. 140.91
to provide similar delegations with respect to functions reserved to
the Commission in Part 23.
Proposed Sec. 23.101(c) would require an SD or MSP to be in
compliance with the minimum regulatory capital requirements at all
times and to be able to demonstrate such compliance to the Commission
at any time. Proposed Sec. 23.103(d) would require an SD or MSP, upon
the request of the Commission, to provide the Commission with
additional information regarding its internal models used to compute
its market risk exposure requirement and OTC derivatives credit risk
requirement. Proposed Sec. 23.105(a)(2) would require an SD or MSP to
provide the Commission with immediate notification if the SD or MSP
failed to maintain compliance with the minimum regulatory capital
requirements, and further authorizes the Commission to request
financial condition reporting and other financial information from the
SD or MSP. Proposed Sec. 23.105(d) authorizes the Commission to direct
an SD or MSP that is subject to capital rules established by a
prudential regulator, or has been designated a systemically important
financial institution by the Financial Stability Oversight Council and
is subject to capital requirements imposed by the Board of Governors of
the Federal Reserve System to file with the Commission copies of its
capital computations for any periods of time specified by the
Commission.
The Commission is proposing to amend Sec. 140.91 to delegate to
the Director of the Division of Clearing and Intermediary Oversight, or
the Director's designee, the authority reserved to the Commission under
proposed Sec. Sec. 23.101(c), 23.103(d), and 23.105(a)(2) and (d). The
delegation of such functions to staff of the Division of Clearing and
Intermediary Oversight is necessary for the effective oversight of SDs
and MSPs compliance with minimum financial and related reporting
requirements. The delegation of authority also is comparable to the
authorities currently delegated to staff of Division of Clearing and
Intermediary Oversight under Sec. 140.91 regarding the supervision of
FCMs compliance with minimum financial requirements.
The following provisions relating to margin requirements are also
proposed to be included in Part 140, in order to provide within Part
140 a complete listing of the functions reserved to the Commission
under Subpart E that are
[[Page 27819]]
proposed to be delegated to the Director of the Division of Clearing
and Intermediary Oversight. As proposed in this release, Part 140 would
include delegations for the Commission's ability under proposed Sec.
23.155(b)(4)(ii) and (iii), with respect to initial margin, and under
Sec. 23.155(c)(1) and (2) with respect to variation margin, to require
at any time that a covered swap entity (``CSE'') provide further data
or analysis concerning a model or methodology used to calculate margin,
or to modify a model or methodology to address potential
vulnerabilities. A similar delegation is provided for the Commission's
ability under Sec. 23.155(c)(4) to require at any time that the CSE
post or collect additional margin because of additional risk posed by a
particular product, or because of additional risk posed by a particular
party to the swap.
The Commission also is proposing in this release to delegate
authority with respect to the Commission's recently proposed Sec.
23.157(d), which would authorize the Commission to take the following
actions regarding margin assets: (i) Require a CSE to provide further
data or analysis concerning any margin asset posted or received; (ii)
require a CSE to replace a margin asset posted to a counterparty with a
different margin asset to address potential risks posed by the asset;
(iii) require a CSE to require a counterparty that is an SD, MSP, or a
financial entity to replace a margin asset posted with the CSE with a
different margin asset to address potential risks posed by the asset;
(iv) require a CSE to provide further data or analysis concerning
margin haircuts; or (v) require a CSE to modify a margin haircut
applied to an asset received from an SD, MSP, or a financial entity to
address potential risks posed by the asset.
Finally, under proposed Sec. 23.158(c), the Commission may at any
time require a CSE to provide further data or analysis concerning any
custodian holding collateral collected by the CSE. Further, the
Commission may at any time require a CSE participant to move assets
held on behalf of a counterparty to another custodian to address risks
posed by the original custodian. The Commission is proposing also to
include delegations in Part 140 with respect to these functions
reserved to the Commission under Sec. 23.158(c). Each of the proposed
delegations would be to the Director of the Division of Clearing and
Intermediary Oversight, with the concurrence of General Counsel. The
Commission requests comment on each of the proposed amendments to Sec.
140.91 described in this release.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \51\ requires that
agencies 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. The Commission has already established certain definitions of
``small entities'' to be used in evaluating the impact of its rules on
such small entities in accordance with the RFA.\52\ SDs and MSPs are
new categories of registrant. Accordingly, the Commission has not
previously addressed the question of whether such persons are, in fact,
small entities for purposes of the RFA.
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\51\ 5 U.S.C. 601 et seq.
\52\ 47 FR 18618 (Apr. 30, 1982).
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The Commission previously has determined that FCMs should not be
considered to be small entities for purposes of the RFA. The
Commission's determination was based in part upon their obligation to
meet the minimum financial requirements established by the Commission
to enhance the protection of customers' segregated funds and protect
the financial condition of FCMs generally.\53\ Like FCMs, SDs will be
subject to minimum capital and margin requirements, and are expected to
comprise the largest global financial firms. The Commission is required
to exempt from designation entities that engage in a de minimis level
of swap dealing in connection with transactions with or on behalf of
customers. Accordingly, for purposes of the RFA for this and future
rulemakings, the Commission is hereby proposing that SDs not be
considered ``small entities'' for essentially the same reasons that
FCMs have previously been determined not to be small entities.
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\53\ Id. at 18619.
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The Commission also has previously determined that large traders
are not ``small entities'' for RFA purposes.\54\ The Commission
considered the size of a trader's position to be the only appropriate
test for purposes of large trader reporting.\55\ MSPs maintain
substantial positions in swaps, creating substantial counterparty
exposure that could have serious adverse effects on the financial
stability of the United States banking system or financial markets.
Accordingly, for purposes of the RFA for this and future rulemakings,
the Commission is hereby proposing that MSPs not be considered ``small
entities'' for essentially the same reasons that large traders have
previously been determined not to be small entities.
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\54\ 47 FR at 18620.
\55\ Id.
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The Commission is carrying out Congressional mandates by proposing
these rules. The Commission is incorporating capital requirements of
SDs and MSPs into the existing regulatory capital frameworks. In so
doing, the Commission has attempted to formulate requirements in the
manner that is consistent with the public interest and existing
regulatory requirements. Accordingly, the Chairman, on behalf of the
Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the
proposed rules will not have a significant economic impact on a
substantial number of small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) \56\ imposes certain
requirements on Federal agencies (including the Commission) in
connection with their conducting or sponsoring any collection of
information as defined by the PRA. This proposed rulemaking, as well as
the proposed rulemaking on margin requirements for uncleared swaps,
which was first published in the Federal Register on April 28, 2011,
and is subject to a comment period that is being extended to correspond
with the comment period for these proposed capital requirements,
contain collections of information for which the Commission has
previously sought or received control number from the Office of
Management and Budget (``OMB''). This proposed rulemaking, as well as
the proposed rulemaking on margin requirements for uncleared swaps,
also would result in new mandatory collections of information within
the meaning of the PRA. Therefore, pursuant to the PRA, the Commission
is submitting a PRA proposal for both the capital and the margin rules,
in the form of an amendment to the Commission's existing collection
under OMB Control Number 3038-0024, to OMB for its review and approval
in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
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\56\ 44 U.S.C. 3501 et seq.
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1. Collections of Information
a. Schedule to Form 1-FR-FCM
The Commission has included as an exhibit to this proposed
rulemaking the additional schedule that the proposed amendments to
Sec. 1.10 would require FCMs to file with respect to the cleared swaps
of their customers. The collection of information required by the
amended Sec. 1.10 are necessary for the Commission's oversight of the
FCM's compliance with its minimum financial requirements under the CEA
and
[[Page 27820]]
implementing regulations of the Commission. The increase in the annual
reporting burden associated with OMB Collection of Information Control
No. 3038-004 would not be significant, as the Commission estimates that
a small percentage of FCMs (approximately 21 FCMs) would be required to
file the schedule, and the schedule will be included in the Form 1-FR-
FCM that they must already file with the Commission. The requirements
in part 23 also require monthly and annual financial reports to be
filed with the Commission. The Commission estimates that no more than
250 SDs and 50 MSPs would be required to file such reports. The
estimated burden of the proposed part 23 financial reporting
requirements was calculated as follows:
Estimated number of respondents: 300.
Reports annually by each respondent: 13.
Total annual responses: 3,900.
Estimated average number of hours per response: 2.75.
Annual reporting burden: 10,725.
b. Approval of Margin Models
In the rulemaking proposing margin requirements for uncleared
swaps, the Commission would require any SD or MSP to file its margin
model with the Commission for approval. Each filing must include an
explanation of the manner in which the model meets the requirements of
the margin rules; the mechanics of, theoretical basis of, and empirical
support for the model; and independent third party validation of the
model. The Commission would process filings for models that comply with
the minimum requirements established in the margin rules, or that are
currently used by a derivatives clearing organization for margining
cleared swaps, that are currently used by an entity subject to regular
assessment by a prudential regulator for margining uncleared swaps, or
that are made available for licensing by a vendor. At a later date, at
which point the Commission may have sufficient resources to evaluate
such models, the Commission may begin processing filings of proprietary
models to be used by SDs and MSPs.
The Commission cannot estimate with precision the frequency with
which margin model filings will be made by SDs and MSPs annually, as an
SD or MSP may be expected to make one initial filing and then to change
or supplement its margin model occasionally. In an attempt to provide
conservative estimates, the calculations below have been developed in
accordance with the Commission's estimate that there will be 250 SDs
and 50 MSPs that will register with it, and with the assumption that
40% of registrants will make 3 model filings per year with respect to
the margining of various swap instruments. The estimated average number
of hours per filing includes not only preparation of the filing, but
also the time associated with third party evaluation of the model.
Estimated number of respondents: 300.
Frequency of filings: One initial response, and then occasional
filings.
Filings annually by each respondent: One initial filing, and 1 to 3
occasional filings annually.
Total annual filings: 300 initial filings, and 360 occasional
filings annually.
Estimated average number of hours per filing: 60 hours.
Annual filing burden: 21,600.
c. Approval of Capital Models
In this rulemaking proposing capital requirements for SDs and MSPs,
the Commission would permit SDs and MSPs to use internal models to
calculate minimum capital requirements, subject to the submission of an
application to the Commission for approval of the internal model. The
application must address several factors, including: (1) Identifying
the categories of positions that the SD or MSP holds in its proprietary
accounts; (2) describing the methods that the SD or MSP will use to
calculate its market risk and credit risk capital requirements; (3)
describing the internal models; and (4) describing how the SD or MSP
will calculate current exposure and potential future exposure. The SD
or MSP also must explain the extent to which the models have been
reviewed and approved by the Federal Reserve Board or, as applicable,
the SEC.
The Commission cannot estimate with precision the frequency with
which SDs and MSPs will file applications with the Commission for the
use of internal capital models. At present, only those SDs or MSPs that
are subject to prudential regulation or regulation by the SEC will be
permitted to use internal models. The Commission cannot presently
determine which SDs and MSPs will be subject either to prudential
regulation or regulation by the SEC, how many of those SDs or MSPs will
file applications with the Commission, or how frequently those SDs and
MSPs may submit applications with respect to revised or new models. The
Commission additionally cannot presently determine at what time it may
be able to consider applications by SDs and MSPs that will be subject
solely to Commission regulation, or how many of those SDs and MSPs may
eventually file applications with the Commission.
In an attempt to provide conservative estimates, the calculations
below have been developed in accordance with the Commission's estimate
that there will be 250 SDs and 50 MSPs that will register with it, and
that 70% of those SDs and MSPs will file initial applications with the
Commission for the use of an internal model. The Commission
additionally estimates that in subsequent years, it will be asked to
review 30 capital models annually.
Estimated number of respondents: 300.
Frequency of responses: One initial response and then
occasional filings.
Reports by each respondent: 1 filing occasionally.
Total responses: 210 initial applications and 30
applications annually.
Estimated average number of hours per response: 30 for
applicants presently using internal capital models, 60 for each
application not subject to approval by a prudential regulator or the
SEC.
Reporting burden: 630 hours initial applications, and up
to 1,800 hours annually.
d. Approval of Counterparty Credit Ratings
This proposed capital rulemaking permits an SD or MSP, which is
required to apply a credit risk factor to its counterparties, to apply
to the Commission for approval to assign internal individual ratings to
each of its counterparties, or for an affiliated bank or affiliated
broker-dealer to do so. The Commission does not have experience with
such an application process, and therefore cannot estimate with
precision the burden hours associated with this regulatory provision.
In an attempt to provide conservative estimate, the Commission
estimates that it may receive up to 4 applications per year from 70% of
the 300 anticipated SDs and MSPs that may use internal application
models, and that the preparation and submission of these applications
would consume up to 8 hours per application. At such time as the
Commission is able to approve internal models of SDs and MSPs that are
not subject to prudential regulation, the Commission estimates that it
will receive up to 4 applications per year from an additional 20% of
SDs and MSPs.
Estimated Number of Respondents: 270.
Frequency of Responses: Up to 4 applications annually.
[[Page 27821]]
Total Annual Responses: 840 applications initially, and an
additional 240 applications eventually.
Estimated average number of hours per response: 8.
Annual Reporting burden: 6,720 initially, plus an
additional 1,920 eventually.
e. Recordkeeping and Occasional Reporting Obligations
In this proposed capital rulemaking, the Commission would require
SDs and MSPs to present certain information to the Commission on
request. Proposed Sec. 23.104 would authorize the Commission to
require an SD or MSP that is not subject to prudential regulation to
file with the Commission additional financial or operational
information, and to prepare and to keep current ledgers or other
similar records which show or summarize each transaction affecting the
SD's or MSP's asset, liability, income, expense and capital accounts.
Under proposed Sec. 23.105, the Commission would require each
registered SD or MSP subject to prudential supervision, or each SD or
MSP designated as a SIFI, to provide to the Commission, on request,
copies of its capital computations and accompanying schedules and other
supporting documentation demonstrating compliance with the applicable
prudential regulator with jurisdiction over the SD or MSP.
SDs and MSPs additionally will be required to keep comprehensive
data records supporting the information contained in the SD's or MSP's
unaudited and annual audited financial reports for a period of five
years. SDs and MSPs using internal capital models also would be
obligated to make and keep current a record of the basis for the credit
rating it applies to each of its counterparties for a period of five
years.
The Commission is unable to estimate with precision how many
requests it will make of SDs and MSPs under proposed Sec. Sec. 23.104
and 23.105 annually. Additionally, it is unable to estimate with
precision the number of records an SD or MSP will be obligated to keep
related to the credit rating it applies to its counterparties. In an
attempt to provide conservative estimates, the Commission anticipates
that it will make 200 requests under Sec. Sec. 23.104 and 23.105 in
the aggregate annually, and that responding to those requests would
consume 5 burden hours. It is estimated that recordkeeping of monthly
and annual reports, estimated at 3,900 records, would consume .4 burden
hours. And, it is estimated that .7 burden hours would be consumed by
210 SDs and MSPs initially and 270 SDs and MSPs eventually to keep
credit rating bases for up to an average of 75 counterparties annually.
i. Occasional Reporting Obligations
Estimated Number of Respondents: 200.
Frequency of Responses: Occasional.
Total Annual Responses: 200.
Estimated average number of hours per response: 5 hours.
Annual Reporting burden: 1,000.
ii. Recordkeeping Obligations
Estimated Number of Recordkeepers: 300.
Estimated Number of Records per Recordkeeper: Average 94
initially and 89 eventually.
Total Annual Recordkeeping: 19,650 initially and 24,150
eventually.
Estimated average number of hours for recordkeeping: .4
burden hours for 3,900 records, .7 burden hours for 15,750 records
initially, and .7 burden hours for 16,905 records eventually.
Annual recordkeeping burden: 12,585 initially and 13,393
eventually.
f. Occasional Notice Filings
Finally, the proposed capital rulemaking contains provisions that
would require registered SDs and MSPs to provide notice to the
Commission in the event that certain material financial or operational
events occur. These include the notice filing obligations contained in
Sec. 1.12 and in proposed Sec. Sec. 23.104 and 23.105. In an attempt
to provide conservative estimates, the Commission anticipates receiving
up to 90 occasional notices annually and that the burden of providing
those notices will consume up to .7 burden hours.
Estimated Number of Respondents: 90.
Frequency of Responses: Occasional.
Total Annual Responses: 90.
Estimated average number of hours per response: .7.
Annual Reporting burden: 63.
2. Information Collection Comments
The Commission invites the public and other Federal agencies to
comment on any aspect of the proposed information collection
requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission will consider public comments on such proposed requirements
in:
Evaluating whether the proposed collections of information
are necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
Evaluating the accuracy of the estimated burden of the
proposed information collection requirements, including the degree to
which the methodology and the assumptions that the Commission employed
were valid;
Enhancing the quality, utility, and clarity of the
information proposed to be collected; and
Minimizing the burden of the proposed information
collection requirements on FCMs, SDs, and MSPs, including through the
use of appropriate automated, electronic, mechanical, or other
technological information collection techniques, e.g., permitting
electronic submission of responses.
Copies of the submission from the Commission to OMB are available
from the CFTC Clearance Officer, 1155 21st Street, NW., Washington, DC
20581, (202) 418-5160 or from http://RegInfo.gov. Organizations and
individuals desiring to submit comments on the proposed information
collection requirements should send those comments to the OMB Office of
Information and Regulatory Affairs at:
The Office of Information and Regulatory Affairs, Office
of Management and Budget, Room 10235, New Executive Office Building,
Washington, DC 20503, Attn: Desk Officer of the Commodity Futures
Trading Commission;
(202) 395-6566 (fax); or
OIRAsubmissions@omb.eop.gov (e-mail).
Please provide the Commission with a copy of submitted comments so
that all comments can be summarized and addressed in the final rule
preamble. Please refer to the ADDRESSES section of this rulemaking and
the margin rulemaking for instructions on submitting comments to the
Commission. OMB is required to make a decision concerning the proposed
information collection requirements between thirty (30) and sixty (60)
days after publication of the NPRM in the Federal Register. Therefore,
a comment to OMB is best assured of receiving full consideration if OMB
(as well as the Commission) receives it within thirty (30) days of
publication of this NPRM.
C. Cost-Benefit Analysis
Section 15(a) of the CEA \57\ requires the Commission to consider
the costs and benefits of its action before issuing a rulemaking under
the CEA. By its terms, Section 15(a) does not require the Commission to
quantify the costs and benefits of a rule or to determine whether the
benefits of the rulemaking outweigh its costs; rather, it simply
[[Page 27822]]
requires that the Commission ``consider'' the costs and benefits of its
actions. Section 15(a) further specifies that the costs and benefits
shall be evaluated in light of five broad areas of market and public
concern: (1) Protection of market participants and the public; (2)
efficiency, competitiveness and financial integrity of futures markets;
(3) price discovery; (4) sound risk management practices; and (5) other
public interest considerations. The Commission may in its discretion
give greater weight to any one of the five enumerated areas and could
in its discretion determine that, notwithstanding its costs, a
particular rule is necessary or appropriate to protect the public
interest or to effectuate any of the provisions or accomplish any of
the purposes of the CEA.
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\57\ 7 U.S.C. 19(a).
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Summary of proposed requirements. The proposed regulations would
implement provisions in Sections 4s(e), (d), and (f) of the Act, which
were added by Section 731 of the Dodd-Frank Act. Sections 4s(e), (d),
and (f) authorize the Commission to adopt regulations imposing capital
requirements and financial condition reporting requirements on SDs and
MSPs. The proposed capital requirements would only apply to SDs and
MSPs that are not subject to regulation by a prudential regulator. The
financial condition reporting requirements primarily apply to SDs and
MSPs that are not subject to regulation by a prudential regulator.
The proposed regulations also amend existing requirements for FCMs.
Section 724 of the Dodd-Frank Act adds a new Section 4d(f) of the Act,
which requires an FCM to segregate from its own assets any money,
securities, and property deposited by swap customers to margin,
guarantee, or secure swap transactions cleared by or through a
derivatives clearing organization. The proposed regulations would
require each FCM holding customer funds for cleared swap customers to
prepare a monthly Statement of Cleared Swap Customer Segregation
Requirements and Funds in Cleared Swap Customer Accounts under 4d(f) of
the CEA (Cleared Swap Segregation Statement). The Cleared Swap
Segregation Statement would be filed as part of the FCMs Form 1-FR-FCM.
The proposal also would amend the notice filing requirements and
capital requirements for FCMs.
Structure of the Analysis
The Commission has decided to propose capital rules for SDs and
MSPs falling under four separate categories: (C1) Those that are
affiliates of U.S. bank holding companies (BHCs) and are not registered
as FCMs; (C2) those that are not affiliated with a BHC and are not
registered as FCMs; (C3) those that are affiliates of a BHC and are
registered as FCMs; (C4) those that are not affiliated with a BHC and
are registered as FCMs. Costs and benefits for each of these four
categories is discussed relative to one of two approaches: (D1) What
constitutes capital follows the current practice for the given
category, and the method for determining the amount of required capital
follows an internal models based approach approved by a prudential
regulator; (D2) what constitutes capital is tangible net equity, and
the method for determining the amount of required capital follows an
internal models based approach approved by a prudential regulator. The
first approach, D1, which defines capital as bank capital per the Basel
Accords, applies to C1 (affiliates of BHCs that are not FCMs). D1 also
applies to C3 (affiliates of BHCs that are FCMs) and C4 (non-affiliates
of BHCs that are FCMs); in which cases, the definition of capital is
adjusted net capital per Regulation 1.17.\58\ The second approach, D2,
which defines capital as tangible net equity, applies to C2 (non-
affiliates of BHCs that are not FCMs).
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\58\ Strictly speaking, for D1 to apply to C1, the method for
determining capital needs to be Basel III, whereas for D1 to apply
to C3 and C4, the method for determining capital needs to be
Regulation 1.17 coupled with an allowance for calculating market
risk and credit risk capital using internal models. The common
feature here is the allowed used of approved internal models. The
subsequent analysis abstracts away from any potential differences.
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1. Costs and Benefits of the Proposed Rule to C1 (Affiliates of BHCs
That Are Not FCMs) and C3 (Affiliates of BHCs That Are FCMs)
The rules proposed by the Commission for non-bank subsidiaries of
BHCs would be the capital rules of the prudential regulator unless the
SD or MSP was an FCM, in which case the capital rules would be the
Commission's current FCM capital rules.
The Commission notes that the five prudential regulators have
recently issued proposed rules that would not impose new capital
requirements on the swap entities subject to their prudential
supervision. Instead, the swap entities are required to comply with the
regulatory capital rules already made applicable to them by their
prudential regulators. As noted by the prudential regulators:
The Agencies have preliminarily determined that compliance with
these regulatory capital requirements is sufficient to offset the
greater risk to the swap entity and the financial system arising
from the use of non-cleared swaps, helps ensure the safety and
soundness of the covered swap entity, and is appropriate for the
greater risk associated with the non-cleared swaps and non-cleared
security-based swaps held as a [swap entity]. In particular, the
Agencies note that the capital rules incorporated by reference into
the proposed rule already address, in a risk-sensitive and
comprehensive manner, the safety and soundness risks posed by a
[swap entity's] derivatives positions. In addition, the Agencies
preliminarily believe that these capital rules sufficiently take
into account and address the risks associated with the derivatives
positions that a covered swap entity holds and the other activities
conducted by a covered swap entity. (internal footnotes
omitted).\59\
\59\ See joint proposed rulemaking issued by the prudential
regulators on April 12, 2011, titled ``Margin and Capital
Requirements for Covered Swap Entities.''
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The Commission is anticipating that some number of nonbank
subsidiaries of BHCs will register with the Commission in order to hold
positions that Section 716 of the Dodd-Frank Act may require federally
insured bank subsidiaries to ``push out'' into affiliates within the
same bank holding company structure. The number of such potential
registrants is not known, but the Commission has proposed rules that
would result in the same capital requirements regardless of which non-
FCM subsidiary within the bank holding company organization holds the
positions. This approach produces neither any material costs nor
benefits relative to D1, defined as bank capital per the Basel
Accords.\60\ The only difference between the proposed rule affecting C1
(affiliate of a BHC that is not an FCM) and the current banking
regulatory requirements is the proposed minimum regulatory capital
requirement of $20 million. The Commission has requested comment on
whether this minimum would result in undue burdens on potential ``push
out'' registrants.
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\60\ This is not to say that the proposed rules for bank capital
requirements are without costs and benefits measured with respect to
some to-be-specified alternative. It is only to say that a
discussion of such costs and benefits is beyond the scope of this
analysis.
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To further promote consistent treatment where an FCM is also a
subsidiary of a BHC, the Commission has proposed amendments to Sec.
1.17 to allow it to compute its capital using internal models that have
been approved by the Federal Reserve Board, or as applicable, the SEC.
Following parallel logic as stated above, the effect of the proposed
rule on C3 (affiliate of a BHC that is an FCM), therefore, is to
produce neither any material costs nor benefits with respect to the
alternative.
[[Page 27823]]
2. Costs and Benefits of the Proposed Rule to C2 (Non-Affiliates of
BHCs That Are Not FCMs) and C4 (Non-Affiliates of BHCs That Are FCMs)
For SDs/MSPs that are not affiliated with BHCs and are not FCMs
(C2), the tangible net equity approach would not place undue
restrictions on an affected firm's working capital. This approach takes
into consideration comments received at a public roundtable held
jointly by the CFTC and SEC on December 10, 2010, which included
representatives from each of the five prudential regulators. Industry
commenters noted that some portion of SD and MSP registrants may
include commercial or other entities for whom the costs of compliance
with either FCM or bank regulatory capital requirements could be
substantial, and that such rules may not fully recognize the ability of
such firms to act as financially responsible SDs and MSPs by excluding
some of their valuable assets from being counted towards regulatory
capital.
SDs and MSPs that are not affiliated with BHCs and are not FCMs
(C2) and SDs and MSPs that not affiliates of a BHC and are FCMs (C4)
might not be permitted to use models. Rather they might have to use the
standardized Basel approach. C2 (non-affiliate of BHCs that are not
FCMs) would be required to follow the tangible net equity method with a
standardized Basel approach with respect to credit and market risks. C4
(non-affiliates that are FCMs) would be required to follow Sec. 1.17,
which generally does not include models. Consequently, while C2 and C4
do not share a common capital definition, the costs and benefits of
each relate to the potential for SDS and MSPs potentially being subject
to a less risk-sensitive (i.e., standardized) capital charge than if
they had been permitted to use an internal models based approach to
capital determination.
In this case, the cost of requiring an SD/MSP to take a
standardized capital charge for some period of time (perhaps,
indefinitely) is the opportunity cost on the potentially higher capital
requirement under the standardized approach measured relative to an
internal models based approach. When determining its proposed rules,
the Commission took into consideration commitments by international
regulators to develop risk-sensitive capital requirements for SDs and
MSPs. As noted in an October 2010 of the Financial Stability Board:
Supervisors should apply prudential requirements that
appropriately reflect the risks, including systemic risks, of non-
centrally cleared OTC derivatives products, such as the reforms
proposed by [Basel Committee on Banking Supervision] relating to
higher capital requirements * * *.\61\
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\61\ See ``Implementing OTC Derivatives Market Reforms'', report
of the Financial Stability Board (FSB) dated October 25, 2010, at p.
34. The FSB was formed in 2009 by representatives of the G-20
countries as a successor to the Financial Stability Forum, formed by
the G-7 countries in 1999.
Under the proposed rules, the amount of capital that these SDs and
MSPs must hold would be determined by proposed market risk and OTC
credit risk requirements that are based on internationally recognized
Based Accord ``standardized'' methodologies for assessing market risk
and OTC derivatives credit risk. The requirements would apply only to
uncleared swaps of the SD that are associated with its swap activities,
and also would apply to any related hedge positions. These proposed
requirements would establish risk sensitive capital requirements that
would require SDs and MSPs to hold increasing or decreasing levels of
capital as the risk of proprietary positions that they carry increases
or decreases, although the level of risk sensitivity achieved under
these requirements may prove less than the corresponding level
attributable to a well calibrated internal model.
To the extent that the proposed rules would limit the potential use
of models, they would potentially increase capital requirements. This
potential cost, in turn, needs to be balanced against the operational
cost to the Commission of validating internal capital models, as well
as the potential model risk arising from an internal models based
capital calculation that turns out to be less conservative than the
corresponding standardized calculation. Since both potential increased
capital requirements resulting under the proposed rules as well as
forgone investment opportunities attributable to that increased capital
are difficult to assess, the Commission invites comment.
Finally, if increased capital requirements result under the
proposed rules, such requirements may promote financial integrity by
reducing the aggregate amount of capital at risk, with the cost of this
reduction being paid in terms of reduced return expectations. Depending
on the level of the increased capital required and the effect it has on
the willingness of market participants to engage in swaps transactions,
market efficiency may be negatively impacted through the introduction
of higher costs. Any significant reduction in market participation
would be anticipated to exercise correspondingly negative consequences
on price discovery through reductions in liquidity.
Public Comment. The Commission invites public comment on its cost-
benefit considerations. Commenters also are invited to submit any data
or other information that they may have quantifying or qualifying the
costs and benefits of the Proposal with their comment letters.
List of Subjects
17 CFR Part 1
Brokers, Commodity futures, Reporting and recordkeeping
requirements.
17 CFR Part 23
Swaps, Swap dealers, Major swap participants, Capital and margin
requirements.
17 CFR Part 140
Authority delegations (Government agencies).
For the reasons stated in this release, the Commission proposes to
amend chapter I of title 17 of the Code of Federal Regulations, by
amending in that chapter part 1; part 23, as proposed to be added at 75
FR 71379, published November 23, 2010; and part 140, as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for part 1 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 9a, 12, 12a,
16, 18, 19, 21, and 23.
2. Amend Sec. 1.10 by revising paragraphs (c), (d)(1)(v),
(d)(2)(iv), (d)(2)(vi), and (g)(2)(ii) to read as follows:
Sec. 1.10 Financial reports of futures commission merchants and
introducing brokers.
* * * * *
(c) Where to file reports. (1) Form 1-FR filed by an introducing
broker pursuant to paragraph (b)(2) of this section need be filed only
with, and will be considered filed when received by, the National
Futures Association. Other reports or information provided for in this
section will be considered filed when received by the regional office
of the Commission with jurisdiction over the state in which the
registrant's principal place of business is located (as set forth in
Sec. 140.02 of this chapter) and by the designated self-regulatory
organization, if any; and reports or other information required to be
filed by this section by an applicant for registration will be
considered filed when received
[[Page 27824]]
by the National Futures Association. Any report or information filed
with the National Futures Association pursuant to this paragraph shall
be deemed for all purposes to be filed with, and to be the official
record of, the Commission.
* * * * *
(d) * * *
(1) * * *
(v) For a futures commission merchant only, the statements of
segregation requirements and funds in segregation for customers trading
on U.S. commodity exchanges and for customers' dealer options accounts,
the statement of secured amounts and funds held in separate accounts
for foreign futures and foreign options customers in accordance with
Sec. 30.7 of this chapter, and the statement of cleared swap customer
segregation requirements and funds in cleared swap customer accounts
under section 4d(f) of the Act as of the date for which the report is
made; and
* * * * *
(2) * * *
(iv) For a futures commission merchant only, the statements of
segregation requirements and funds in segregation for customers trading
on U.S. commodity exchanges and for customers' dealer options accounts,
the statement of secured amounts and funds held in separate accounts
for foreign futures and foreign options customers in accordance with
Sec. 30.7 of this chapter, and the statement of cleared swap customer
segregation requirements and funds in cleared swap customer accounts
under section 4d(f) of the Act as of the date for which the report is
made;
* * * * *
(vi) A reconciliation, including appropriate explanations, of the
statement of the computation of the minimum capital requirements
pursuant to Sec. 1.17 of this part and, for a futures commission
merchant only, the statements of segregation requirements and funds in
segregation for customers trading on U.S. commodity exchanges and for
customers' dealer option accounts, the statement of secured amounts and
funds held in separate accounts for foreign futures and foreign options
customers in accordance with Sec. 30.7 of this chapter, and the
statement of cleared swap customer segregation requirements and funds
in cleared swap customer accounts under section 4d(f) of the Act, in
the certified Form 1-FR with the applicant's or registrant's
corresponding uncertified most recent Form 1-FR filing when material
differences exist or, if no material differences exist, a statement so
indicating; and
* * * * *
(g) * * *
(2) * * *
(ii) The following statements and footnote disclosures thereof: the
Statement of Financial Condition in the certified annual financial
reports of futures commission merchants and introducing brokers; the
Statements (to be filed by a futures commission merchant only) of
Segregation Requirements and Funds in Segregation for customers trading
on U.S. commodity exchanges and for customers' dealer options accounts,
and the Statement (to be filed by a futures commission merchant only)
of Secured Amounts and Funds held in Separate Accounts for foreign
futures and foreign options customers in accordance with Sec. 30.7 of
this chapter, and the Statement (to be filed by futures commission
merchants only) of Cleared Swap Customer Segregation Requirements and
Funds in Cleared Swap Customer Accounts under section 4d(f) of the Act.
3. Amend Sec. 1.12 by:
a. Revising paragraphs (b)(3), (b)(4), (f)(4), and (h); and
b. Adding paragraph (b)(5).
The revisions and addtion read as follows:
Sec. 1.12 Maintenance of minimum financial requirements by futures
commission merchants and introducing brokers.
* * * * *
(b) * * *
(3) 150 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member, unless such
amount has been determined by a margin-based capital computation set
forth in the rules of the registered futures association, and such
amount meets or exceeds the amount of adjusted net capital required
under the margin-based capital computation set forth in Sec.
1.17(a)(1)(i)(B) of this part, in which case the required percentage is
110 percent,
(4) For securities brokers or dealers, the amount of net capital
specified in Rule 17a-11(c) of the Securities and Exchange Commission
(17 CFR 240.17a-11(c)), or
(5) For security-based swap dealers or material security-based swap
participants, the amount of net capital specified in the rules of the
Securities and Exchange Commission that impose comparable reporting
requirements as set forth in this paragraph (b), must file written
notice to that effect as set forth in paragraph (i) of this section
within twenty-four (24) hours of such event.
* * * * *
(f) * * *
(4) A futures commission merchant shall report immediately by
telephone, confirmed immediately in writing by facsimile notice,
whenever any commodity futures, option, swap or other Commission
regulated account it carries is subject to a margin call, or call for
other deposits required by the futures commission merchant, that
exceeds the futures commission merchant's excess adjusted net capital,
determined in accordance with Sec. 1.17 of this part, and such call
has not been answered by the close of business on the day following the
issuance of the call. This applies to all accounts carried by the
futures commission merchant, whether customer, noncustomer, or omnibus,
that are subject to margining, including commodity futures, options on
futures, and swap positions. In addition to actual margin deposits by
an account owner, a futures commission merchant may also take account
of favorable market moves in determining whether the margin call is
required to be reported under this paragraph.
* * * * *
(h) Whenever a person registered as a futures commission merchant
knows or should know that the total amount of its funds on deposit in
segregated accounts on behalf of customers, that the total amount set
aside on behalf of customers trading on non-United States markets, or
that the total amount of its funds in segregated accounts on behalf of
customers for cleared swap transactions is less than the total amount
of such funds required by the Act and the Commission's rules to be on
deposit in segregated futures accounts, secured amount accounts, or
segregated cleared swap accounts, the registrant must report such
deficiency immediately by telephone notice, confirmed immediately in
writing by facsimile notice, to the registrant's designated self-
regulatory organization and the principal office of the Commission in
Washington, DC, to the attentions of the Director and the Chief
Accountant of the Division of Clearing and Intermediary Oversight.
* * * * *
4. Amend Sec. 1.16 by revising paragraphs (a)(4), (d)(1), and
(d)(2)(iv) to read as follows:
Sec. 1.16 Qualifications and reports of accountants.
(a) * * *
(4) Customer. The term ``customer'' includes a customer as defined
in
[[Page 27825]]
Sec. 1.3(k) of this part; a cleared swaps customer as defined in Sec.
22.2 of this chapter; and a foreign futures or foreign options customer
as defined in Sec. 30.1(c) of this chapter.
* * * * *
(d) Audit objectives. (1) The audit must be made in accordance with
generally accepted auditing standards and must include a review and
appropriate tests of the accounting system, the internal accounting
controls, and the procedures for safeguarding customer and firm assets
in accordance with the provisions of the Act and the regulations
thereunder, since the prior examination date. The audit must include
all procedures necessary under the circumstances to enable the
independent licensed or certified public accountant to express an
opinion on the financial statements and schedules. The scope of the
audit and review of the accounting system, the internal controls, and
procedures for safeguarding customer and firm assets must be sufficient
to provide reasonable assurance that any material inadequacies existing
at the date of the examination in the accounting system, the internal
accounting controls, and the procedures for safeguarding customer and
firm assets (including, in the case of a futures commission merchant,
the segregation requirements of section 4d(a)(2) of the Act and these
regulations, the secured amount requirements of the Act and these
regulations, and the segregation requirements for cleared swap
positions under section 4d(f) of the Act and these regulations) will be
discovered. Additionally, as specified objectives the audit must
include reviews of the practices and procedures followed by the
registrant in making periodic computations of the minimum financial
requirements pursuant to Sec. 1.17 of this chapter and in the case of
a futures commission merchant, daily computations of the segregation
requirements of section 4d(a)(2) of the Act and these regulations, the
secured amount requirements of the Act and these regulations, and the
segregation requirements for cleared swap positions under section 4d(f)
of the Act and these regulations.
(2) * * *
(iv) Result in violations of the Commission's segregation, secured
amount or cleared swaps segregation amount (in the case of a futures
commission merchant), recordkeeping or financial reporting requirements
to the extent that could reasonably be expected to result in the
conditions described in paragraph (d)(2)(i), (ii), or (iii) of this
section
* * * * *
5. Amend Sec. 1.17 by:
a. Revising paragraph (a)(1)(i)(A);
b. Revising paragraph (b)(2);
c. Revising paragraph (b)(9);
d. Revising paragraph (c)(2)(i);
e. Revising paragraphs (c)(2)(ii)(D) and (G);
f. Adding paragraphs (c)(5)(iii) and (iv);
g. Revising paragraphs (c)(5)(v), (viii), and (ix);
h. Revising paragraph (c)(6); and
i. Redesignating paragraphs (c)(7) and (c)(8) as paragraphs (c)(8)
and (c)(9) and add new paragraph (c)(7).
The revisions and additions read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
(a)(1)(i) * * *
(A) $1,000,000, Provided, however, that if the futures commission
merchant also is a registered swap dealer, the minimum amount shall be
$20,000,000;
* * * * *
(b) * * *
(2) Customer. This term means customer as defined in Sec. 1.3(k)
of this chapter; cleared over the counter customer as defined in Sec.
1.17(b)(10) of this chapter, and includes a foreign futures or foreign
options customer as defined in Sec. 30.1(c) of this chapter.
* * * * *
(9) Cleared over the counter derivative positions means over the
counter derivative instruments, including swaps as defined in section
1a(47) of the Act, of any person in accounts that are carried on the
books of the futures commission merchant and cleared by any
organization permitted to clear such instruments under the laws of the
relevant jurisdiction, including cleared swaps as defined in section
1a(7) of the Act.
* * * * *
(c) * * *
(2) * * *
(i) Exclude any unsecured commodity futures, option, cleared swap,
or other Commission regulated account containing a ledger balance and
open trades, the combination of which liquidates to a deficit or
containing a debit ledger balance only: Provided, however, Deficits or
debit ledger balances in unsecured customers', non-customers', and
proprietary accounts, which are the subject of calls for margin or
other required deposits may be included in current assets until the
close of business on the business day following the date on which such
deficit or debit ledger balance originated providing that the account
had timely satisfied, through the deposit of new funds, the previous
day's debit or deficits, if any, in its entirety.
(ii) * * *
(D) Receivables from registered futures commission merchants or
brokers, resulting from commodity futures, options, cleared swaps, or
other Commission regulated transactions, except those specifically
excluded under paragraph (c)(2)(i) of this section;
* * * * *
(G) Receivables from third-party custodians that arise from initial
margin deposits associated with bilateral swap transactions pursuant to
Sec. 23.158 of this chapter.
(5) * * *
(iii) For positions in over-the-counter interest rate swaps that
are not cleared by a clearing organization, the following amounts:
(A) If not hedged with U.S. Treasury securities of corresponding
maturities or matched with offsetting interest rate swap positions with
corresponding terms and maturities, the applicable haircut shall be the
notional amount of the interest rate swaps multiplied by the applicable
percentages for the underlying securities specified in Rule 240.15c3-
1(c)(2)(vi)(A)(i) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(2)(vi)(A)(i)), as if such notional amount was the market
value of a security issued or guaranteed as to principal or interest by
the United States;
(B) If hedged with U.S. Treasury securities of corresponding
maturities or matched with offsetting interest rate swap positions with
corresponding terms and maturities, and such interest rate swaps are
maturing in ten years or less, the applicable haircut shall be one
percent of the notional amount of the interest rate swaps; and
(C) If hedged with U.S. Treasury securities of corresponding
maturities or matched with offsetting interest rate swap positions with
corresponding terms and maturities, and such interest rate swaps are
maturing in excess of ten years, the applicable haircut shall be three
percent of the notional amount of the interest rate swaps;
(iv) For the net position in the following:
(A) Over-the-counter credit default swaps that are not cleared by a
clearing organization, the notional principal amount multiplied by the
applicable percentages, as determined by the underlying securities and
the remaining maturity of the swap agreement, that are
[[Page 27826]]
specified in Rule 240.15c3-1(c)(2)(vi) of the Securities and Exchange
Commission (17 CFR 240.15c3-1(c)(2)(vi)) (``securities haircuts'') and
100 percent of the value of ``nonmarketable securities'' as specified
in Rule 240.15c3-1(c)(2)(vii) of the Securities and Exchange Commission
(17 CFR 240.15c3-1(c)(2)(vii));
(B) Over-the-counter equity swaps that are not cleared by a
clearing organization, 15 percent of the notional principal amount;
(C) Over-the-counter foreign currency swap transactions involving
euros, British pounds, Canadian dollars, Japanese yen, or Swiss francs,
6 percent of the notional principal amount of the swap transaction;
(D) Over-the-counter foreign currency swap transactions involving
currencies other than euros, British pounds, Canadian dollars, Japanese
yen, or Swiss francs, 20 percent of the notional principal amount of
the swap transaction;
(E) Over-the-counter commodity swaps, 20 percent of the market
value of the notional amount of the underlying commodities; or
(F) Over-the-counter swap transactions involving an underlying
instrument that is not listed in paragraph (c)(5)(iv)(A), (B), (C),
(D), or (E) of this section, 20 percent of the effective notional
principal amount of the swap transaction.
(v) In the case of securities and obligations used by the applicant
or registrant in computing net capital, and in the case of a futures
commission merchant with securities in segregation pursuant to sections
4d(a)(2) and 4d(f) of the Act and the regulations in this chapter, and
Sec. 30.7 secured accounts as set forth in part 30 of this chapter,
which were not deposited by customers, the percentages specified in
Rule 240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission (17
CFR 240.15c3-1(c)(2)(vi)) (``securities haircuts'') and 100 percent of
the value of ``nonmarketable securities'' as specified in Rule
240.15c3-1(c)(2)(vii) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(2)(vii));
* * * * *
(viii) In the case of a futures commission merchant, for
undermargined customer commodity futures, options, cleared swaps or
other Commission regulated accounts the amount of funds required in
each such account to meet maintenance margin requirements of the
applicable board of trade or if there are no such maintenance margin
requirements, clearing organization margin requirements applicable to
such positions, after application of calls for margin or other required
deposits which are outstanding three business days or less. If there
are no such maintenance margin requirements or clearing organization
margin requirements, then the amount of funds required to provide
margin equal to the amount necessary after application of calls for
margin or other required deposits outstanding three business days or
less to restore original margin when the original margin has been
depleted by 50 percent or more: Provided, To the extent a deficit is
excluded from current assets in accordance with paragraph (c)(2)(i) of
this section such amount shall not also be deducted under this
paragraph (c)(5)(viii). In the event that an owner of a customer
account has deposited an asset other than cash to margin, guarantee or
secure his account, the value attributable to such asset for purposes
of this subparagraph shall be the lesser of the value attributable to
the asset pursuant to the margin rules of the applicable board of
trade, or the market value of the asset after application of the
percentage deductions specified in this paragraph (c)(5);
(ix) In the case of a futures commission merchant, for
undermargined commodity futures, options, cleared swaps, or other
Commission regulated noncustomer and omnibus accounts the amount of
funds required in each such account to meet maintenance margin
requirements of the applicable board of trade or if there are no such
maintenance margin requirements, clearing organization margin
requirements applicable to such positions, after application of calls
for margin or other required deposits which are outstanding two
business days or less. If there are no such maintenance margin
requirements or clearing organization margin requirements, then the
amount of funds required to provide margin equal to the amount
necessary after application of calls for margin or other required
deposits outstanding two business days or less to restore original
margin when the original margin has been depleted by 50 percent or
more: Provided, To the extent a deficit is excluded from current assets
in accordance with paragraph (c)(2)(i) of this section such amount
shall not also be deducted under this paragraph (c)(5)(ix). In the
event that an owner of a noncustomer or omnibus account has deposited
an asset other than cash to margin, guarantee or secure his account the
value attributable to such asset for purposes of this subparagraph
shall be the lesser of the value attributable to such asset pursuant to
the margin rules of the applicable board of trade, or the market value
of such asset after application of the percentage deductions specified
in this paragraph (c)(5);
* * * * *
(6) * * *
(i)(A) Any futures commission merchant that is also registered with
the Securities and Exchange Commission as a securities broker or
dealer, and who also satisfies the other requirements of this paragraph
(c)(6), may elect to compute its adjusted net capital using the
alternative capital deductions that the Securities and Exchange
Commission has approved by written order, provided, however, that such
order was dated before May 12, 2011;
(B) If an election under this paragraph (c)(6) was authorized
before the date specified in paragraph (c)(6)(i)(A) of this section,
and the futures commission merchant otherwise remains in compliance
with this paragraph (c)(6), a futures commission merchant that is
permitted by the Securities and Exchange Commission to use alternative
capital deductions for its unsecured receivables from over-the-counter
transactions in derivatives, or for its proprietary positions in
securities, commodities, forward contracts, swap transactions, options,
or futures contracts, may continue to use these same alternative
capital deductions when computing its adjusted net capital in lieu of
the standard deductions otherwise specified in this section.
(C) If a futures commission merchant computing alternative
deductions under paragraph (c)(6)(B) of this section is also registered
with the Commission as swap dealer or major swap participant, or
registered with the Securities and Exchange Commission as a security-
based swap dealer or major security-based swap participant, the
alternative deductions approved under this paragraph (c)(6) shall
remain effective only if the futures commission merchant has filed an
application under Sec. 23.103 of this chapter and the application is
pending approval. A denial or approval of an application made under
Sec. 23.103 shall also terminate approval of alternative deductions
under this paragraph (c)(6). The futures commission merchant's capital
deductions must thereafter be calculated as required under the terms of
the Commission's order issued under Sec. 23.103.
* * * * *
(7) Any futures commission merchant that is also registered as a
swap dealer
[[Page 27827]]
or major swap participant, or is also registered as a security-based
swap dealer or major security-based swap participant, and which has
received approval of its application to the Commission under Sec.
23.103 of this chapter for capital computations using the firm's
internal models, shall calculate its adjusted net capital in accordance
with the terms and conditions of such Commission approval.
* * * * *
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
6. The authority citation for part 23 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b-1, 6c, 6p, 6r, 6s, 6t, 9,
9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
7. Part 23, as proposed to be added at 75 FR 71379, November 213,
2010, is amended by adding Subpart E to read as follows:
Subpart E--Capital and Margin Requirements for Swap Dealers and
Major Swap Participants
Sec.
23.100 Definitions applicable to capital requirements.
23.101 Minimum financial requirements for swap dealers and major
swap participants.
23.102 Tangible net equity.
23.103 Calculation of market risk exposure requirement and over-the-
counter derivatives credit risk requirement using internal models.
23.104 Calculation of market risk exposure requirement and over-the-
counter derivatives credit risk requirement when models are not
approved.
23.105 Maintenance of minimum financial requirements by swap dealers
and major swap participants.
23.106 Financial recordkeeping and reporting requirements for swap
dealers and major swap participants.
23.107-23.149 [Reserved]
Sec. 23.100 Definitions applicable to capital requirements.
For purposes of Sec. Sec. 23.101 through 23.149 of subpart E, the
following terms are defined as follows:
Market risk exposure. This term means the risk of loss resulting
from movements in market prices. Market risk exposure includes
``specific risk'' (referring to those risks that affect the market
value of a specific instrument, such as the credit risk of the issuer
of the particular instrument, but do not materially alter broad market
conditions), and it also includes market risk in general (referring to
the change in the market value of a particular asset that results from
broad market movements, such as a change in market interest rates,
foreign exchange rates, equity prices, and commodity prices).
Market risk exposure requirement. This term refers to the amount
that the registered swap dealer or major swap participant is required
to compute under Sec. 23.104, or to compute using internal models as
approved under Sec. 23.103.
Over-the-counter derivatives credit risk. This term refers to the
risk that the counterparty to an over-the-counter transaction could
default before the final settlement of the transaction's cash flows.
Over-the-counter derivatives credit risk requirement. This term
refers to the amount that the registered swap dealer or major swap
participant is required to compute under Sec. 23.104, or to compute
using internal models approved under Sec. 23.103.
Prudential regulator. This term has the same meaning as set forth
in section 1a(39) of the Act, and includes 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, as applicable
to a swap dealer or major swap participant.
Regulatory capital requirement. This term refers to each of the
capital requirements that Sec. 23.101 of this part applies to a swap
dealer or major swap participant.
Sec. 23.101 Minimum financial requirements for swap dealers and major
swap participants.
(a)(1) Except as provided in paragraph (a)(2), (3), or (4) of this
section, each registered swap dealer must meet or exceed the greatest
of the following regulatory capital requirements:
(i) Tangible net equity (as defined in Sec. 23.102 of this part)
in an amount equal to $20,000,000 plus the amounts calculated under
this part for the swap dealer's market risk exposure requirement and
its over-the-counter derivatives credit risk requirement associated
with swap positions and related hedge positions that are part of the
swap dealer's swap activities; or,
(ii) The amount of capital required by a registered futures
association of which the swap dealer is a member.
(2) Except as provided in paragraph (a)(3) or (4) of this section,
each registered swap dealer that is a subsidiary of a U.S. bank holding
company must meet or exceed the greatest of the following regulatory
capital requirements:
(i) $20 million of Tier 1 capital as defined in 12 CFR part 225,
appendix A, Sec. II.A;
(ii) The swap dealer's minimum risk-based ratio requirements set
forth in 12 CFR part 225, and any appendices thereto, as if the swap
dealer itself were a U.S. bank-holding company; or,
(iii) The amount of capital required by a registered futures
association of which the swap dealer is a member.
(3) A registered swap dealer that is subject to minimum capital
requirements established by rule or regulation of a prudential
regulator, or a registered swap dealer that also is a registered
futures commission merchant subject to the capital requirements of
Sec. 1.17 of this chapter, is not subject to the regulatory capital
requirements set forth in paragraph (a)(1) or (2) of this section.
(4) A registered swap dealer that is a U.S. nonbank financial
company that has been designated a systemically important financial
institution by the Financial Stability Oversight Council and subject to
supervision by the Board of Governors of the Federal Reserve System is
not subject to the regulatory capital requirements set forth in
paragraph (a)(1) or (2) of this section.
(b)(1) Except as provided in paragraph (b)(2), (3), or (4) of this
section, each major swap participant must meet or exceed the greatest
of the following regulatory capital requirements:
(i) Tangible net equity (as defined in Sec. 23.102 of this part)
in an amount equal to $20,000,000 plus the amounts calculated under
this part for the major swap participant's market risk exposure
requirement and its over-the-counter derivatives credit risk
requirement associated with its swap positions and related hedge
positions; or
(ii) The amount of capital required by a registered futures
association of which the major swap participant is a member.
(2) Except as provided in paragraph (b)(3) or (4) of this section,
each registered major swap participant that is a subsidiary of a U.S.
bank-holding company must meet or exceed the greatest of the following
regulatory capital requirements:
(i) $20 million of Tier 1 capital as defined in 12 CFR part 225,
appendix A, section II.A;
(ii) The major swap participant's minimum risk-based ratio
requirements set forth in 12 CFR part 225, and any appendices thereto,
as if the major swap participant itself were a U.S. bank-holding
company; or,
(iii) The amount of capital required by a registered futures
association of which the major swap participant is a member.
[[Page 27828]]
(3) A registered major swap participant that is subject to minimum
capital requirements established by rule or regulation of a prudential
regulator, or a registered major swap participant that also is a
registered futures commission merchant subject to the capital
requirements of Sec. 1.17 of this chapter, is not subject to the
regulatory capital requirements set forth in paragraph (b)(1) or (2) of
this section.
(4) A registered major swap participant that is a U.S. nonbank
financial company that has been designated a systemically important
financial institution by the Financial Stability Oversight Council and
subject to supervision by the Board of Governors of the Federal Reserve
System is not subject to the regulatory capital requirements set forth
in paragraph (b)(1) or (2) of this section.
(c)(1) Before any applicant may be registered as a swap dealer or
major swap participant, the applicant must demonstrate to the
satisfaction of the National Futures Association one of the following:
(i) Its compliance with the applicable regulatory capital
requirements in paragraphs (a)(1), (2), (b)(1) or (2) of this section;
(ii) that it is a futures commission merchant that complies with
Sec. 1.17 of this chapter;
(iii) that its minimum regulatory capital requirements are
supervised by a prudential regulator in paragraph (a)(3) or (b)(3) of
this section; or
(iv) that it is designated by the Financial Stability Oversight
Council as a systemically important financial institution and subject
to supervision by the Federal Reserve Board under paragraph (a)(4) or
(b)(4) of this section.
(2) Each swap dealer and major swap participant subject to the
minimum capital requirements set forth in paragraphs (a) and (b) of
this section must be in compliance with the Commission's minimum
capital requirements at all times and must be able to demonstrate such
compliance to the satisfaction of the Commission.
Sec. 23.102 Tangible net equity.
(a) Tangible net equity is a swap dealer's or major swap
participant's equity as determined under U.S. generally accepted
accounting principles, and excludes goodwill and other intangible
assets.
(b)(1) Subject to the provisions of paragraph (b)(2) of this
section:
(i) Tangible net equity is computed by consolidating in a single
computation assets and liabilities of any subsidiary or affiliate for
which the swap dealer or major swap participant guarantees, endorses,
or assumes directly or indirectly the obligations or liabilities; or
(ii) If an opinion of outside counsel is obtained as provided for
in paragraph (b)(3) of this section, a swap dealer or major swap
participant may elect to consolidate assets and liabilities of a
subsidiary or affiliate whose liabilities and obligations have not been
guaranteed, endorsed, or assumed directly or indirectly by the swap
dealer or major swap participant, but which is majority owned and
controlled by the swap dealer or major swap participant.
(2) If the consolidation required or permitted under paragraph
(b)(1) of this section results in the increase of the swap dealer's or
major swap participant's tangible net equity or decreases the minimum
regulatory capital requirement, such benefits shall not be recognized
unless an opinion of counsel meeting the requirements of paragraph
(b)(3) of this section has been obtained by the swap dealer or major
swap participant.
(3) For purposes of paragraph (b)(1) or (2) of this section, the
swap dealer or major swap participant shall demonstrate by written
opinion of outside counsel that the net asset values or the portion
thereof related to the parent's ownership interest in the subsidiary or
affiliate, may be caused by the swap dealer or major swap participant
or an appointed trustee, to be distributed to the swap dealer or major
swap participant within 30 calendar days. Such opinion also must set
forth the actions necessary to cause such a distribution to be made,
identify the parties having the authority to take such actions,
identify and describe the rights of other parties or classes of
parties, including but not limited to customers, general creditors,
subordinated lenders, minority shareholders, employees, litigants, and
governmental or regulatory authorities, who may delay or prevent such a
distribution and such other assurances as the Commission by rule or
interpretation may require. Such opinion must be current and
periodically renewed in connection with the swap dealer's or major swap
participant's annual audit pursuant to part 23 of this title or upon
any material change in circumstances.
(4) In preparing a consolidated computation of tangible net equity:
(i) Consolidated tangible net equity shall be reduced by the
estimated amount of any tax reasonably anticipated to be incurred upon
distribution of the assets of the subsidiary or affiliate; and
(ii) Each swap dealer or major swap participant included within the
consolidation shall at all times be in compliance with the regulatory
capital requirements to which it is subject.
(5) No swap dealer or major swap participant shall guarantee,
endorse, or assume directly or indirectly any obligation or liability
of a subsidiary or affiliate unless the obligation or liability is
reflected in the computation of tangible net equity of the swap dealer
or major swap participant, except as provided in paragraph (b)(4)(ii)
of this section.
Sec. 23.103 Calculation of market risk exposure requirement and over-
the-counter derivatives credit risk requirement using internal models
(a) A registered swap dealer or major swap participant may apply to
the Commission for approval to use internal models under terms and
conditions required by the Commission and by these regulations when
calculating:
(1) the amounts that the swap dealer or major swap participant must
add to its tangible net equity for its market risk exposure requirement
and over-the-counter derivatives credit risk requirement to compute its
minimum regulatory capital requirement under Sec. Sec. 23.101(a)(1)(i)
or 23.101(b)(1)(i), respectively, of this part;
(2) Its market risk and over-the-counter derivatives credit risk
requirements under 12 CFR part 225, Appendix E and Appendix G, if the
swap dealer or major swap participant is a subsidiary of a U.S. bank
holding company that must meet regulatory capital requirements set
forth in Sec. 23.101(a)(2)(ii) or Sec. 23.101(b)(2)(ii) of this part;
or
(3) The deductions from its net capital for market risk exposure
and over-the-counter derivatives credit risk, in lieu of deductions
otherwise required under Sec. 1.17(c) of this chapter, if the swap
dealer or major swap participant also is registered as a futures
commission merchant.
(b) The application shall be in writing and filed with the regional
office of the Commission having local jurisdiction over the swap dealer
or major swap participant as set forth in Sec. 140.2 of this chapter.
The application may be filed electronically in accordance with
instructions approved by the Commission and specified on the
Commission's Web site. A petition for confidential treatment of
information within the application may be submitted according to
procedures set forth in Sec. 145.9 of this chapter.
(c) The application must identify the categories of positions for
which the
[[Page 27829]]
swap dealer or major swap participant will use internal models for its
computations for market risk and over-the-counter derivatives credit
risk, and, for each such category, provide a description of the methods
that the swap dealer or major swap participant will use to calculate
its deductions, and also, if calculated separately, deductions for
specific risk; a description of the internal models, and an overview of
the integration of the models into the internal risk management control
system of the swap dealer or major swap participant; a description of
how the swap dealer or major swap participant will calculate current
exposure and potential future exposure for its over-the-counter
derivatives credit risk; a description of how the swap dealer or major
swap participant will determine internal credit ratings of
counterparties and internal credit risk weights of counterparties, if
applicable; and a description of the estimated market risk exposure and
over-the-counter derivatives credit risk exposure amounts to be
reported by the swap dealer or major swap participant.
(d) The swap dealer or major swap participant must promptly, upon
the request of the Commission at any time, provide any other
explanatory information as the Commission may require at its discretion
regarding the swap dealer's or major swap participant's internal models
and the swap dealer's or major swap participant's computation of its
market risk exposure or over-the-counter derivatives credit risk
requirements.
(e) Except as permitted under paragraph (f) of this section, the
swap dealer or major swap participant requesting approval under this
section must be either:
(1) A subsidiary of a U.S. bank holding company whose calculations
of minimum risk-based capital requirements under Sec. 23.101 complies
with the requirements that are set forth in regulations of the Board of
Governors of the Federal Reserve System (Federal Reserve Board) at 12
CFR part 225, appendix E and appendix G for calculating capital
requirements for its market risk exposure and over-the-counter
derivatives credit risk requirements, and whose internal models have
been reviewed and are subject to regular assessment by the Federal
Reserve Board; or
(2) A security-based swap dealer or major security-based swap
participant registered with the Securities and Exchange Commission, and
whose internal models used for calculating capital requirements for its
market risk exposure and its over-the-counter derivatives credit risk
have been reviewed and are subject to regular assessment by the
Securities and Exchange Commission.
(f) At any time after the effective date of this rule, the
Commission may in its sole discretion determine by written order that
swap dealers or major swap participants not described in paragraph (e)
of this section also may apply for approval under this section to
calculate the amount of their market risk exposure requirements or
over-the-counter derivatives credit risk requirements using proprietary
internal models.
(g) The Commission may approve or deny the application, or approve
an amendment to the application, in whole or in part, subject to any
conditions or limitations the Commission may require, if the Commission
finds the approval to be necessary or appropriate in the public
interest or for the protection of customers, after determining, among
other things, whether the applicant has met the requirements of this
section and is in compliance with other applicable rules promulgated
under the Act and by self-regulatory organizations.
(h) A swap dealer or major swap participant may no longer use
internal models to compute its market risk exposure requirement and
over-the-counter counterparty credit risk requirement, upon the
occurrence of any of the following:
(1) Internal models that received Commission approval under
paragraph (e) of this section are no longer periodically reviewed or
assessed by the Federal Reserve Board or the Securities and Exchange
Commission;
(2) The swap dealer or major swap participant has changed
materially a mathematical model described in the application or changed
materially its internal risk management control system without first
submitting amendments identifying such changes and obtaining Commission
approval for such changes;
(3) The Commission determines that the internal models are no
longer sufficient for purposes of the capital calculations of the swap
dealer or major swap participant as a result of changes in the
operations of the swap dealer or major swap participant;
(4) The swap dealer or major swap participant fails to come into
compliance with its requirements under this section, after having
received from the Director of the Division of Clearing and Intermediary
Oversight written notification that the firm is not in compliance with
its requirements, and must come into compliance by a date specified in
the notice; or
(5) The Commission by written order finds that permitting the swap
dealer or major swap participant to continue to use the internal models
is no longer necessary or appropriate for the protection of customers
of the futures commission merchant (if the swap dealer or major swap
participant is also a futures commission merchant) or of the integrity
of Commission-regulated markets.
Sec. 23.104 Calculation of market risk exposure requirement and over-
the-counter derivatives credit risk requirement when models are not
approved.
(a) General requirements for calculations. If internal models have
not been submitted and received approval under Sec. 23.103 of this
part, the market risk exposure requirement shall be calculated as set
forth in paragraphs (b) through (d) of this section, and the over-the-
counter derivatives credit risk requirement shall be calculated as set
forth in paragraphs (e) through (j) of this section.
(b) Market risk exposure requirement. (1) A swap dealer or major
swap participant that must meet the minimum regulatory capital
requirements in Sec. 23.101(a)(1)(i) or 23.101(b)(1)(i), respectively,
shall calculate its market risk exposure requirement as the sum of the
amounts for specific risk in paragraphs (c) of this section and the
amounts for market risk in general in paragraph (d) of this section, as
applied to the swap dealer's or major swap participant's:
(i) Swaps that are not cleared; and
(ii) Debt instruments, equities, commodities or foreign currency,
including derivatives of the same, that hedge such uncleared swaps;
(2) A swap dealer or major swap participant that must meet the
requirements in Sec. 23.101(a)(2)(ii) or Sec. 23.101(b)(2)(ii) of
this part shall calculate the market risk deductions required by 12 CFR
part 225, Appendix E as the sum of the amounts for specific risk in
paragraphs (c) of this section and the amounts for market risk in
general in paragraph (d) of this section, as applied to the swap
dealer's or major swap participant's ``covered positions'', as that
term is defined in 12 CFR part 225, Appendix E. Section 2(a); and
(3) A swap dealer or major swap participant that is also a futures
commission merchant shall calculate its deductions from net capital for
market risk and over-the-counter derivatives credit risk in accordance
with Sec. 1.17(c) of this chapter.
[[Page 27830]]
(4) The following definitions apply for purposes of the calculation
of the market risk exposure requirement:
``Credit derivative'' means a financial contract that allows one
party (the protection purchaser) to transfer the credit risk of one or
more exposures (reference exposure(s)) to another party (the protection
provider).
``Debt positions'' means fixed-rate or floating rate instruments,
and other instruments with values that react primarily to changes in
interest rates, including certain non-convertible preferred stock;
convertible bonds; instruments subject to repurchase and lending
agreements; and any derivatives (including written and purchased
options) for which the underlying instrument is a debt position.
Excluded from this definition are asset-backed securities, mortgage-
backed securities and collateralized debt obligations (except for pass-
through mortgage-backed securities issued or guaranteed as to principal
or interest by the United States or any agency thereof); municipal
securities; and non-investment grade debt securities. Debt instruments
excluded from this definition shall remain subject to applicable
haircuts under Sec. 240.15c3-1 of this title.
``Equity Positions'' means equity instruments and other instruments
with values that react primarily to changes in equity prices, including
voting or non-voting common stock, certain convertible bonds, and
commitments to buy or sell equity instruments. Also included are
derivatives (including written and purchased options) for which the
underlying is an equity position.
(c) Specific risk. (1) The required deduction from capital for
specific risk shall equal the sum of the weighted values for debt
positions held by the swap dealer or major swap participant, as
determined in paragraph (c)(2) of this section, plus the sum of the
weighted values of the equity positions held by the swap dealer or
major swap participant, as determined under paragraph (c)(3) of this
section.
(2) Sum of weighted values for debt positions. The sum of the
required weighted values of debt positions is determined by multiplying
the weighting factor indicated in Table A in paragraph (c)(2)(v) of
this section by the absolute value of the current market value of each
net long or short debt position held by the swap dealer or major swap
participant, and summing all of the calculated weighted values for each
position. For purposes of the calculation:
(i) Interest rate derivatives shall be included as set forth in
paragraph (d)(2) of this section;
(ii) Credit derivatives shall be included as set forth in paragraph
(c)(4) of this section;
(iii) Long and short debt positions (including derivatives) in
identical debt issues or debt indices may be netted; and
(iv) Debt instruments are classified in Table A of this section as
one of the following categories:
(A) ``Government category'' includes all debt instruments of
central governments that are members of the Organization for Economic
Co-operation and Development (``OECD'') including bonds, Treasury
bills, and other short-term instruments, as well as local currency
instruments of non-OECD central governments to the extent of
liabilities booked in that currency;
(B) ``Qualifying category'' includes debt instruments of U.S.
government-sponsored agencies, general obligation debt instruments
issued by states and other political subdivisions of OECD countries,
multilateral development banks, and debt instruments issued by U.S.
depository institutions or OECD-banks that do not qualify as capital of
the issuing institution; or
(C) ``Other category'' includes debt instruments that are not
included in the government or qualifying categories.
(v) Table A is as set forth as follows:
Table A--``Specific Risk'' Weighting Factors for Debt Positions
------------------------------------------------------------------------
Remaining maturity Weighting factor
Category (contractual) (in percent)
------------------------------------------------------------------------
Government................... N/A.................. 0.00
Qualifying................... 6 months or less..... 0.25
Over 6 months to 24 1.00
months.
Over 24 months....... 1.60
Other........................ N/A.................. 8.00
------------------------------------------------------------------------
(3) Sum of the weighted values for equity positions. The sum of
the required weighted values of equity positions is determined by
multiplying a weighting factor of 8 percent by the absolute value of
the current market value of each net long or short equity position, and
summing all of the risk-weighted values. For purposes of the
calculation:
(i) Equity derivatives shall be included as set forth in paragraph
(d)(4) of this section; and
(ii) Long and short equity positions (including derivatives) in
identical equity issues or equity indices in the same market may be
netted.
(4) Credit derivatives. The following requirements apply when
computing specific risk charges for credit derivatives:
(i) For each credit derivative in which the swap dealer or major
swap participant is the protection seller, the credit derivative is
treated as a long notional position in the reference exposure, and
where the swap dealer or major swap participant is the protection
buyer, the credit derivative is treated as a short notional position in
the reference exposure.
(ii) The specific risk charge for an individual debt position that
represents purchased credit protection is capped at the market value of
the protection.
(iii) A set of transactions consisting of a debt position and its
credit derivative hedge has a specific risk charge of zero if the debt
position is fully hedged by a total return swap (or similar instrument
where there is a matching of payments and changes in market value of
the position) and there is an exact match between the reference
obligation of the swap and the debt position, the maturity of the swap
and the debt position, and the currency of the swap and the debt
position.
(iv) The specific risk charge for a set of transactions consisting
of a debt position and its credit derivative hedge that does not meet
the criteria of paragraph (c)(4)(iii) of this section is equal to 20.0
percent of the capital requirement for the side of the transaction with
the higher capital requirement when the credit risk of the position is
fully hedged by a credit default swap or similar instrument and there
is an exact match between the reference obligation of the credit
derivative hedge and the debt position, the maturity of the credit
derivative
[[Page 27831]]
hedge and the debt position, and the currency of the credit derivative
hedge and the debt position.
(v) The specific risk charge for a set of transactions consisting
of a debt position and its credit derivative hedge that does not meet
the criteria of either paragraphs (c)(4)(iii) or (iv) of this section,
but in which all or substantially all of the price risk has been
hedged, is equal to the specific risk charge for the side of the
transaction with the higher specific risk charge.
(vi) The total specific risk charge for a portfolio of nth-to-
default credit derivatives is the sum of the specific risk charges for
individual nth-to-default credit derivatives, as computed under this
paragraph. The specific risk charge for each nth-to-default credit
derivative position applies irrespective of whether a swap dealer or
major swap participant is a net protection buyer or net protection
seller.
(vii) The specific risk charge for a first-to-default credit
derivative is the lesser of:
(A) The sum of the specific risk charges for the individual
reference credit exposures in the group of reference exposures; or
(B) The maximum possible credit event payment under the credit
derivative contract.
(viii) Where a swap dealer or major swap participant has a risk
position in one of the reference credit exposures underlying a first-
to-default credit derivative and this credit derivative hedges the swap
dealer's or major swap participant's risk position, the swap dealer or
major swap participant is allowed to reduce both the specific risk
charge for the reference credit exposure and that part of the specific
risk charge for the credit derivative that relates to this particular
reference credit exposure such that its specific risk charge for the
pair reflects the net position in the reference credit exposure. Where
a swap dealer or major swap participant has multiple risk positions in
reference credit exposures underlying a first-to-default credit
derivative, this offset is allowed only for the underlying reference
credit exposure having the lowest specific risk charge.
(ix) The specific risk charge for a second or-subsequent-to-default
credit derivative is the lesser of:
(A) The sum of the specific risk charges for the individual
reference credit exposures in the group of reference exposures, but
disregarding the (n-1) obligations with the lowest specific risk add-
ons; or
(B) The maximum possible credit event payment under the credit
derivative contract.
(x) For second-or-subsequent-to-default credit derivatives, no
offset of the specific risk charge with an underlying reference credit
exposure is allowed.
(d) Market Risk in General. The required deduction from capital for
the market risk in general of the swap dealer or major swap
participant's proprietary positions shall be computed as set forth in
this paragraph:
(1) Interest rate risk: Time-bands and zones. A swap dealer or
major swap participant shall calculate a general market risk capital
charge for interest rate risk on proprietary positions that equals the
sum of the total time-band disallowances in paragraph (d)(1)(vii) of
this section; the total intra-zone disallowances and the total inter-
zone disallowances in paragraphs (d)(1)(viii)(C) and (F) of this
section, and the amount of the final net risk-weighted long or short
position in paragraph (d)(1)(viii)(G) of this section, in accordance
with the following methodology:
(i) Each long or short interest rate position shall be reported at
its current market value and distributed into the time bands of the
maturity ladder specified in Table B of this section. Interest rate
derivatives shall be included as set forth in paragraph (d)(2) of this
section. For purposes of this distribution into time-bands, fixed-rate
instruments are allocated according to the remaining term to maturity
and floating-rate instruments according to the next repricing date.
(ii) The long interest rate positions in each time-band are summed
and the short interest rate positions in each time-band are summed.
(iii) The summed long interest rate positions in each time-band are
multiplied by the appropriate risk-weight factor set forth in Table B
of this section to determine the risk-weighted long interest rate
position for each time-band. The summed short interest rate positions
in each time-band also are multiplied by the appropriate risk-weight
factor in Table B of this section to determine the risk-weighted short
interest rate position for each time-band.
(iv) Table B is as set forth as follows:
Table B--Time-Bands and Risk Weights for Interest Rate Positions
----------------------------------------------------------------------------------------------------------------
Risk weight
Zone Coupon 3% or more Coupon less than 3% (%)
----------------------------------------------------------------------------------------------------------------
1.............................. 1 month or less................ 1 month or less............... 0.00
1.............................. 1 to 3 months.................. 1 to 3 months................. 0.20
1.............................. 3 to 6 months.................. 3 to 6 months................. 0.40
1.............................. 6 to 12 months................. 6 to 12 months................ 0.70
2.............................. 1 to 2 years................... 1.0 to 1.9 years.............. 1.25
2.............................. 2 to 3 years................... 1.9 to 2.8 years.............. 1.75
2.............................. 3 to 4 years................... 2.8 to 3.6 years.............. 2.25
3.............................. 4 to 5 years................... 3.6 to 4.3 years.............. 2.75
3.............................. 5 to 7 years................... 4.3 to 5.7 years.............. 3.25
3.............................. 7 to 10 years.................. 5.7 to 7.3 years.............. 3.75
3.............................. 10 to 15 years................. 7.3 to 9.3 years.............. 4.50
3.............................. 15 to 20 years................. 9.3 to 10.6 years............. 5.25
3.............................. Over 20 years.................. 10.6 to 12 years.............. 6.00
3.............................. ............................... 12 to 20 years................ 8.00
Over 20 years................. 12.50
----------------------------------------------------------------------------------------------------------------
(v) If a time-band includes both risk-weighted long interest rate
positions and short interest rate positions, such risk-weighted long
positions and short interest rate positions are netted, resulting in a
single net risk-weighted long or short interest rate position for each
time-band.
(vi) If risk-weighted long interest rate positions and risk-
weighted short interest rate positions in a time-band have been netted,
a ``time-band disallowance'' charge is computed equal to 10 percent of
the smaller of the total risk-weighted long interest rate position
[[Page 27832]]
or the total risk-weighted short interest rate position, or if the
total long risk-weighted interest rate position and the total short
risk-weighted interest rate position are equal, 10 percent of either
long or short position.
(vii) The total time-band disallowance equals the sum of the
absolute values of the individual disallowances for each time-band in
Table B.
(viii) Table C of this section also groups the time-bands into
three ``zones'': Zone 1 consists of the first three time-bands (0 up to
1 month; 1 month up to 3 months, and 3 months up to 6 months); zone 2
consists of the next four time-bands (6 months up to 12 months; 1 year
up to 2 years; 2 years up to 3 years; and 3 years up to 4 years), and
the remaining time-bands in Table C are in zone 3. Table C is as set
forth below:
Table C--Horizontal Disallowance
----------------------------------------------------------------------------------------------------------------
Between
Zone Time band Within the adjacent zones Between zones
zone (%) (%) 1 and 3 (%)
----------------------------------------------------------------------------------------------------------------
1................................. 1 mth or less............... 40 40 100
1................................. 1 to 3 mths................. .............. .............. ..............
1................................. 3 to 6 mths................. .............. .............. ..............
1................................. 6 to 12 mths................ .............. .............. ..............
2................................. 1 to 2 yrs.................. 30 .............. ..............
2................................. 2 to 3 yrs.................. .............. .............. ..............
2................................. 3 to 4 yrs.................. .............. .............. ..............
3................................. 4 to 5 yrs.................. 30 40 ..............
3................................. 5 to 7 yrs.................. .............. .............. ..............
3................................. 7 to 10 yrs................. .............. .............. ..............
3................................. 10 to 15 yrs................ .............. .............. ..............
3................................. 15 to 20 yrs................ .............. .............. ..............
3................................. Over 20 yrs................. .............. .............. ..............
----------------------------------------------------------------------------------------------------------------
(A) If a zone includes both risk-weighted long positions and risk-
weighted short interest rate positions in different time-bands, the
risk-weighted long positions and risk-weighted short positions in all
of the time-bands within the zone are netted, resulting in a single net
risk-weighted long or short position for each zone.
(B) An ``intra-zone disallowance'' is computed by multiplying the
percent disallowance factors for each zone set out in Table C of this
section by the smaller of the net risk-weighted long or net risk-
weighted short positions within the zone, or if the positions are
equal, a percentage of either position.
(C) The total intra-zone disallowance equals the sum of the
absolute values of the individual intra-zone disallowances.
(D) Risk-weighted long and short positions are then netted between
zone 1 and zone 2, between zone 2 and zone 3, and then zone 3 and zone
1.
(E) An ``inter-zone disallowance'' is calculated by multiplying the
percent disallowance in Table C of this section by the smaller of the
net long or short position eliminated by the inter-zone netting, or if
the positions are equal, a percentage of either position.
(F) The total inter-zone disallowance equals the sum of the
absolute values of the individual inter-zone disallowances.
(G) Lastly, the net risk-weighted long interest rate position or
net risk-weighted short interest rate position remaining in the zones
are summed to reach a single net risk-weighted long or net risk-
weighted short.
(2) Interest rate derivative contracts. (i) Derivative contracts
are converted into positions in the relevant underlying instrument and
are included in the calculation of specific and general market risk
capital charges as described in paragraphs (c) and (d) of this section.
The amount to be included is the market value of the principal amount
of the underlying or of the notional underlying. In the case of a
futures contract on a corporate bond index, positions are included at
the market value of the notional underlying portfolio of securities.
(ii) Futures and forward contracts (including forward rate
contracts) are converted into a combination of a long position and
short position in the notional security. The maturity of a futures
contract or a forward rate contract is the period until delivery or
exercise of the contract, plus the life of the underlying instrument.
(iii) Swaps are treated as two notional positions in the relevant
instruments with appropriate maturities. The receiving side is treated
as the long position and the paying side is treated as the short
position. For example, an interest rate swap in which the registrant is
receiving floating-rate interest and paying fixed is treated as a long
position in a floating rate instrument with a maturity equivalent to
the period until the next interest rate reset date and a short position
in a fixed-rate instrument with a maturity equivalent to the remaining
life of the swap.
(iv) For swaps that pay or receive a fixed or floating interest
rate against some other reference price, for example, an equity index,
the interest rate component is slotted into the appropriate repricing
maturity category, with the long or short position attributable to the
equity component being included in the equity framework set out in this
section.
(v) Offsets of long and short positions (both actual and notional)
are permitted in identical derivative instruments with exactly the same
issuer, coupon, currency, and maturity before slotting these positions
into time-bands. A matched position in a futures and its corresponding
underlying may also be fully offset and, thus, excluded from the
calculation, except when the futures comprises a range of deliverable
instruments. No offsetting is allowed between positions in different
currencies.
(vi) Offsetting positions in the same category of instruments can
in certain circumstances be regarded as matched and treated by the swap
dealer or major swap participant as a single net position which should
be entered into the appropriate time-band. To qualify for this
treatment the positions must be based on the same underlying
instrument, be of the same nominal value, and be denominated in the
same currency. The separate sides of different swaps also may be
``matched'' subject to the same conditions. In addition:
(A) For futures, offsetting positions in the notional or underlying
instruments
[[Page 27833]]
to which the futures contract relates must be for identical instruments
and the instruments must mature within seven days of each other;
(B) For swaps and forward rate contracts, the reference rate (for
floating rate positions) must be identical and the coupon closely
matched; and
(C) For swaps, forward rate contracts and forwards, the next
interest reset date, or for fixed coupon positions or forwards the
remaining maturity, must correspond within the following limits:
(1) If the reset (remaining maturity) dates occur within one month,
then the reset (remaining maturity) dates must be on the same day;
(2) If the reset (remaining maturity) dates occur between one month
and one year later, then the reset (remaining maturity) dates must
occur within seven days of each other, or if the reset (remaining
maturity) dates occur over one year later, then the reset (remaining
maturity) dates must occur within thirty days of each other.
(3) Equity Risk. A swap dealer or major swap participant shall
calculate a general market risk charge for equity risk on its
proprietary positions equal to 8 percent of its net position in each
national equity market. For each national equity market, the net
position of the swap dealer or major swap participant equals the
difference between the sum of the long positions and the sum of the
short positions at current market value. Equity derivatives shall be
included in this calculation as set forth in paragraph (d)(4) of this
section.
(4) Equity derivatives. (i) Equity derivatives must be converted
into the notional equity positions in the relevant underlying. For
example, an equity swap in which a swap dealer or major swap
participant is receiving an amount based on the change in value of one
particular equity or equity index and paying a different index will be
treated as a long position in the former and a short position in the
latter.
(ii) Futures and forward contracts relating to individual equities
should be reported as current market prices of the underlying. Futures
relating to equity indices should be reported as the marked-to-market
value of the notional underlying equity portfolio. Equity swaps are
treated as two notional positions, with the receiving side as the long
position and the paying side as the short position. If one of the legs
involves receiving/paying a fixed or floating interest rate, the
exposure should be slotted into the appropriate repricing maturity band
for debt securities. Matched positions in each identical equity in each
national market may be treated as offsetting and excluded from the
capital calculation, with any remaining position included in the
calculations for specific and general market risk. For example, a
future in a given equity may be offset against an opposite cash
position in the same equity.
(5) Foreign Exchange Risk. The swap dealer or major swap
participant shall calculate a market risk charge for foreign exchange
risk on its proprietary positions equal to:
(i) 8.0 percent of the sum of:
(A) The greater of the sum of the net open short positions or the
sum of the net open long positions in each currency; and
(B) The net open position in gold, regardless of sign.
(ii) For purposes of the calculation in paragraph (d)(5)(i) of this
section, the net open position in each currency and gold is the sum of:
(A) The net spot position determined by deducting all liabilities
denominated in a currency (or gold) from all assets denominated in the
same currency (or gold), including accrued interest earned but not yet
received and accrued expenses, and
(B) All foreign exchange derivatives and any other item
representing a profit or loss in foreign currencies. Forward currency
positions should be valued at current spot market exchange rates.
(iii) In order to report the required charge in U.S. currency, the
calculation of the net open position requires the nominal amount (or
net present value) of the net open position in each foreign currency
(and gold) to be converted at spot rates into the reporting currency.
(6) Commodities risk. The swap dealer or major swap participant
shall calculate a market risk charge for the commodities risk of its
proprietary positions. For purposes of this calculation, each long and
short commodity position (spot and forward) is expressed in terms of
the standard unit of measurement (such as barrels, kilos, or grams).
Commodity derivative positions also are converted into notional
positions. The open positions in each category of commodities are then
converted at current spot rates into U.S. currency, with long and short
positions offset to arrive at the net open position in each commodity.
Positions in different categories of commodities may not be offset
unless deliverable against each other. The total capital requirement
for commodities risk is the sum of the following:
(i) 15.0 percent of the net open position, long or short, in each
commodity, and
(ii) 3.0 percent of the swap dealer or major swap participant's
gross positions, long plus short, in the particular commodity. In
valuing gross positions in commodity derivatives for this purpose, a
swap dealer or major swap participant should use the current spot
price.
(7) Option positions. (i) A swap dealer or major swap participant
is not required to deduct a capital charge for market risk if the swap
dealer or major swap participant writes options that are hedged by
perfectly matched long positions in exactly the same options.
(ii) Except for options for which no capital charge is required
under paragraph of (d)(7)(i) of this section, a swap dealer or major
swap participant shall calculate its market risk charges (both specific
and general market) for option activities using the ``delta-plus
method''. Under the delta plus method, a swap dealer or major swap
participant shall include delta-weighted options positions within the
appropriate measurement framework set forth in paragraphs (c) through
(d)(6) of this section.
(iii) The delta-weighted option position is equal to the market
value of the underlying instrument multiplied by the option delta. The
delta represents the expected change in the option's price as a
proportion of a change in the price of the underlying instrument. For
example, an option whose price changes $1 for every $2 change in the
price of the underlying instrument has a delta of 0.50.
(iv) In addition to the capital charges associated with the
option's delta, each option position is subject to additional capital
charges to reflect risks for the gamma (the change of the delta for a
given change in the price of the underlying) and the vega (the
sensitivity of the option price with respect to a change in volatility)
for each such option position (including hedge positions). The option
delta, and gamma and vega sensitivities shall be calculated according
to the swap dealer or major swap participant's option pricing model and
will be subject to Commission review. The capital requirement for delta
risk, plus the additional capital charges for gamma and vega risks, are
calculated as follows:
(A) Options with debt instruments or interest rates as the
underlying instrument. The delta-weighted options positions are
included in the specific risk calculations under paragraph (c) of this
section, and also are slotted into the debt instrument time-bands in
Table B of this section, using a two-legged approach requiring one
entry at the time the underlying contract takes effect and
[[Page 27834]]
one at the time the underlying contract matures; and
(1) Floating rate instruments with caps or floors should be treated
as a combination of floating rate securities and a series of European
style options;
(2) For options such as caps and floors whose underlying instrument
is an interest rate, the delta and gamma should be expressed in terms
of a hypothetical underlying security;
(3) For gamma risk, for each time-band, net gammas that are
negative are multiplied by the risk weights set out in Table D and by
the square of the market value of the underlying instrument (net
positive gammas may be disregarded);
(4) Table D is as set forth as follows:
Table D
----------------------------------------------------------------------------------------------------------------
Risk-weight
Assumed for gamma
Time-band Modified interest rate (average
duration change (%) assumed for
time band)
----------------------------------------------------------------------------------------------------------------
Under 1 month................................................... 0.00 1.00 0.00000
1 up to 3 months................................................ 0.20 1.00 0.00020
3 up to 6 months................................................ 0.40 1.00 0.00080
6 up to 12 months............................................... 0.70 1.00 0.00245
1 up to 2 years................................................. 1.40 0.90 0.00794
2 up to 3 years................................................. 2.20 0.80 0.01549
3 up to 4 years................................................. 3.00 0.75 0.02531
4 up to 5 years................................................. 3.65 0.75 0.03747
5 up to 7 years................................................. 4.65 0.70 0.05298
7 up to 10 years................................................ 5.80 0.65 0.07106
10 up to 15 years............................................... 7.50 0.60 0.10125
15 up to 20 years............................................... 8.75 0.60 0.13781
Over 20 years................................................... 10.00 0.60 0.18000
----------------------------------------------------------------------------------------------------------------
(5) For volatility risk, the capital requirements for vega are
calculated in each time-band assuming a proportional shift in
volatility of 25.0 percent; and
(6) The additional capital requirement for gamma and vega risk is
the absolute value of the sum of the individual capital requirements
for net negative gammas plus the absolute value of the sum of the
individual capital requirements for vega risk for each time-band.
(B) Options with equities as the underlying. The delta-weighted
option positions are included in the calculation of the specific risk
charge under paragraph (c) of this section, and also are incorporated
in the general market risk charge calculated under paragraph (d)(3) of
this section, with individual equity issues and indices treated as
separate underlyings; and
(1) For gamma risk, the net gammas that are negative for each
underlying are multiplied by 0.72 percent (in the case of an individual
equity) or 0.32 percent (in the case of an index as the underlying) and
by the square of the market value of the underlying;
(2) For volatility risk, the capital requirement for vega is
calculated for each underlying, assuming a proportional shift in
volatility of 25.0 percent; and
(3) The additional capital requirement for gamma and vega risk is
the absolute value of the sum of the individual capital requirements
for net negative gammas plus the absolute value of the individual
capital requirements for vega risk.
(C) Options on foreign exchange and gold positions. The net delta
(or delta-based) equivalent of the total book of foreign currency and
gold options is incorporated into the measurement of the exposure in a
single currency position as set forth in paragraph (d)(5) of this
section; and
(1) For gamma risk, for each underlying exchange rate, net gammas
that are negative are multiplied by 0.32 percent and by the square of
the market value of the positions;
(2) For volatility risk, the capital requirements for vega are
calculated for each currency pair and gold assuming a proportional
shift in volatility of 25.0 percent; and
(3) The additional capital requirement for gamma and vega risk is
the absolute value of the sum of the individual capital requirements
for net negative gammas plus the absolute value of the sum of the
individual capital requirements for vega risk.
(D) Options on commodities. The delta-weighted positions are
incorporated into the measure described in paragraph (d)(6) of this
section; and
(1) For gamma risk, net gammas that are negative for each
underlying are multiplied by 1.125 percent and by the square of the
market value of the commodity;
(2) For volatility risk, a bank calculates the capital requirements
for vega for each commodity assuming a proportional shift in volatility
of 25.0 percent; and
(3) The additional capital requirement for gamma and vega risk is
the absolute value of the sum of the individual capital requirements
for net negative gammas plus the absolute value of the sum of the
individual capital requirements for vega risk.
(e) Credit Risk. The swap dealer or major swap participant shall
compute an additional capital requirement for the credit risk of over-
the-counter derivatives transactions that are not cleared in an amount
equal to the sum of the following:
(1) A counterparty exposure charge in an amount equal to the sum of
the following:
(i) The net replacement value in the account of each counterparty
that is insolvent, or in bankruptcy, or that has senior unsecured long-
term debt in default; and
(ii) For a counterparty not otherwise described in paragraph
(e)(1)(i) of this section, the credit equivalent amount of the swap
dealer or major swap participant's exposure to the counterparty, minus
collateral values as set forth in this section, multiplied by a credit
risk factor of 50 percent or a credit risk factor computed under
paragraph (e)(1)(iii) of this section, multiplied by 8 percent;
(iii) Counterparties may be rated by the swap dealer or major swap
participant, or by an affiliated bank or affiliated broker-dealer of
the swap dealer or major swap participant, upon
[[Page 27835]]
approval by the Commission on application by the swap dealer or major
swap participant. The application will specify which internal ratings
will result in application of a 20 percent risk weight, 50 percent risk
weight, or 150 percent risk weight. Based on the strength of the
applicant's internal credit risk management system, the Commission may
approve the application. The swap dealer or major swap participant must
make and keep current a record of the basis for the credit rating for
each counterparty. The records must be maintained in accordance with
Sec. 1.31 of this chapter.
(2) A concentration charge by counterparty in an amount equal to 50
percent of the amount of the current exposure to the counterparty in
excess of 5 percent of the tangible net equity of the swap dealer or
major swap participant and a portfolio concentration charge of 100
percent of the amount of the swap dealer or major swap participant's
aggregate current exposure for all counterparties in excess of 50
percent of the tangible net equity of the swap dealer or major swap
participant.
(f) Calculation of the credit equivalent amount. The credit
equivalent amount of a swap dealer or major swap participant's exposure
to a counterparty is the sum of the swap dealer or major swap
participant's current exposure to the counterparty, and the swap dealer
or major swap participant's potential future exposure to the
counterparty.
(g) The current exposure of the swap dealer or major swap
participant to a counterparty is calculated as follows:
(1) For a single over-the-counter position, the current exposure is
the greater of the mark-to-market value of the over-the-counter
position or zero.
(2) For multiple over-the-counter positions, the current credit
exposure is the greater of:
(i) The net sum of all positive and negative mark-to-market values
of the individual over-the-counter positions, subject to permitted
netting pursuant to a qualifying master netting agreement; or
(ii) Zero.
(h) The potential future exposure of the swap dealer or major swap
participant is calculated as follows:
(1) For a single over-the counter position, the potential future
exposure, including an over-the-counter position with a negative mark-
to-market value, is calculated by multiplying the notional principal
amount of the position by the appropriate conversion factor in Table E
of this section. For purposes of this calculation, the swap dealer or
major swap participant must use the apparent or stated notional
principal amount multiplied by any multiplier in the over-the-counter
position. For exchange rate contracts and other similar contracts in
which the notional principal amount is equivalent to the cash flows,
notional principal amount is the net receipts to each party falling due
on each value date in each currency. The potential future exposure of
the protection provider of a credit derivative is capped at the net
present value of the amount of unpaid premiums. For an over-the-counter
derivative contract with multiple exchanges of principal, the
conversion factor is multiplied by the number of remaining payments in
the derivative contract. For an over-the-counter derivative contract
that is structured such that on specified dates any outstanding
exposure is settled and the terms are reset so that the market value of
the contract is zero, the remaining maturity equals the time until the
next reset date. For an interest rate derivative contract with a
remaining maturity of greater than one year that meets these criteria,
the minimum conversion factor is 0.005.
Table E
--------------------------------------------------------------------------------------------------------------------------------------------------------
Foreign exchange Precious metals
Remaining maturity Interest rate rate and gold Credit Equity (except gold) Other
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less.................................. 0.00 0.01 0.10 0.06 0.07 0.10
Over one to five years............................ 0.005 0.05 0.10 0.08 0.07 0.12
Over five years................................... 0.015 0.075 0.10 0.10 0.08 0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
(2) For multiple over-the-counter positions that are subject to a
qualifying master netting agreement, the swap dealer or major swap
participant shall compute its potential future exposure in accordance
with the following formula: Anet = (0.4 x Agross) + (0.6 x NGR x
Agross), where:
(i) Agross equals the sum of the potential future exposure for each
individual over-the-counter position subject to the qualifying master
netting agreement; and
(ii) NGR equals the ratio of the net current credit exposure to the
gross current credit exposure. In calculating the NGR, the gross
current credit exposure equals the sum of the positive current credit
exposures of all individual over-the-counter derivative contracts
subject to the qualifying master netting agreement.
(i) Netting agreements. In computing its credit equivalent amount
pursuant to paragraph (f) of this section, a swap dealer or major swap
participant may net gross receivables and gross payables to and from a
single counterparty if the swap dealer or major swap participant has
entered into a netting agreement with the counterparty that meets the
following criteria:
(1) The netting agreement is legally enforceable in each relevant
jurisdiction, including in insolvency proceedings;
(2) The gross receivables and gross payables that are subject to
the netting agreement with a counterparty can be determined at any
time; and
(3) For internal risk management purposes, the swap dealer or major
swap participant monitors and controls its exposure to the counterparty
on a net basis.
(j) Collateral. (1) Subject to the haircuts specified in paragraph
(j)(2) of this section, a swap dealer or major swap participant may
reduce its credit risk equivalent computed under paragraph (f) of this
section to the extent of the market value of collateral pledged to and
held by the swap dealer or major swap participant to secure an over-
the-counter position. The collateral is subject to the following
requirements:
(i) The collateral must be in the swap dealer or major swap
participant's physical possession or control; Provided, However,
collateral may include collateral held in independent third party
accounts as provided under part 23 of this chapter;
(ii) The collateral must meet the requirements specified in a
credit support agreement meeting the requirements of Sec. 23.151 of
this part; and
(iii) If the counterparty is a swap dealer, major swap participant
or financial entity as defined in Sec. 23.150 of this part:
(A) The collateral must be financial collateral that is liquid and
transferable; marked-to-market each day, and subject
[[Page 27836]]
to a daily maintenance margin requirement;
(B) The collateral must be capable of being liquidated promptly by
the swap dealer or major swap participant without intervention by any
other party;
(C) The collateral must be subject to an agreement that is legally
enforceable by the swap dealer or major swap participant against the
counterparty and any other parties to the agreement;
(D) The collateral cannot consist of securities issued by the
counterparty or a party related to the swap dealer or major swap
participant or to the counterparty; and
(E) The collateral cannot be used in determining the credit rating
of the counterparty.
(2) A swap dealer or major swap participant must reduce the market
value of the counterparty's collateral used to reduce the swap dealer's
or major swap participant's credit risk equivalent amount computed
under paragraph (f) of this section by:
(i) Applying the market haircuts specified in Sec. 1.17(c)(5) of
this chapter, and a further deduction of 8 percent of the market value
of the collateral when the settlement currency of the interest rate
position and collateral currency are not the same; or
(ii) where the collateral has been received from a counterparty
that is not a swap dealer, major swap participant, or a financial
entity as defined in Sec. 23.150 of this part, applying the haircuts
required pursuant to a credit support agreement meeting the
requirements of Sec. 23.151.
(k) Sample Calculation of General Market Risk for Debt Instruments
Using the Maturity Method. (1) The following positions are slotted into
a maturity ladder as shown below, which uses the risk weights specified
in Table B of this section:
(i) Qualifying bond, $13.33mn market value, remaining maturity 8
years, coupon 8 percent;
(ii) Government bond, $75mn market value, remaining maturity 2
months, coupon 7 percent;
(iii) Interest rate swap, $150 mn, bank receives floating rate
interest and pays fixed, next interest reset after 12 months, remaining
life of swap is 8 years (The position should be reported as the market
value of the notional underlying. Depending on the current interest
rate, the market value of each leg of the swap (i.e. the 8 year bond
and the 9 months floater) can be either higher or lower than the
notional amount. For sake of simplicity the example assumes that the
current interest rate is identical with the one the swap is based on.)
(iv) Long position in interest rate future, $50mn, delivery date
after 6 months, life of underlying government security is 3.5 years
(assumes the current interest rate is identical to the one the futures
is based on).
----------------------------------------------------------------------------------------------------------------
Time-band and Risk-weighted Net time-band Net zone
Zone position Risk weight % position positions positions
----------------------------------------------------------------------------------------------------------------
1..................... 0-1 mth.......... 0.00
1-3 mth Long 75 0.20 Long 0.15....... Long 0.15....... Long 1.00.
Gov. bond.
3-6 mth Short 50 0.40 Short 0.20...... Short 0.20......
Future.
6-12 mths Long 0.70 Long 1.05....... Long 1.05.......
150 Swap.
2..................... 1-2 yrs.......... 1.25
2-3 yrs.......... 1.75
3-4 yrs Long 50 2.25 Long 1.125...... Long 1.125...... Long 1.125.
Future.
3..................... 4-5 yrs.......... 2.75
5-7 yrs.......... 3.25
7-10 yrs Short 3.75 Short 5.625, Short 5.125..... Short 5.125.
150 Swap, Long Long 0.050.
13.33 Qual Bond.
10-15 yrs........ 4.50
15-20 yrs........ 5.25
Over 20 yrs...... 6.00
----------------------------------------------------------------------------------------------------------------
(2) A vertical disallowance is calculated for time-band 7-10 years,
and equals 10 percent of the matched positions in the time-band--10.0 x
0.5 = 0.05 ($50,000).
(3) A horizontal disallowance is calculated for zone 1, and equals
40 percent of the matched positions in the zone--40.0 x 0.20 = 0.80
($80,000). The remaining net position in Zone 1 equals +1.00.
(4) A horizontal disallowance is calculated for adjacent zones 2
and 3. It equals 40 percent of the matched positions between the
zones--40.0 x 1.125 = 0.45 (450,000). The remaining position in zone 3
equals -4.00.
(5) A horizontal disallowance is calculated between zones 1 and 3.
It equals 100 percent of the matched positions between the zones--100 x
1.00 = 1.00 (1,000,000).
(6) The remaining net open position equals 3.00 ($3,000,000). The
total capital requirement for general market risk for this portfolio
equals:
------------------------------------------------------------------------
------------------------------------------------------------------------
The vertical disallowance.................................. $50,000
Horizontal disallowance in zone 1.......................... 80,000
Horizontal disallowance-- zones 2 and 3.................... 450,000
Horizontal disallowance-- zones 1 and 3.................... 1,000,000
Overall net open position.................................. 3,000,000
------------
Total requirement for general market risk.............. 4,580,000
------------------------------------------------------------------------
(l) Sample Calculation for Delta-Plus Method for Options. (1)
Assume the swap dealer or major swap participant has a European short
call option on a commodity with an exercise price of 490 and a market
value of the underlying 12 months from the expiration of the option at
500; a risk-free interest rate at 8 percent per annum, and the
volatility at 20 percent. The current delta for this position is
according to the Black-Scholes formula -0.721 (that is, the price of
the option changes by -0.721 if the price of the underlying moves by
1). The gamma is -0.0034 (that is, the delta changes by -0.0034 from -
0.721 to -0.7244 if the price of the underlying moves by 1). The
current value of the option is 65.48.
(2) The first step under the delta-plus method is to multiply the
market value of the commodity by the absolute value of the delta: 500 x
0.721 = 360.5. The delta-weighted position is then incorporated into
the measure described for general market risk for commodities. If no
other positions in the commodity exist, the delta-weighted position is
multiplied by 0.15 to calculate the capital requirement for delta:
360.5 times 0.15 = 54.075.
(3) The capital requirement for gamma is calculated according to
the Taylor expansion by multiplying the absolute
[[Page 27837]]
value of the assumed gamma of -0.0034 by 1.125 percent and by the
square of the market value of the underlying: 0.0034 x 0.01125 x 500\2\
= 9.5625.
(4) The capital requirement for vega is calculated next. The
assumed current (implied) volatility is 20 percent. Since only an
increase in volatility carries a risk of loss for a short call option,
the volatility has to be increased by a relative shift of 25 percent.
This means that the vega capital requirement has to be calculated on
the basis of a change in volatility of 5 percentage points from 20
percent to 25 percent in this example. According to the Black-Scholes
formula used here, the vega equals 168. Thus, a 1 percent or 0.01
increase in volatility increases the value of the option by 1.68.
Accordingly, a change in volatility of 5 percentage points increases
the value: 5 x 1.68 = 8.4. This is the capital requirement for vega
risk.
(m) Summary of Treatment for Interest Rate Derivatives. (1) The
following chart summarizes the application of specific risk and general
market risk charges for specific types of interest rate derivatives.
------------------------------------------------------------------------
Specific risk General market risk
Instrument charge charge
------------------------------------------------------------------------
Exchange-Traded Future:
Government security....... No............... Yes, as two
positions.
Corporate debt security... Yes.............. Yes, as two
positions.
Index on short-term No............... Yes, as two
interest rates (e.g. positions.
LIBOR).
OTC Forward:
Government security....... No............... Yes, as two
positions.
Corporate debt security... Yes.............. Yes, as two
positions.
Index on short-term No............... Yes, as two
interest rates.. positions.
FRAs, Swaps............... No............... Yes, as two
positions.
Forward foreign exchange.. No............... Yes, as one position
in each currency.
Options:
Government security....... No.
Corporate debt security... Yes.............. General market risk
charge for each type
of transaction,
using the Delta-plus
method (gamma and
vega receive
separate capital
charges).
Index on short-term No.
interest rates.
------------------------------------------------------------------------
(2) The chart provided in paragraph (m)(1) of this section is
provided as a summary only. The requirements for specific risk and
general market risk charges applicable to interest rate derivatives are
set forth in paragraphs (a) through (d) of this section.
Sec. 23.105 Maintenance of minimum financial requirements by swap
dealers and major swap participants.
(a) Each swap dealer or major swap participant who is subject to
the minimum capital requirements under Sec. 23.101 of this part and
who knows or should have known that its capital at any time is less
than the minimum required by Sec. 23.101 of this part, must:
(1) Give telephonic notice, to be confirmed in writing by facsimile
notice, that the swap dealer's or major swap participant's capital is
less than that required by Sec. 23.101 of this part. The notice must
be given immediately after the swap dealer or major swap participant
knows or should know that its capital is less than that required by
Sec. 23.101 of this part; and
(2) Provide together with such notice documentation in such form as
necessary to adequately reflect the swap dealer's or major swap
participant's capital condition as of any date such person's capital is
less than the minimum required. The swap dealer or major swap
participant must provide similar documentation for other days as the
Commission may request.
(b) Each swap dealer or major swap participant who is subject to
the minimum capital requirements under Sec. 23.101 of this part and
who knows or should have known that its capital at any time is less
than 110 percent of its minimum capital requirement as determined under
Sec. 23.101 of this part, must file written notice to that effect
within 24 hours of such event.
(c) Each swap dealer or major swap participant who is subject to
capital rules established by a prudential regulator, or has been
designated a systemically important financial institution by the
Financial Stability Oversight Council and is subject to capital
requirements imposed by the Board of Governors of the Federal Reserve
System, must provide immediate written notice transmitted by facsimile
if it fails to maintain compliance with the minimum capital
requirements established by the prudential regulator or the Board of
Governors of the Federal Reserve System.
(d) Upon the request of the Commission, each swap dealer or major
swap participant who is subject to capital rules established by a
prudential regulator, or has been designated a systemically important
financial institution by the Financial Stability Oversight Council and
is subject to capital requirements imposed by the Board of Governors of
the Federal Reserve System must provide the Commission with copies of
its capital computations for any periods of time specified by the
Commission. The capital computations must be computed in accordance
with the requirements of the swap dealer's or major swap participant's
prudential regulator, and must include all supporting schedules and
other documentation.
(e) If a swap dealer or major swap participant at any time fails to
make or to keep current the books and records required by these
regulations, such swap dealer or major swap participant must, on the
same day such event occurs, provide facsimile notice of such fact,
specifying the books and records which have not been made or which are
not current, and within 48 hours after giving such notice file a
written report stating what steps have been and are being taken to
correct the situation.
(f) A swap dealer or major swap participant that is subject to the
minimum capital requirements set forth in Sec. 23.101 of this part,
must provide written facsimile notice of a substantial reduction in
capital as compared to that last reported in a financial report filed
with the Commission pursuant to Sec. 23.105 of this part. This notice
shall be provided as follows:
(1) If any event or series of events, including any withdrawal,
advance, loan or loss cause, on a net basis, a reduction in tangible
net equity of
[[Page 27838]]
20 percent or more, notice must be provided within two business days of
the event or series of events causing the reduction; and
(2) If the equity capital of the swap dealer or major swap
participant would be withdrawn by action of a stockholder or a partner
or a limited liability company member or by redemption or repurchase of
shares of stock by any of the consolidated entities or through the
payment of dividends or any similar distribution, or an unsecured
advance or loan would be made to a stockholder, partner, sole
proprietor, limited liability company member, employee or affiliate,
such that the withdrawal, advance or loan would cause, on a net basis,
a reduction in excess net tangible equity of 30 percent or more, notice
must be provided at least two business days prior to the withdrawal,
advance or loan that would cause the reduction: Provided, however, That
the provisions of paragraphs (f)(1) and (2) of this section do not
apply to any futures or swaps transaction in the ordinary course of
business between a swap dealer or major swap participant and any
affiliate where the swap dealer or major swap participant makes payment
to or on behalf of such affiliate for such transaction and then
receives payment from such affiliate for such transaction within two
business days from the date of the transaction.
(3) Upon receipt of such notice from a swap dealer or major swap
participant, the Director of the Division of Clearing and Intermediary
Oversight or the Director's designee may require that the swap dealer
or major swap participant provide, within three business days from the
date of the request or such shorter period as the Director or designee
may specify, such other information as the Director or designee
determines to be necessary based upon market conditions, reports
provided by swap dealer or major swap participant, or other available
information.
(g) Every notice and written report required by this section to be
filed by a swap dealer or major swap participant shall be filed with
the regional office of the Commission with jurisdiction over the state
in which the swap dealer's or major swap participant's principal place
of business is located, as set forth in Sec. 140.02 of this chapter,
and with the registered futures association of which the swap dealer or
major swap participant is a member. In addition, every notice and
written report required to be given by this section must also be filed
with the Chief Accountant of the Division of Clearing and Intermediary
Oversight at the Commission's principal office in Washington, DC.
Sec. 23.106 Financial recordkeeping and reporting requirements for
swap dealers and major swap participants.
(a)(1) Except as provided in paragraph (a)(2) of this section, each
registered swap dealer or major swap participant must comply with the
requirements set forth in paragraphs (b) through (j) of this section.
(2) The requirements in paragraphs (b) through (j) of this section
do not apply to any swap dealer or major swap participant that:
(i) Is subject to the capital requirements of a prudential
regulator;
(ii) Has been designated a systemically important financial
institution by the Financial Stability Oversight Council and is subject
to supervision by the Board of Governors of the Federal Reserve System;
or
(iii) Is registered as a futures commission merchant.
(b) Each swap dealer or major swap participant shall prepare and
keep current ledgers or other similar records which show or summarize,
with appropriate references to supporting documents, each transaction
affecting its asset, liability, income, expense and capital accounts,
and in which (except as otherwise permitted in writing by the
Commission) all its asset, liability and capital accounts are
classified in accord with generally accepted accounting principles as
established in the United States, and as otherwise may be necessary for
the capital calculations required under Sec. 23.101. Such records must
be maintained in accordance with Sec. 1.31 of this chapter.
(c)(1) Each swap dealer and major swap participant shall file
financial reports meeting the requirements in paragraph (c)(2) of this
section as of the close of business each month. Such financial reports
must be filed no later than 17 business days after the date for which
the report is made.
(2) The monthly financial reports must be prepared in the English
language and be denominated in United States dollars. The monthly
financial reports shall include a statement of financial condition, a
statement of income/loss, a statement reconciling the net equity in the
statement of financial condition to the firm's tangible net equity, a
schedule detailing, as applicable under Sec. 23.101, the calculation
of the firm's minimum tangible net equity requirement or its minimum
risk-based capital ratios requirements, and showing the excess or
deficiency in its regulatory capital after subtracting the minimum
tangible net equity requirement from its tangible net equity, or after
comparing its risk-based capital ratios to its minimum risk-based
capital ratios. The monthly report and schedules must be prepared in
accordance with generally accepted accounting principles as established
in the United States.
(d)(1) Each swap dealer and major swap participant shall file
annual audited financial reports certified in accordance with paragraph
(d)(2) of this section, and including the information specified in
paragraph (d)(3) of this section, as of the close of its fiscal year no
later than 90 days after the close of the swap dealer's and major swap
participant's fiscal year.
(2) The annual audited financial report shall be certified in
accordance with the provisions of paragraphs (a) through (e) of Sec.
1.16 of this chapter: Provided, however, that for purposes of
application of the provisions of Sec. 1.16 to swap dealers and major
swap participants, the term ``Sec. 23.101'' shall be substituted for
the term ``Sec. 1.17,'' and the terms ``swap dealer'' or ``major swap
participant'' shall be substituted for the term ``futures commission
merchant,'' as appropriate.
(3) The annual audited financial reports shall be prepared in
accordance with generally accepted accounting principles as established
in the United States, be prepared in the English language, and
denominated in United States dollars. The annual audited financial
reports must include the following:
(i) A statement of financial condition as of the date for which the
report is made;
(ii) Statements of income (loss), cash flows, and changes in
ownership equity for the period between the date of the most recent
certified statement of financial condition filed with the Commission
and the date for which the report is made;
(iii) Appropriate footnote disclosures;
(iv)(A) If the swap dealer or major swap participant must comply
with capital requirements set forth in Sec. 23.101(a)(1) of this part,
a schedule including the swap dealer's or major swap participant's net
equity; its intangible assets; its minimum tangible net equity; its
minimum tangible net equity requirement; and the excess or deficiency
in its regulatory capital after subtracting the minimum tangible net
equity requirement from its tangible net equity; or
(B) If the swap dealer or major swap participant must comply with
capital requirements set forth in Sec. 23.101(a)(2) of this part, a
schedule including the swap dealer's or major swap participant's
minimum risk-based capital ratio requirements as calculated using
requirements set forth in 12 CFR.
[[Page 27839]]
part 225, and appendices thereto, as if the subsidiary itself were a
U.S. bank-holding company; its risk-based capital ratios; and the
excess or deficiency in its regulatory capital after comparing its
risk-based capital ratios to its minimum risk-based capital ratio
requirements.
(v) Such further material information as may be necessary to make
the required statements not misleading.
(e) A registered swap dealer or major swap participant may not
change its fiscal year from that used in its most recent report filed
under paragraph (c) or (d) of this section unless it has requested and
received written approval for the change from a registered futures
association of which it is a member.
(f) Attached to each financial report filed pursuant to this
section must be an oath or affirmation that to the best knowledge and
belief of the individual making such oath or affirmation the
information contained in the financial report is true and correct. The
individual making such oath or affirmation must be: If the swap dealer
or major swap participant is a sole proprietorship, the proprietor; if
a partnership, any general partner; if a corporation, the chief
executive officer or chief financial officer; and, if a limited
liability company or limited liability partnership, the chief executive
officer, the chief financial officer, the manager, the managing member,
or those members vested with the management authority for the limited
liability company or limited liability partnership.
(g) From time to time the Commission may, by written notice,
require any swap dealer or major swap participant to file financial or
operational information on a daily basis or at such other times as may
be specified by the Commission. Such information must be furnished in
accordance with the requirements included in the written Commission
notice.
(h) Procedures for filing with Commission. (1) Unless filed
electronically as permitted under paragraph (h)(2) of this section, all
filings made under this section must be addressed to, and received at,
the location of the regional office of the Commission with jurisdiction
over the state in which the registrant's principal place of business is
located as set forth in Sec. 140.02 of this chapter.
(2) All filings of financial reports made pursuant to this section
may be submitted to the Commission in electronic form using a form of
user authentication assigned in accordance with procedures established
by or approved by the Commission, and otherwise in accordance with
instructions issued by or approved by the Commission, if the swap
dealer or major swap participant has provided the Commission with the
means necessary to read and to process the information contained in
such report. Any such electronic submission must clearly indicate the
swap dealer or major swap participant on whose behalf such filing is
made and the use of such user authentication in submitting such filing
will constitute and become a substitute for the manual signature of the
authorized signer. In the case of a financial report required under
paragraphs (c), (d), or (g) of this section and filed via electronic
transmission in accordance with procedures established by or approved
by the Commission, such transmission must be accompanied by the user
authentication assigned to the authorized signer under such procedures,
and the use of such user authentication will constitute and become a
substitute for the manual signature of the authorized signer for the
purpose of making the oath or affirmation referred to in paragraph (f)
of this section.
(i) Public availability of reports. (1) Financial information
required to be filed pursuant to this section, and not otherwise
publicly available, will be treated as exempt from mandatory public
disclosure for purposes of the Freedom of Information Act and the
Government in the Sunshine Act and parts 145 and 147 of this chapter,
except for the information described in paragraph (i)(2) of this
section.
(2) The following information will be publicly available:
(i) As applicable, the amounts calculated by the swap dealer or
major swap participant as its tangible net equity; its minimum tangible
net equity requirement; its tangible net equity in excess of its
minimum tangible net equity requirement; its risk-based capital ratios;
and the excess or deficiency in its regulatory capital after comparing
its risk-based capital ratios to its minimum risk-based capital ratio
requirements.
(ii) The opinion of the independent public accountant in the
certified annual financial reports.
(3) All information that is exempt from mandatory public disclosure
under paragraph (i)(1) of this section will, however, be available for
official use by any official or employee of the United States or any
State, by the National Futures Association and by any other person to
whom the Commission believes disclosure of such information is in the
public interest.
Sec. Sec. 23.107-23.149 [Reserved]
PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION
7. The authority citation for part 140 continues to read as
follows:
Authority: 7 U.S.C. 2 and 12a.
8. Amend Sec. 140.91 by revising the section heading and adding
paragraphs (a)(9) through (15) to read as follows:
Sec. 140.91 Delegation of authority to the Director of the Division
of Clearing and Intermediary Oversight.
(a) * * *
(9) All functions reserved to the Commission in Sec. 23.101(c)(2)
of this chapter, with the concurrence of the General Counsel or his or
her designee;
(10) All functions reserved to the Commission in Sec. 23.103(d) of
this chapter, with the concurrence of the General Counsel or his or her
designee;
(11) All functions reserved to the Commission in Sec. 23.105(a)(2)
and (d) of this chapter, with the concurrence of the General Counsel or
his or her designee;
(12) All functions reserved to the Commission in Sec.
23.155(b)(4)(ii), (iii) and (c)(4) of this chapter, with the
concurrence of the General Counsel or his or her designee;
(13) All functions reserved to the Commission in Sec. 23.156(c)(1)
and (2) of this chapter, with the concurrence of the General Counsel or
his or her designee;
(14) All functions reserved to the Commission in Sec. 23.157(d) of
this chapter, with the concurrence of the General Counsel or his or her
designee; and
(15) All functions reserved to the Commission in Sec. 23.158(c) of
this chapter, with the concurrence of the General Counsel or his or her
designee.
* * * * *
Issued in Washington, DC, on April 27, 2011, by the Commission.
David A. Stawick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Capital Requirements of Swap Dealers and Major Swap
Participants--Commission Voting Summary and Statements of Commissioners
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn, Sommers
and Chilton voted in the affirmative; Commissioner O'Malia voted in
the negative.
[[Page 27840]]
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rulemaking to establish capital
requirements for nonbank swap dealers and major swap participants.
The Dodd-Frank Act requires capital requirements to help ensure the
safety and soundness of swap dealers and major swap participants.
Capital rules help protect commercial end-users and other market
participants by requiring that dealers have sufficient capital to
stand behind their obligations with such end-users and market
participants. The proposal fulfills the Dodd-Frank Act's mandate in
Section 731 to establish capital rules for all registered swap
dealers and major swap participants that are not banks, including
nonbank subsidiaries of bank holding companies.
The proposed rule addresses capital requirements for swap
dealers and major swap participants in three different categories:
(1) If they are an futures commission merchants (FCMs); 2) if they
are subsidiaries of bank holding companies or systemically important
financial institutions; or 3) if they are neither.
With regard to dealers that also are FCMs, generally speaking,
the Commission's existing capital rules for FCMs would apply. This
is to ensure that FCMs have sufficient capital to continue to carry
and clear customer swaps and futures transactions cleared by a DCO.
The proposed rule would require dealers that are subsidiaries of
bank holding companies or that have been designated as systemically
important financial institutions by the Financial Stability
Oversight Council (FSOC) to follow the rules set by the prudential
regulators. For instance, a subsidiary of a U.S. bank holding
company would have to comply with the capital requirements set by
the Federal Reserve Board as if the subsidiary itself were a U.S.
bank holding company. This is intended to prevent regulatory
arbitrage and ensure consistency among capital regimes for those
entities that are regulated by prudential regulators.
For those swap dealers and major swap participants that are not
regulated for capital by a prudential capital and not FCMs, part of
a bank holding company or a systemically important financial
institution, the proposed rule departs from bank capital rules. It
takes into consideration that these dealers are likely to have
different balance sheets from those financial institutions that
traditionally have been subject to prudential supervision. Such
entities would be required to maintain a minimum level of tangible
net equity greater than $20 million plus a measurement for market
risk and a measurement for credit risk. This market risk and credit
risk would be scaled to the dealers' activities and be measured
based upon swaps activity and related hedges. The proposal would
allow such firms to recognize as part of their capital fixed assets
and other assets that traditionally have not been recognized by
prudential regulators.
I also support the proposed rulemaking's financial condition
reporting requirements that relate generally to capital and other
matters. These reporting requirements are comparable to existing
requirements for FCMs and will facilitate ongoing financial
oversight of these entities.
CFTC staff worked very closely with prudential regulators to
establish these capital requirements that are comparable to the
maximum extent practicable. Staff also consulted with the SEC and
with international authorities. The rule benefited from the CFTC and
SEC staff roundtable on capital and margin requirements where we
received significant input from the public.
Note: The following exhibit also will not appear in the Code of
Federal Regulations.
BILLING CODE P
[[Page 27841]]
[GRAPHIC] [TIFF OMITTED] TP12MY11.002
[FR Doc. 2011-10881 Filed 5-11-11; 8:45 am]
BILLING CODE C
Last Updated: May 12, 2011
See Also:
