2011-9598
-
Federal Register, Volume 76 Issue 82 (Thursday, April 28, 2011)[Federal Register Volume 76, Number 82 (Thursday, April 28, 2011)]
[Proposed Rules]
[Pages 23732-23749]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-9598]
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Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 /
Proposed Rules
[[Page 23732]]
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038--AC97
Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing regulations to implement new statutory
provisions enacted by Title VII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (``Dodd-Frank Act''). The proposed
regulations would implement the new statutory framework of Section
4s(e) of the Commodity Exchange Act (``CEA''), added by Section 731 of
the Dodd-Frank Act, which requires the Commission to adopt capital and
initial and variation margin requirements for certain swap dealers
(``SDs'') and major swap participants (``MSPs''). The proposed rules
address initial and variation margin requirements for SDs and MSPs. The
proposed rules will not impose margin requirements on non-financial end
users. The Commission will propose rules regarding capital requirements
for SDs and MSPs at a later date. The Commission will align the comment
periods of these two proposals so that commenters will have an
opportunity to review each before commenting on either.
DATES: Comments must be received on or before June 27, 2011.
ADDRESSES: You may submit comments, identified by RIN 3038-AC97, and
Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants by any of the following methods:
Agency Web site, via its Comments Online process at http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: Send to David A. Stawick, Secretary, Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street,
NW., Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Please submit your comments using only one method.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that may be exempt from disclosure under the Freedom of
Information Act, a petition for confidential treatment of the exempt
information may be submitted according to the established procedures in
Sec. 145.9 of the Commission's regulation, 17 CFR 145.9.
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from 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: John C. Lawton, Deputy Director,
Thomas Smith, Deputy Director, or Thelma Diaz, Associate Director,
Division of Clearing and Intermediary Oversight, 1155 21st Street, NW.,
Washington, DC 20581. Telephone number: 202-418-5480 and electronic
mail: jlawton@cftc.gov; tsmith@cftc.gov; or tdiaz@cftc.gov.
SUPPLEMENTARY INFORMATION:
I. Background
A. Legislation Requiring Rulemaking for Margin Requirements of SDs and
MSPs
On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\
Title VII of the Dodd-Frank Act amended the CEA \2\ to establish a
comprehensive regulatory framework 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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\1\ 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.
\2\ 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 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 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 regulations governing margin.
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 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. 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, the Federal
Home Loan Mortgage
[[Page 23733]]
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 a SD or MSP.
In general, therefore, the Commission is required to establish
margin 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 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.
B. Considerations for SD and MSP Rulemaking Specified in Section 4(s)
Section 4s(e)(3)(A) states the need to offset the greater risk that
swaps that are not cleared pose to SDs, MSPs, and the financial system,
and directs the Commission, United States Securities and Exchange
Commission (``SEC''), and prudential regulators to adopt capital and
margin requirements that: (1) Help ensure the safety and soundness of
the registrant; and (2) are appropriate for the risk associated with
the uncleared swaps they hold. Section 4s(e)(3)(C) permits the use of
noncash collateral, as the Commission and the prudential regulators
each determines to be consistent with: (1) Preserving the financial
integrity of markets trading swaps; and (2) preserving the stability of
the United States financial system.
C. Consultation With SEC and Prudential Regulators
The Commission has worked closely with the prudential regulators
and the SEC in designing these rules. Every effort has been made to be
as consistent as possible with the rules being considered by the
prudential authorities. Section 4s(e)(3)(D) of the CEA requires that
the Commission, SEC, and prudential regulators (together, referred to
as ``Agencies'') establish and maintain, to the maximum extent
practicable, comparable minimum initial and variation margin
requirements for SDs, MSPs, security-based swap dealers (``SSDs'') and
major security-based swap participants (``MSSPs'') (together, referred
to as ``swap registrants''). Section 4s(e)(3)(D) also requires the
Agencies to periodically, but not less frequently than annually,
consult on minimum margin requirements for swap registrants. As
directed by Dodd-Frank, and consistent with precedent for harmonizing
where practicable the minimum margin requirements of dual registrants,
staff from each of the Agencies has had the opportunity to provide oral
and written comments on the proposal and the proposed regulations
incorporate elements of the comments provided.
D. Structure and Approach
Consistent with the objectives set forth above, this release
summarizes regulations that the Commission proposes in order to
establish minimum initial and variation margin 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 CEA in a new Part
23.\3\ By this Federal Register release, the Commission is proposing to
adopt Subpart E of Part 23, pertaining to the capital and margin
requirements and related financial condition reporting requirements of
SDs and MSPs.\4\
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\3\ See 75 FR 71379 (Nov. 23, 2010).
\4\ As noted above, the Commission will propose rules related to
capital and financial condition reporting in a separate release.
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II. Proposed Margin Regulations
A. Introduction
Section 4s(e)(2)(B) of the CEA provides that:
The Commission shall adopt rules for swap dealers and major swap
participants, with respect to their activities as a swap dealer or
major swap participant, for which there is not a prudential regulator
imposing--
(i) Capital requirements; and
(ii) Both initial and variation margin requirements on all swaps
that are not cleared by a registered derivatives clearing organization.
Section 4s(e)(3)(A) of the CEA provides that:
To offset the greater risk to the swap dealer or major swap
participant and the financial system arising from the use of swaps that
are not cleared, the requirements imposed under paragraph (2) shall
(i) Help ensure the safety and soundness of the swap dealer or
major swap participant; and
(ii) Be appropriate for the risk associated with the non-cleared
swaps.
During the recent financial crisis, derivatives clearing
organizations (``DCOs'') met all their obligations without any
financial infusions from the government. By contrast, significant sums
were expended as the result of losses incurred in connection with
uncleared swaps, most notably at AIG. A key reason for this difference
is that DCOs all use variation margin and initial margin as the
centerpiece of their risk management programs while these tools were
often not used in connection with uncleared swaps. Consequently, in
designing the proposed margin rules for uncleared swaps, the Commission
has built upon the sound practices for risk management employed by
central counterparties for decades.
Variation margin entails marking open positions to their current
market value each day and transferring funds between the parties to
reflect any change in value since the previous time the positions were
marked. This process prevents losses from accumulating over time and
thereby reduces both the chance of default and the size of any default
should one occur.
Initial margin serves as a performance bond against potential
future losses. If a party fails to meet its obligation to pay variation
margin, resulting in a default, the other party may use initial margin
to cover most or all of any loss based on the need to replace the open
position.
Well-designed margin systems protect both parties to a trade as
well as the overall financial system. They serve both as a check on
risk-taking that might exceed a party's financial capacity and as a
resource that can limit losses when there is a failure.
The statutory provisions cited above reflect Congressional
recognition that (i) margin is an essential risk-management tool and
(ii) uncleared swaps pose greater risks than cleared swaps. In
particular, it is noteworthy that Section 4s(e)(2)(B)(ii) requires both
variation margin and initial margin for SDs and MSPs on all uncleared
swaps and that Section 4s(e)(3)(A) explicitly refers to the greater
risk of uncleared swaps. In addition to the disciplines of regular
collection of initial and variation margin previously mentioned,
central clearing
[[Page 23734]]
provides additional means of risk mitigation.
First, unlike an SD or MSP, a DCO is not in the business of taking
positions in the market. By definition, a DCO runs a perfectly matched
book. Second, a DCO only deals with members who must meet certain
financial, risk management, and operational standards. Third, a DCO may
turn to those members to help liquidate or transfer open positions in
the event of a member default. Fourth, DCOs typically, by rule, have
the ability to mutualize a portion of the tail risk associated with a
clearing member default through the use of guarantee funds and similar
mechanisms.
Concern has been expressed that the imposition of margin
requirements on uncleared swaps will be very costly for SDs and MSPs.
However, margin has been, and will continue to be, required for all
cleared products. Given the Congressional reference to the ``greater
risk'' of uncleared swaps and the requirement that margin for such
swaps ``be appropriate for the risk,'' the Commission believes that
establishing margin requirements for uncleared swaps that are at least
as stringent as those for cleared swaps is necessary to fulfill the
statutory mandate. Within these statutory bounds the Commission has
endeavored to limit costs appropriately. For example, as discussed
below, the proposal would permit margin reductions for positions with
offsetting risk characteristics.
The proposals set forth below were developed in consultation with
the prudential regulators. They are consistent in almost all material
respects with provisions that the Commission understands are being
proposed by the prudential regulators.\5\ Salient differences will be
noted below.
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\5\ The Commission anticipates that the prudential regulators
will publicly post their proposed rules on their Web sites, see,
e.g., http://www.fdic.gov/.
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The discussion below addresses: (i) The products covered by the
proposed rules; (ii) the market participants covered by the proposed
rules; (iii) permissible methods of calculating initial margin; (iv)
permissible methods of calculating variation margin; (v) permissible
margin assets; and (vi) permissible custodial arrangements.
B. Products
The proposal would cover only swaps executed after the effective
date of the regulation that are not cleared by a DCO. The proposal
would not apply to swaps executed before the effective date of the
final regulation. The Commission believes that the pricing of existing
swaps reflects the credit arrangements under which they were executed
and that it would be unfair to the parties and disruptive to the
markets to require that the new margin rules apply to those positions.
However, the Commission requests comment on whether SDs and MSPs should
be permitted voluntarily to include pre-effective date swaps in
portfolios margined pursuant to the proposed rules. The Commission also
anticipates that existing positions would be taken into account under
the capital rule to be proposed at a later date.
The Commission also wishes to emphasize that the proposal does not
apply to forward contracts. Under the CEA, the CFTC does not regulate
forward contracts. Accordingly, the Commission believes that the
requirements of Section 4s(e) do not apply to forward contracts.
C. Market Participants
1. Overview
The proposed regulations would impose requirements on SDs and MSPs
for which there is no prudential regulator (``covered swap entities''
or ``CSEs''). Because different types of counterparties may pose
different levels of risk, the requirements would vary in some respects
depending on the category of counterparty. The proposed regulations
would not impose margin requirements on non-financial end users.
Proposed Sec. 23.151 would require each CSE to execute
documentation regarding credit support arrangements that is consistent
with the requirements of these rules with each counterparty. The
documentation would specify in advance material terms such as how
margin would be calculated, what types of assets would be permitted to
be posted, what margin thresholds, if any, would apply, and where
margin would be held. This provision is consistent with the
documentation requirement recently proposed by the Commission as Sec.
23.504.\6\ Having comprehensive documentation in advance concerning
these matters would allow each party to a swap to manage its risks more
effectively throughout the life of the swap and to avoid disputes
regarding issues such as valuation. The Commission solicits comment
regarding whether it should require SDs and MSPs to document the
procedures by which any disputes concerning the valuation of a swap or
the valuation of assets collected or posted as initial or variation
margin may be resolved.
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\6\ Swap Trading Relationship Documentation Requirements for
Swap Dealers and Major Swap Participants, 76 FR 6715 (Feb. 8, 2011).
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Under rules being proposed by the prudential regulators for SDs and
MSPs that are banks, the parties are allowed to make particular
variation margin calculations pursuant to a qualifying master netting
agreement. The Commission understands that this term will be defined
under rules proposed by the prudential regulators to mean a legally
enforceable agreement to offset positive and negative mark-to-market
values of one or more swaps or security-based swaps that meet a number
of specific criteria designed to ensure that these offset rights are
fully enforceable, documented, and monitored by the covered swap
entity.
As noted, the Commission has previously proposed Sec. 23.504,
which requires SDs and MSPs to have swap trading relationship
documentation with each counterparty. Under proposed Sec.
23.504(b)(1), this documentation ``shall be in writing and shall
include all terms governing the trading relationship between the swap
dealer or major swap participant and its counterparty, including,
without limitation, terms addressing payment obligations, netting of
payments, events of default or other termination events, calculation
and netting of obligations upon termination, transfer of rights and
obligations, governing law, valuation, and dispute resolution
procedures.'' \7\
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\7\ Id.
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Under proposed Sec. 23.600(c)(4)(v)(A), SDs and MSPs would be
required to have risk management policies and procedures addressing
legal risks associated with their business as swap dealers or major
swap participants, including risks associated with ``determinations
that transactions and netting arrangements entered into have a sound
legal basis.'' \8\ Taken together, it is the Commission's belief that
all SDs and MSPs entering into trading relationship documentation with
their counterparties would be required to have a sound legal basis to
determine that such agreements will be enforceable in accordance with
their terms.
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\8\ See Regulations Establishing and Governing the Duties of
Swap Dealers and Major Swap Participants, 75 FR 71397, 71405 (Nov.
23, 2010).
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The Commission solicits comment regarding whether proposed
Sec. Sec. 23.501 and 23.600 are sufficient to ensure that SDs and MSPs
have a sound legal basis for their swap documentation or whether the
Commission should adopt the concept of ``qualifying master netting
agreements'' from existing banking regulations.
[[Page 23735]]
2. Positions Between CSEs and Other SDs or MSPs
Proposed Sec. 23.152 addresses initial margin and variation margin
requirements for positions of CSEs with other SDs or MSPs. (The latter
would include both SD/MSPs that are CSEs and SD/MSPs for which there is
a prudential regulator.) The regulation would require CSEs to collect
initial margin for every uncleared swap with another SD or MSP on or
before the date of execution of the swap.\9\ The proposed rule would
require the CSEs to maintain initial margin from its counterparty equal
to or greater than an amount calculated pursuant to proposed Sec.
23.155, discussed below, until the swap is liquidated.\10\ The credit
support arrangements between a CSE and its counterparty would be
prohibited from containing a threshold below which the CSE was not
required to post initial margin, i.e., zero thresholds would be
required.
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\9\ In previously proposed rules, execution has been defined to
mean, ``with respect to a swap transaction, an agreement by the
counterparties (whether orally, in writing, electronically, or
otherwise) to the terms of the swap transaction that legally binds
the counterparties to such terms under applicable law.''
Confirmation, Portfolio Reconciliation, and Portfolio Compression
Requirements for Swap Dealers and Major Swap Participants, 75 FR
81519, 81530 (Dec. 28, 2010). Additionally, swap transaction has
been defined to mean ``any event that results in a new swap or in a
change to the terms of a swap, including execution, termination,
assignment, novation, exchange, transfer, amendment, conveyance, or
extinguishing of rights or obligations of a swap.'' Id. at 81531.
\10\ The use of the term ``liquidated'' in this context should
be construed to include all ownership events related to that swap,
including expiration or maturation.
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(In order to reduce transaction costs, proposed Sec. 23.150 would
establish a ``minimum transfer amount'' of $100,000. Initial and
variation margin payments would not be required to be made if below
that amount. This amount was selected in consultation with the
prudential regulators. It represents an amount sufficiently small that
the level of risk reduction might not be worth the transaction costs of
moving the money. It only affects the timing of collection; it does not
change the amount of margin that must be collected once the $100,000
level is exceeded.)
CSEs also would be required to collect variation margin for all
trades with another SD or MSP. Again, zero thresholds would be
required, and the obligation would continue on each business day until
the swap is liquidated. The proposal contains a provision stating that
a CSE would not be deemed to have violated its obligation to collect
variation margin if it took certain steps. Specifically, if a
counterparty failed to pay the required variation margin to the CSE,
the CSE would be required to make the necessary efforts to attempt to
collect the variation margin, including the timely initiation and
continued pursuit of formal dispute resolution mechanisms, or otherwise
demonstrate upon request to the satisfaction of the Commission that it
has made appropriate efforts to collect the required variation margin
or commenced termination of the swap.
It is the nature of the dealer business that dealers are at the
center of the markets in which they participate. Similarly, a major
swap participant, by its terms, is a significant trader. Collectively,
SDs and MSPs pose greater risk to the markets and the financial system
than other swap market participants. Accordingly, under the mandate of
Section 4s(e), the Commission believes that they should be required to
collect margin from one another.
3. Positions Between CSEs and Financial Entities
Proposed Sec. 23.153 addresses initial margin and variation margin
requirements for positions between CSEs and financial entities.
Proposed Sec. 23.150 would define a financial entity as a counterparty
that is not an SD or MSP and that is either: (i) A commodity pool as
defined in Section 1a(5) of the Act; (ii) a private fund as defined in
Section 202(a) of the Investment Advisors Act of 1940; (iii) an
employee benefit plan as defined in paragraphs (3) and (32) of section
3 of the Employee Retirement Income and Security Act of 1974; (iv) a
person predominantly engaged in activities that are in the business of
banking, or in activities that are financial in nature as defined in
Section 4(k) of the Bank Holding Company Act of 1956; (v) a person that
would be a financial entity described in (i) or (ii) if it were
organized under the laws of the United States or any State thereof;
(vi) the government of any foreign country or a political subdivision,
agency, or instrumentality thereof; or (vii) any other person the
Commission may designate. With three modifications discussed below,
this definition tracks the definition in Section 2(h)(7)(C) of the Act
that is used in connection with an exception from any applicable
clearing mandate.
Item (v) of the proposed definition adds entities that would be a
commodity pool or private fund if organized in the United States. The
Commission believes that such entities would pose similar risks to
those of similar entities located within the United States.
Item (vi) of the proposed definition adds any government of any
foreign country or any political subdivision, agency, or
instrumentality thereof. The Commission notes that these types of
sovereign counterparties do not fit easily into the proposed rule's
categories of financial and nonfinancial entities. In comparing the
characteristics of sovereign counterparties with those of financial and
nonfinancial entities, the Commission preliminarily believes that the
financial condition of a sovereign will tend to be closely linked with
the financial condition of its domestic banking system, through common
effects of the business cycle on both government finances and bank
losses, as well as through the safety net that many sovereigns provide
to banks. Such a tight link with the health of its domestic banking
system, and by extension with the broader global financial system,
makes a sovereign counterparty similar to a financial entity both in
the nature of the systemic risk and the risk to the safety and
soundness of the covered swap entity. As a result, the Commission
preliminarily believes that sovereign counterparties should be treated
as financial entities for purposes of the proposed rule's margin
requirements.
Item (vii) in the proposed definition permits the Commission to
designate additional entities as financial entities. The Commission
understands that the prudential regulators are proposing the same
provision. This would enable regulators to accomplish the purposes of
Section 4s in circumstances where they identify additional entities
whose activities and risk profile warrant inclusion. The Commission
solicits comment on whether these entities are appropriate, whether
additional entities should be designated as financial entities, and
what criteria should be applicable.
The Commission believes that financial entities, which generally
are not using swaps to hedge or mitigate commercial risk, potentially
pose greater risk to CSEs than non-financial entities. Accordingly, if
a CSE chooses to expose itself to such risk, it should take steps to
mitigate such risks.
Initial margin would be required to be collected by CSEs for every
trade with a financial entity on or before the date of execution of the
swap. The proposed rule would require the CSEs to maintain initial
margin from its counterparty equal to or greater than an amount
calculated pursuant to proposed Sec. 23.155, discussed below, until
the swap is liquidated.
[[Page 23736]]
Zero thresholds would be required except for certain financial
entities \11\ that: (i) Are subject to capital requirements established
by a prudential regulator or a State insurance regulator; (ii)
predominantly use swaps to hedge; and (iii) do not have significant
swaps exposure.\12\ The proposal set forth ranges within which the
threshold would fall. These eligibility standards and ranges were
established in consultation with the prudential regulators.
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\11\ The prudential regulators proposed rulemaking refers to
these financial entities as ``low-risk'' financial entities based on
the relative risk posed by the type of counterparty.
\12\ Significant swap exposure is defined by reference to rules
previously proposed by the Commission. See Further Definition of
``Swap Dealer,'' ``Security-Based Swap Dealer,'' ``Major Swap
Participant,'' ``Major Security-Based Swap Participant'' and
``Eligible Contract Participant'' 75 FR 80174 (Dec. 21, 2010).
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The Commission solicits comment on whether thresholds should be
permitted at all, and if so, what entities should be eligible, and at
what level they should be set. If the Commission determines to permit
thresholds, it anticipates that the final rule would establish a single
level rather than a range.
Similarly, variation margin would also be required to be collected
by CSEs on all transactions with a financial entity. Zero thresholds
would be required with the same exception discussed above for initial
margin. Any applicable thresholds for initial and variation margin
would be separate and therefore could be cumulative. The obligation
would continue on each business day until the swap is liquidated.
The Commission notes that under the proposed rule each CSE would be
required to collect variation margin from financial entities but would
not be required to pay variation margin to them. This approach is
consistent with what the prudential regulators are proposing in their
margin rules. The rationale is that when an SD pays variation margin to
an financial entity that is not subject to capital requirements, money
is flowing from a regulated entity to an unregulated one. By following
this approach in its proposed rules, the Commission is endeavoring to
follow Section 4s(e)(D)(ii)'s requirement that Commission regulations
on margin be comparable to those of the prudential regulators ``to the
maximum extent practicable.''
The Commission wishes to highlight and solicits comment regarding
the risk management effects of this approach and its appropriateness
under Section 4s(e)(E)(3)(A) of the CEA. As noted above, two-way
variation margin has been a keystone of the ability of DCOs to manage
risk. Each day current exposure is removed from the market through the
payment and collection of variation margin for all products and all
participants regardless of their identity or financial resources.
If two-way variation margin were not required for uncleared swaps
between CSEs and financial entities, the CSE's exposures may be allowed
to accumulate. In contrast to initial margin, which is designed to
cover potential future exposures, variation margin addresses actual
current exposures, that is, losses that have already occurred.
Unchecked accumulation of such exposures was one of the characteristics
of the financial crisis which, in turn, led to the enactment of the
Dodd-Frank Act.
Moreover, both payment and collection of variation margin help
ensure the safety and soundness of the swap dealer or major swap
participant. Daily collection helps the safety and soundness of the CSE
by removing current exposure from each counterparty. But daily payment
also helps safety and soundness by preventing the CSE from building up
exposures that it cannot fulfill.
Finally, two-way variation would address the risk associated with
the non-cleared swaps held as a swap dealer or major swap participant.
Uncleared swaps are likely to be more customized and consequently trade
in a less liquid market than cleared swaps. As a result, uncleared
swaps might take a longer time and require a greater price premium to
be liquidated than cleared swaps, particularly in a distressed market
conditions. Failure to remove current exposures in advance of such a
situation through daily, two-way variation margin could exacerbate any
losses in the event of a SD or MSP default.
Accordingly, in addition to requesting comment on the proposed
requirement for collection of variation margin set forth below as
23.153(b)(1), the Commission also requests comment on whether it should
adopt an additional provision as follows:
For each uncleared swap between a covered swap entity and a
financial entity, each covered swap entity shall pay variation
margin as calculated pursuant to Sec. 23.156 of this part directly
to the financial entity or to a custodian selected pursuant to Sec.
23.158 of this part. Such payments shall start on the business day
after the swap is executed and continue each business day until the
swap is liquidated.
Many of the considerations discussed above also might apply to two-
way initial margin. The Commission solicits comments on whether two-way
initial margin is appropriate for transactions between CSEs and
financial entities.
4. Positions Between CSEs and Non-financial Entities
The proposal would not impose margin requirements on non-financial
entities. Proposed Sec. 23.150 would define a non-financial entity as
a counterparty that is not a swap dealer, a major swap participant, or
a financial entity. The Commission believes that such entities, which
are using swaps to hedge commercial risk, pose less risk to CSEs than
financial entities. Consistent with Congressional intent,\13\ the
proposal would not impose margin requirements on such positions.
---------------------------------------------------------------------------
\13\ Letter from Chairman Debbie Stabenow, Committee on
Agriculture, Nutrition and Forestry, U.S. Senate, Chairman Frank D.
Lucas, Committee on Agriculture, United States House of
Representatives, Chairman Tim Johnson, Committee on Banking,
Housing, and Urban Affairs, U.S. Senate, and Chairman Spencer
Bachus, Committee on Financial Services, United States House of
Representatives to Secretary Timothy Geithner, Department of
Treasury, Chairman Gary Gensler, U.S. Commodity Futures Trading
Commission, Chairman Ben Bernanke, Federal Reserve Board, and
Chairman Mary Shapiro, U.S. Securities and Exchange Commission
(April 6, 2011); Letter from Chairman Christopher Dodd, Committee on
Banking, Housing, and Urban Affairs, U.S. Senate, and Chairman
Blanche Lincoln, Committee on Agriculture, Nutrition, and Forestry,
U.S. Senate, to Chairman Barney Frank, Financial Services Committee,
United States House of Representatives, and Chairman Collin
Peterson, Committee on Agriculture, United States House of
Representatives (June 30, 2010); see also 156 Cong. Rec. S5904
(daily ed. July 15, 2010) (statement of Sen. Lincoln)
---------------------------------------------------------------------------
The proposal would require that CSEs have credit support
arrangements in place consistent with proposed Sec. 23.504.\14\ This
would ``help ensure the safety and soundness of the swap dealer or
major swap participant'' by providing clarity as its rights and
obligations. The proposal would not dictate the terms of any margin
arrangements other than stating that each covered swap entity may
accept as margin from non-financial entities only assets for which the
value is reasonably ascertainable on a periodic basis in a manner
agreed to by the parties in the credit support arrangements.
---------------------------------------------------------------------------
\14\ Swap Trading Relationship Documentation Requirements for
Swap Dealers and Major Swap Participants, 76 FR 6715 (Feb. 8, 2011).
---------------------------------------------------------------------------
The parties would be free to set initial margin and variation
margin requirements in their discretion and any thresholds agreed upon
by the parties would be permitted. The proposal would require that CSEs
pay and collect initial margin and variation margin as set forth in
their agreements with their counterparties. The Commission understands
that the proposal differs
[[Page 23737]]
from the proposal of the prudential regulators which would require that
CSEs collect variation margin from non-financial entities at least once
per week, if applicable thresholds were exceeded.
The proposal would require each CSE to calculate hypothetical
initial and variation margin amounts each day for positions held by
non-financial entities. That is, the CSE must calculate what the margin
amounts would be if the counterparty were another SD or MSP.\15\ These
calculations would serve as risk management tools that would assist the
CSE in measuring its exposure. Moreover, they would likely be necessary
for CSEs in computing any capital requirements that might be
applicable.
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\15\ This is consistent with the requirement set forth in
Section 4s(h)(3)(B)(iii)(II) that SDs and MSPs must disclose to
counterparties who are not SDs or MSPs a daily mark for uncleared
swaps.
---------------------------------------------------------------------------
D. Calculation of Initial Margin
Proposed Sec. 23.155 addresses how initial margin should be
calculated. Models meeting specified standards would be permissible. If
no model meeting the standards of the rule is available, the CSE would
set margin in accordance with an alternative approach described below.
1. Models
Proposed Sec. 23.155(b) sets forth requirements for models. Under
proposed Sec. 23.155(b)(1), the following would be eligible: (i) A
model currently in use for margining cleared swaps by a DCO, (ii) a
model currently in use for margining uncleared swaps by an entity
subject to regular assessment by a prudential regulator, or (iii) a
model available for licensing to any market participant by a vendor.
Unlike the banking institutions that will be overseen by the prudential
regulators, the CSEs subject to the Commissions regulations may not
have proprietary models. Moreover, given current budget constraints,
the Commission does not have the resources to review numerous models
individually. Accordingly, at this time, the Commission is proposing to
permit the use of certain non-proprietary models. The proposal,
however, also contains a provision which would permit the Commission to
issue an order that would allow the use of proprietary models in the
future should the Commission obtain sufficient resources.
This is an aspect of the proposal that differs from the prudential
regulators' approach. Because many banks already have proprietary
models, and because the prudential regulators have the resources to
review individual proprietary models, the prudential regulators would
not permit the use of DCO models or the use of models licensed to
market participants. The Commission solicits comment on the feasibility
of the use of DCO models or third party models by CSEs for margining
uncleared swaps.
Proposed Sec. 23.155(b)(2) further requires that a model meet
specified standards. The following are some of the elements that would
be required in a model:
The valuation of a swap must take into account all
significant, identifiable risk factors, including any non-linear risk
characteristics;
The valuation of a swap must be based on pricing sources
that are accurate and reliable;
The model must set margin to cover at least 99% of price
changes by product and by portfolio over at least a 10-day liquidation
horizon;
The model must be validated by an independent third party
before being used and annually thereafter;
The swap dealer or major swap participant must conduct
back testing and stress testing of the model on a regular basis; and
If the swap product is also offered for non-mandatory
clearing by a registered DCO, the initial margin collected may not be
less than the initial margin required by the DCO.
Parties could add individualized credit surcharges to the margin amount
produced by the model.
These standards are consistent with the standards that the
Commission understands that the prudential regulators are proposing.
They are also similar to the standards the Commission has used in
evaluating DCO margin models, and that prudential regulators have used
in assessing bank margin models.
Proposed Sec. 23.155(b)(3) would require that models be filed with
the Commission. The filing would include a complete explanation of:
The manner in which the model meets the requirements of
this section;
The mechanics of the model;
The theoretical basis of the model;
The empirical support for the model; and
Any independent third party validation of the model.
Under proposed Sec. 23.155(b)(4), the Commission could approve or
deny the application by an SD or MSP to use an initial margin model, 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 after determining, among other things, whether the
applicant had met the requirements of the section and was in compliance
with other applicable rules promulgated under the Act and by self-
regulatory organizations.
Under proposed Sec. 23.155(b)(4), the Commission also could at any
time require a CSE to provide further data or analysis concerning the
amount of initial margin required or on deposit. In addition, the
Commission could at any time require a CSE to modify the model to
address potential vulnerabilities. These measures are designed to be
prudent safeguards to be used to address weaknesses that may only
become apparent over time.
2. Alternative Method
Proposed Sec. 23.155(c) provides that if a model meeting the
standards of the rule is not used, margin must be calculated in
accordance with a specified alternative method. The Commission
determined that a potentially effective way to measure the risk of
uncleared swaps in cases where models were unavailable would be to base
the margin requirements on the margin requirements for related cleared
products.
Proposed Sec. 23.155(c)(1) provides that the CSE identify in the
credit support arrangements the swap cleared by a DCO in the same asset
class as the uncleared swap for which the terms and conditions most
closely approximate the terms and conditions of the uncleared swap. If
there is no cleared swap whose terms and conditions closely approximate
the uncleared swap, the swap dealer or major swap participant must
identify in the credit support arrangements the futures contract
cleared by a DCO in the same asset class as the uncleared swap which
most closely approximates the uncleared swap and would be most likely
to be used to hedge the uncleared swap.
The CSE would ascertain the margin the DCO would require for the
position. The CSE would then multiply the amount for a cleared swap by
2.0 in order to determine the margin required for the uncleared swap or
multiply the amount for a cleared futures contract by 4.4 in order to
determine the margin required for the uncleared swap.
The multiplier is calculated by comparing the anticipated
liquidation time horizon for the cleared product to the anticipated
liquidation time horizon for the uncleared swap and then applying
several add-ons for additional risk factors. To illustrate, typically,
a cleared futures contract is margined
[[Page 23738]]
using a one-day liquidation time period, while under the proposal, an
uncleared swap would be margined using a 10-day period. A standard way
to measure the increase in risk over the longer period is to multiply
the margin for the shorter period by the square root of the longer
period. The square root of 10 is 3.162.
The proposal would increase this number to address several
additional risks. A 10% cushion would be added to reflect that a 10-day
period may be insufficient for some customized products. An additional
10% cushion would be added to reflect that the square root method
assumes a normal distribution of prices which might not be true for
customized products. An additional 20% cushion would be added to
reflect the basis risk between the cleared and uncleared products.
Taking into account these add-ons yields a total multiplier of 4.4.
A similar calculation for cleared swaps yields a multiplier of 2.0.
The margin for cleared swaps generally would be higher than the margin
for cleared futures because cleared swaps generally would be subject to
a 5-day liquidation time.\16\ The greater similarity in the anticipated
liquidation time results in a smaller multiplier when comparing
uncleared swaps to cleared swaps than when comparing uncleared swaps to
cleared futures.
---------------------------------------------------------------------------
\16\ In rules the Commission previously proposed for DCOs,
cleared swaps traded on a swap execution facility or executed
bilaterally would be subject to a minimum five-day liquidation
period for purposes of calculating initial margin, whereas swaps
traded on a designated contract market may be subject to a minimum
one-day requirement. Risk Management Requirements for Derivatives
Clearing Organizations, 76 FR 3698, 3704-05 (Jan. 20, 2011). To the
extent that a cleared swap was subject to the one-day requirement,
the appropriate multiplier would be the same as the futures
multiplier.
---------------------------------------------------------------------------
This alternative model is another aspect of the proposal that
differs from the prudential regulators' approach. Their alternative
uses percentages of notional value. The Commission considered using a
similar approach but recognized that the use of notional percentages is
an imprecise measure that does not capture the nuances of risk and it
appeared to be more appropriate to base initial margins for uncleared
swaps on those required by DCOs for similar cleared swaps. The
Commission invites comment on the relative merits of the two
alternative approaches. In this regard, the Commission requests comment
on the appropriateness of the levels of initial margin set forth in the
prudential regulators' alternative approach.
Proposed Sec. 23.155(c)(2) addresses portfolio offsets for swaps
with correlated risk profiles under the alternative method. Again, the
proposal is conservative. Reductions in margin based on offsetting risk
characteristics of products would not be permitted across asset classes
except between currencies and interest rates. Any reductions in margin
based on offsetting risk characteristics of products within an asset
class must have a sound theoretical basis and significant empirical
support. No reduction may exceed 50% of the amount that would be
required for the swap in the absence of a reduction.
Proposed Sec. 23.155(c)(3) provides for modifications for
particular products or positions. Each CSE would be required to monitor
the coverage provided by margin established pursuant to this paragraph
(c) and collect additional margin if appropriate to address the risk
posed by particular products or positions.
Under proposed Sec. 23.155(c)(4), the Commission could at any time
require the CSE to post or collect additional margin because of
additional risk posed by a particular product. Furthermore, the
Commission could at any time require a CSE to post or collect
additional margin because of additional risk posed by a particular
party to the swap. For example, if the Commission were to learn that a
particular counterparty was experiencing financial difficulty, it might
need to take steps to ensure that the CSE held margin appropriate for
the risk associated with the position. These measures are designed to
be prudent safeguards similar to those discussed above.
E. Calculation of Variation Margin
Proposed Sec. 23.156 addresses how variation margin should be
calculated. Proposed Sec. 23.156(b) sets forth several requirements.
The valuation of each swap must be determined pursuant to a method
agreed upon by the parties in the credit support arrangements. It must
be consistent with the requirements set forth in proposed Section
23.504(b) of this part.\17\ It must be set forth with sufficient
specificity to allow the counterparty, the Commission, and any
applicable prudential regulator to calculate the requirement
independently.
---------------------------------------------------------------------------
\17\ Swap Trading Relationship Documentation Requirements for
Swap Dealers and Major Swap Participants, 76 FR 6715 (Feb. 8, 2011).
---------------------------------------------------------------------------
Under proposed Sec. 23.155(c), the Commission could at any time
require the CSE to provide further data or analysis concerning the
methodology. Furthermore, the Commission could at any time require a
CSE to modify the methodology to address potential vulnerabilities.
These measures are designed to be prudent safeguards to be used to
address weaknesses that may only become apparent over time.
As noted above, the Commission previously proposed Sec.
23.504(b)(4), which would require that the swap trading documentation
include written documentation in which the parties agree on the
methods, procedures, rules and inputs for determining the value of each
swap at any time from execution to the termination, maturity, or
expiration of the swap. The agreed methods, procedures, rules and
inputs would be required to constitute a complete and independently
verifiable methodology for valuing each swap entered into between the
parties. Proposed Sec. 23.504(b)(4)(iii) would require that the
methodology include complete alternative methods for determining the
value of the swap in the event that one or more inputs to the
methodology become unavailable or fail, such as during times of market
stress or illiquidity. The provisions proposed in this release are
intended together with those previously proposed rules to ensure that
all swap positions are accurately and reliably marked to market and all
valuation disputes are resolved in a timely manner, thereby reducing
risk.
F. Forms of Margin
Proposed Sec. 23.157 addresses the types of assets that would be
acceptable as margin in transactions involving CSEs. There are
differences between initial margin and variation margin and within each
category depending on counterparties.
1. Initial Margin
Proposed Sec. 23.157(a)(2) provides that CSEs may only accept as
initial margin from SDs, MSPs, or financial entities, the following
assets:
Immediately available cash funds denominated in U.S.
dollars or the currency in which payment obligations under the swap are
required to be settled;
Any obligation which is a direct obligation of, or fully
guaranteed as to principal and interest by, the United States or an
agency of the United States; or
Any senior debt obligation of the Federal National
Mortgage Association, the Federal Home Loan Mortgage Corporation, a
Federal Home Loan Bank, the Federal Agricultural Mortgage Corporation,
or any obligation that is an ``insured obligation,'' as that term is
defined in 12 U.S.C. 2277a(3), of a Farm Credit System bank.
[[Page 23739]]
These are assets for which there are deep and liquid markets and,
therefore, assets that can be readily valued and easily liquidated. The
Commission requests comment on whether additional types of assets
should be acceptable.
To the extent a non-financial entity and a CSE have agreed that the
non-financial entity will post initial margin, proposed Sec.
23.157(a)(3) provides flexibility for initial margin posted by non-
financial entities with CSEs as to what assets are permissible. The
standard is simply that the value of the asset is reasonably
ascertainable on a periodic basis. This is in accordance with the
statement in Section 4s(e)(3)(C) that the Commission permit the use of
non-cash collateral as it determines consistent with preserving the
financial integrity of the markets and preserving the stability of the
United States financial system. The Commission understands that current
market practice would support a periodic valuation of the assets used
as noncash collateral, but solicits comment from market participants
regarding how practical the requirement is. In particular, the
Commission requests comment on how frequently such collateral could and
should be valued.
The Commission understands that this differs from the proposal of
the prudential regulators. The prudential regulators would require CSEs
to collect as initial margin for non-financial entities only the assets
listed previously to cover any exposure above the credit exposure
limit.
2. Variation Margin
Proposed Sec. 23.157(b) would require that variation payments by
CSEs, or financial entities be in cash or United States Treasury
securities. This is consistent with the general purpose of variation
margin of eliminating current exposure through the use of liquid,
easily valued assets.
To the extent a non-financial entity and a CSE have agreed that the
non-financial entity will post variation margin, proposed Sec.
23.157(b)(3) provides flexibility for variation margin posted by non-
financial entities with CSEs as to what assets are permissible. The
standard is simply that the value of the asset is reasonably
ascertainable on a periodic basis. As was the case for initial margin,
this is in accordance with the statement in Section 4s(e)(3)(C) that
the Commission permit the use of non-cash collateral.
Proposed Sec. 23.157(c) establishes haircuts for assets received
by a CSE from an SD, MSP, or financial entity as follows:
Margin Value Ranges for Non-Cash Collateral
[% of market value]
------------------------------------------------------------------------
Duration (years)
--------------------------------------
0-5 5-10 > 10
------------------------------------------------------------------------
U.S. Treasuries and Fully
Guaranteed Agencies:
Bills/Notes/Bonds/Inflation [98-100] [95-99] [94-98]
Indexed.....................
Zero Coupon, STRIPs.......... [97-99] [94-98] [90-94]
FHFA-Regulated Institutions
Obligations and Insured
Obligations of FCS Banks:
Bills/Notes/Bonds............ [96-100] [94-98] [93-97]
Zero Coupon.................. [95-99] [93-97] [89-93]
------------------------------------------------------------------------
These haircuts were based on a consultation with prudential regulators
who use them in other contexts.
Proposed Sec. 23.157(d) would authorize certain actions by the
Commission regarding margin assets. The Commission could:
Require a CSE to provide further data or analysis
concerning any margin asset posted or received;
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;
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;
Require a CSE to provide further data or analysis
concerning margin haircuts; or
Require a CSE to modify a margin haircut applied to an
asset received from an SD or MSP, or a financial entity to address
potential risks posed by the asset.
All these actions are intended to be methods for ensuring the safety
and soundness of the CSE and protecting the financial system.
G. Custodial Arrangements
Proposed Sec. 23.158 addresses custodial arrangements. The
proposal is intended to safeguard margin assets.
Under proposed Sec. 23.158(a) each CSE must offer each
counterparty the opportunity to select a custodian that is not
affiliated with the CSE. Further, each CSE must hold initial margin
received from a counterparty that is an SD or MSP at a custodian that
is independent of the CSE and the counterparty. Similarly, a CSE that
posts initial margin with a counterparty that is an SD or MSP must
require the counterparty to hold the initial margin at a custodian that
is independent of the SD or MSP and the counterparty.
Further, the proposal would require that the custodian be subject
to the same insolvency regime as the CSE. This would facilitate quicker
recovery of margin assets.
Under proposed Sec. 23.158(b)(1) each CSE must specify in each
custodial agreement that the custodian may not rehypothecate margin
assets or reinvest them in assets that are not permitted forms of
margin. Further, upon certification to the custodian in accordance with
the provisions of 23.602(b)(1) by a party that it is entitled to
receipt of margin, the custodian must release margin to the certifying
party.\18\
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\18\ Protection of Collateral of Counterparties to Uncleared
Swaps; Treatment of Securities in a Portfolio Margining Account in a
Commodity Broker Bankruptcy, 75 FR 75432 (Dec. 3, 2010).
---------------------------------------------------------------------------
Under proposed Sec. 23.158(b)(2), upon receipt of initial margin
from a counterparty, no CSE may post such assets as margin for a swap,
a security-based swap, a commodity for future delivery, a security, a
security futures product, or any other product subject to margin. These
provisions are designed to prevent the same asset from being passed
around as margin for multiple positions.
Under proposed Sec. 23.158(c), the Commission may at any time
require a CSE to provide further data or analysis concerning any
custodian. 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
[[Page 23740]]
original custodian. These provisions are designed to protect the assets
of the parties to the contract.
H. Request for Comment
The Commission requests comment on all aspects of the proposed
rules regarding margin. In particular, the Commission requests comment
on the following:
Are proposed Sec. Sec. 23.501 and 23.600 sufficient to
ensure that SDs and MSPs have a sound legal basis for their swap
documentation, or should the Commission adopt the concept of
``qualifying master netting agreements'' from existing banking
regulations?
It is the Commission's understanding that the prudential
regulators would require SDs and MSPs that are banks to appropriately
take into account and address the credit risk posed by the counterparty
and the risks of uncleared swaps, and further the prudential
authorities would require SDs and MSPs that are banks to enforce those
credit limit policies, or credit thresholds, with regard to the banks'
counterparties. The Commission previously proposed Sec.
23.600(c)(1),\19\ which would require SDs and MSPs to set risk
tolerance limits for themselves. One of the critical risk limits in any
risk management program would relate to credit risk. The Commission
solicits comment regarding whether it should adopt a requirement,
similar to the one proposed by the prudential authorities, requiring
non-bank SDs and MSPs to enforce their credit risk limits as a matter
of policy.
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\19\ See Regulations Establishing and Governing the Duties of
Swap Dealers and Major Swap Participants, 75 FR 71397, 71404 (Nov.
23, 2010) (requiring that SDs and MSPs ``take into account market,
credit, liquidity, foreign currency, legal, operational, settlement,
and any other applicable risks together with a description of the
risk tolerance limits set by the swap dealer or major swap
participant and the underlying methodology''). Additionally, the
risk tolerance limits would have to be reviewed and approved
quarterly by senior management and annually by the governing body,
and exceptions to risk tolerance limits would require prior approval
of a supervisor in the risk management unit.
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What effects will the proposed rules have on the overall
liquidity of the financial markets?
Would the proposed rules have differing effects on
liquidity by asset class?
Would the proposed rules have differing effects on
liquidity by class of participant?
Should the Commission permit thresholds for either initial
margin or variation margin?
If so, what standards should apply?
Is the proposed definition of financial entity
appropriate?
Should the Commission instead define financial entity as a
person that is not eligible to claim an exception from mandatory
clearing under section 2(h)(7) of the Act?
Should the Commission exercise authority to designate
additional persons as financial entities?
If so, what standards should apply?
Do the definitions adequately identify financial entities
that have different levels of risk?
Should nonfinancial entities also be separated according
to levels of risk?
If so, on what basis (e.g., in a manner similar to the
classification of financial entities)?
If so, how should the requirement apply differently to
such nonfinancial entities?
Is the classification of sovereign counterparties as
financial entities appropriate in light of the risks posed by these
counterparties?
If not, what other classification would be appropriate,
and why?
Should sovereign counterparties receive their own distinct
counterparty classification that is different from those
classifications in the proposed rule?
If so, why?
How should the permitted uncollateralized exposures to a
sovereign counterparty differ from those that are allowed for financial
or non-financial entities?
Is it appropriate to distinguish between financial and
non-financial counterparties for the purpose of this risk-based
approach?
Does the proposed rule require greater clarity with
respect to the treatment of U.S. Federal, State, or municipal
government counterparties? If so, how should such counterparties be
treated?
Should a counterparty that is a bank holding company or
nonbank financial firm subject to enhanced prudential standards under
Section 165 of the Dodd-Frank Act be treated similarly to swap entity
counterparties?
Should counterparties that are small financial
institutions using derivatives to hedge their risks be treated in the
same manner as non-financial entities for purposes of the margin
requirements?
Would requiring a CSE to post initial margin to non-SD/MSP
counterparties reduce systemic risk (e.g., by reducing leverage in the
financial system or reducing systemic vulnerability to the failure of a
covered swap entity)?
Are there alternatives that address those risks more
efficiently or with greater transparency?
Would requiring a CSE to post initial margin to non-SD/MSP
counterparties raise any concerns with respect to the safety and
soundness of the CSE, taking into consideration the requirement that
initial margin be segregated and held with a third party custodian?
Would requiring a CSE to post initial margin to non-SD/MSP
counterparties remove one or more incentives for that CSE to choose,
where possible, to structure a transaction so that it need not be
cleared through a DCO in order to avoid pledging initial margin?
Would this approach be consistent with the statutory
factors the Commission is directed to take into account under sections
4s of the Act?
Is one-way initial margin in trades between CSEs and
financial entities consistent with the requirement under Section 4s(e)
that margin requirements offset the greater risk arising from the use
of swaps that are not cleared?
Is one-way variation margin in trades between CSEs and
financial entities consistent with the requirement under Section 4s(e)
that margin requirements offset the greater risk arising from the use
of swaps that are not cleared?
Is one-way initial margin in trades between CSEs and
financial entities consistent with the requirement under Section 4s(e)
that margin requirements help ensure the safety and soundness of SDs
and MSPs?
Is one-way variation margin in trades between CSEs and
financial entities consistent with the requirement under Section 4s(e)
that margin requirements help ensure the safety and soundness of SDs
and MSPs?
Is one-way initial margin in trades between CSEs and
financial entities consistent with the requirement under Section 4s(e)
that margin requirements be appropriate for the risks associated with
uncleared swaps?
Is one-way variation margin in trades between CSEs and
financial entities consistent with the requirement under Section 4s(e)
that margin requirements be appropriate for the risks associated with
uncleared swaps?
Is one-way initial margin in trades between CSEs and
financial entities consistent with the requirement under section 15(b)
that the Commission endeavor to take the least anticompetitive means of
achieving the objectives of the Act?
Is one-way variation margin in trades between CSEs and
financial entities consistent with the requirement under section 15(b)
that the Commission endeavor to take the least anticompetitive means of
achieving the objectives of the Act?
[[Page 23741]]
If initial and variation margin are not required to be
paid by CSEs to non-SDs/MSPs, does it create an expectation that a swap
dealer subject to oversight by a prudential regulator is more
creditworthy than other swap dealers because it might receive a
financial backstop?
What are the bankruptcy implications for counterparties of
SDs or MSPs if initial and variation margin are not required to be paid
by CSEs to non-SDs/MSPs?
Is the minimum transfer amount appropriate?
Are there widely-available initial margin models that
could be used?
Is the adaptation of DCO models for use for uncleared
swaps feasible?
Should models approved by foreign regulators be permitted?
Should models be limited to models based on value-at-risk
concepts, or are other models appropriate to measure initial margin?
If so, how should those models apply and be incorporated
into the various aspects of the proposed rule?
To the extent that the parties' swap trading relationship
documentation would permit portfolio margining of swaps, should SDs and
MSPs be permitted to include swaps executed prior to the effective date
of these margin rules in their calculation of initial margin, provided
that the parties would include all swaps covered by that documentation
(i.e., they would not be permitted to selectively include certain swaps
in the portfolio)?
Should offsetting exposures, diversification, and other
hedging benefits be recognized more broadly across substantially
dissimilar asset classes?
If so, what limits, if any, would be placed on the
recognition of offsetting exposures, diversification, and other hedging
benefits, and how could these be measured, monitored and validated on
an ongoing and consistent basis across substantially dissimilar asset
classes?
Should the minimum time horizon vary across swaps? For
example, should it vary based on asset class?
If so, how should the horizons differ and what would be
the basis for the different horizons?
Can initial margin models be calibrated to a stress period
in a transparent and consistent manner?
Are there any other systemic risk implications of
requiring that initial margin be calibrated to a period of financial
stress rather than to a recent or normal historical period?
Is the proposed prudential standard for initial margin of
a 99th percentile price move over a 10-day horizon, calibrated using
historical data incorporating a period of significant financial stress,
appropriate?
Is a 10-day horizon sufficient to cover the likely
liquidation period on uncleared swaps?
Will the requirement to calibrate to a period of
significant financial stress reduce the potential procyclicality of the
margin requirement sufficiently? For example, would a minimum margin
requirement as a backstop to the modeled initial margin amounts be a
prudent approach to addressing procyclicality concerns?
Is ``period of significant financial stress'' a well-
understood concept? How might it be clarified?
What would be the benefits and costs of replacing the
requirement to calibrate the initial margin model using a period of
significant financial stress with a requirement to calibrate the
initial margin model using a longer historical data sample (such as 10
years), as an alternative way to reduce the potential procyclicality of
the margin requirement?
Should market participants be able to comply with the
requirement to calibrate the initial margin requirement to a historical
period of significant financial stress for newer products with little,
if any, market history?
If so, how?
Should CSEs be required to disclose their models to their
counterparties who are not SDs or MSPs?
How closely does the alternative methodology approximate
risk?
Would a percentage of notional value approach be
appropriate under any circumstances?
With respect to either alternative for calculating initial
margin requirements, should swap positions that pose no counterparty
risk to the covered swap entity, such as a sold call option with the
full premium paid at inception of the trade, be excluded from the
initial margin calculation?
Is the list of acceptable forms of margin appropriate?
Should the types of eligible collateral listed be
broadened to other types of assets (e.g. securities backed by high-
quality mortgages or issues with a third-party guarantee)?
If so, how might the systemic risk issue be effectively
mitigated?
Should the types of eligible collateral listed be
broadened to include immediately-available cash funds denominated in
foreign currency, even where such currency is not the currency in which
payment obligations under the swap are required to be settled?
If so, which currencies (e.g., those accepted by a
derivatives clearing organization as initial margin for a cleared
swap)?
If so, what haircut, if any, should apply to such foreign
currency?
What criteria and factors could be used to determine the
set of acceptable non-cash collateral?
How could appropriate haircuts be determined for valuing
these assets for margin purposes?
Should the types of eligible collateral listed be
broadened to include foreign sovereign debt securities?
If so, which foreign sovereign debt securities (e.g.,
those accepted by a derivatives clearing organization as initial margin
for a cleared swap)?
If so, what haircut, if any, should apply?
Should fixed income securities issued by a well-known
seasoned issuer that has a high credit standing, are unsubordinated,
historically display low volatility, are traded in highly liquid
markets, and have valuations that are readily calculated be added to
the list of eligible collateral for initial margin?
If so, how should the concept of a ``high credit
standing'' be defined in a way that does not reference credit ratings?
Should there be any limits on the types of collateral
accepted by CSEs from non-financial entities?
The proposal states that each covered swap entity shall
accept as margin from non-financial entities only assets for which the
value is reasonably ascertainable on a periodic basis in a manner
agreed to by the parties in the credit support arrangements. Should the
Commission be more specific with regard to how non-traditional
collateral should be valued?
Should the Commission be more specific with regard to how
frequently margin assets should be valued?
Is the table of haircuts appropriate?
Are the proposed custodial arrangements appropriate?
Is it necessary to require segregation of initial margin
in order to address the systemic risk issues discussed above?
What alternatives to segregation would effectively address
these systemic risk issues?
What are the potential operational, liquidity and credit
costs of requiring segregation of initial margin by swap entities?
What would be the expected liquidity impact and cost of
the proposed segregation requirement on market participants?
How can the impact of the proposed rule on the liquidity
and costs of swaps market participants be mitigated?
[[Page 23742]]
Are the limitations placed on rehypothecation and
reinvestment under the proposed rule appropriate or necessary?
Would additional or alternative limitations be
appropriate?
Should certain forms of rehypothecation (e.g., the lending
of securities pledged as collateral) or additional types of
reinvestment be permitted?
Is the proposed rule's requirement that the custodian must
be located in a jurisdiction that applies the same insolvency regime to
the custodian as would apply to the covered swap entity necessary or
appropriate?
Would additional or alternative requirements regarding the
location of the custodian be appropriate?
Are there circumstances where rehypothecation should be
permitted?
What role could self-regulatory organizations play in
overseeing compliance with the proposed regulations?
In designing these rules, the Commission has taken care to
minimize the burden on those parties that will not be registered with
the Commission as SDs and MSPs. To the extent that market participants
believe that additional measures should be taken to reduce the burden
or increase the benefits of documenting swap transactions, the
Commission welcomes all comments.
Pursuant to Section 716, certain ``push-out'' entities
might initially be subject to the margin rules of the prudential
regulators, but by July of 2013 would come under the margin rules of
the Commission. The Commission requests comment on what steps would be
appropriate to facilitate a smooth transition for such entities and
their counterparties.
The Commission recognizes that there will be differences
in the size and scope of the business of particular SDs and MSPs.
Therefore, comments are solicited on whether certain provisions of the
proposed regulations should be modified or adjusted to reflect the
differences among SDs and MSPs or differences among asset classes.
How long would SDs and MSPs require to come into
compliance with the proposed rules? Will compliance take less time for
swaps between such registrants and longer for swaps between registrants
and non-registrants?
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities.\20\ The
Commission previously has established certain definitions of ``small
entities'' to be used in evaluating the impact of its regulations on
small entities in accordance with the RFA.\21\ The proposed regulations
would affect SDs and MSPs.
---------------------------------------------------------------------------
\20\ 5 U.S.C. 601 et seq.
\21\ 47 FR 18618 (Apr. 30, 1982).
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SDs and MSPs are new categories of registrants. Accordingly, the
Commission has not previously addressed the question of whether such
persons are, in fact, small entities for purposes of the RFA. The
Commission previously has determined, however, that futures commission
merchants (``FCMs'') should not be considered to be small entities for
purposes of the RFA.\22\ The Commission's determination was based, in
part, upon the obligation of FCMs 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.\23\ 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 SD
registration any entities that engage in a de minimis level of swaps
dealing in connection with transactions with or on behalf of customers.
The Commission believes that this exemption would exclude small
entities from registration. Accordingly, for purposes of the RFA for
this rulemaking, the Commission is hereby determining that SDs are not
``small entities'' for essentially the same reasons that FCMs have
previously been determined not to be small entities and in light of the
exemption from the definition of SD for those engaging in a de minimis
level of swap dealing.
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\22\ Id. at 18619.
\23\ Id.
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The Commission also has previously determined that large traders
are not ``small entities'' for RFA purposes.\24\ In that determination,
the Commission considered that a large trading position was indicative
of the size of the business. MSPs, by statutory definition, maintain
substantial positions in swaps or maintain outstanding swap positions
that create 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 rulemaking, the Commission is hereby determining that MSPs are not
``small entities'' for essentially the same reasons that large traders
have previously been determined not to be small entities.
---------------------------------------------------------------------------
\24\ Id. at 18620.
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The Commission also previously has determined that ECPs are not
small entities for RFA purposes. Because ECPs are not small entities,
and persons not meeting the definition of ECP may not conduct
transactions in uncleared swaps, the Commission need not conduct a
regulatory flexibility analysis respecting the effect of these proposed
rules on ECPs.
Accordingly, this proposed rule will not have a significant
economic effect on any small entity. Therefore, the Chairman, on behalf
of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that
the proposed regulations will not have a significant economic impact on
a substantial number of small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act (PRA) \25\ imposes certain requirements
on Federal agencies (including the Commission) in connection with their
conducting or sponsoring any collection of information as defined by
the PRA. This proposed rulemaking would result in the collection of
information requirements within the meaning of the PRA, as discussed
below. The collections of information that are proposed by this
rulemaking are found in proposed Sec. 23.151 and Sec. 23.155 and are
necessary to implement new Section 4s(e) of the CEA, which expressly
requires the Commission to adopt rules governing margin requirements
for SDs and MSPs. For the sake of operational efficiency, the
Commission will be submitting a consolidated PRA proposal for both the
capital and margin rules to the Office of Management and Budget (OMB)
for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------
\25\ 44 U.S.C. 3501 et seq.
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Collection of Information. (Regulations and Forms Pertaining to the
Financial Integrity of the Marketplace, OMB Control Number 3038-0024.)
C. Cost-Benefit Analysis
Section 15(a) of the CEA \26\ requires the Commission to consider
the costs and benefits of its actions before issuing a rulemaking under
the CEA. Section 15(a) 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
[[Page 23743]]
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
regulation is necessary or appropriate to protect the public interest
or to effectuate any of the provisions or to accomplish any of the
purposes of the CEA.
---------------------------------------------------------------------------
\26\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
Summary of proposed requirements. The proposed regulations would
implement certain provisions of section 731 of the Dodd-Frank Act,
which adds new sections 4s(e) of the CEA. Under the proposal, each CSE
would be required to execute swap trading relationship documentation
regarding credit support arrangements with each swap counterparty,
including other SDs or MSPs. The proposed regulations also would
require each CSE to calculate and to collect from its counterparties,
that are SDs, MSPs, or financial entities, initial margin for each
bilateral swap transaction that was not cleared by or through a
derivatives clearing organization. The proposal also would requires
each CSE to calculate each business day, and collect from its
counterparties, that are SDs, MSPs, or financial entities, variation
margin for each bilateral swap transaction that is not cleared by or
through a derivatives clearing organization. CSEs, however, are not
required to collect initial margin or exchange variation margin with a
counterparty that qualifies as a non-financial entity.
Costs. The Commission recognizes that to the extent SDs and MSPs
currently do not post initial margin with one another, and have
thresholds for variation margin, the proposal will impose costs upon
them. The Commission further recognizes that to the extent that
financial entities currently do not post initial margin or have high
variation margin thresholds, the proposal will impose costs upon them.
The Commission notes that while the amounts of initial margin that
would be required to be posted would be substantial, initial margin is
a performance bond. Thus, the cost is not equal to the total initial
margin posted, but rather the opportunity cost of immobilizing those
assets. That is, SDs, MSPs, and financial entities would likely receive
a lower return on the resources posted as margin than they would
receive if they were free to apply those resources to other uses.
With respect to variation margin, sound risk management dictates
that counterparties mark open positions to the market. Therefore, the
costs here would also be opportunity costs. That is, to the extent SDs,
MSPs, and financial entities currently have variation margin
thresholds, they might be required to pay variation margin more
frequently or earlier than would occur in the absence of the rule.
The Commission does not believe that the requirement that the
parties document their credit support arrangements will impose
significant costs. The Commission understands that such documentation
is widespread if not universal.
Benefits. The Commission believes that the benefits of the proposal
are very significant. The economy recently experienced a severe
recession. A key contributing factor was the problems suffered by large
institutions in the financial services sector. Those problems were, in
part, attributable to positions those firms held in swaps.
Many of those firms are likely to be SDs, MSPs, or financial
entities. As discussed more fully above, the Commission believes that
the proposed margin requirements will significantly decrease the risk
that SDs, MSPs, and financial entities will incur such extreme losses
on their swap positions as to imperil the financial system of the
United States. In addition to this systemic benefit, the proposal would
benefit each of the individual participants in the swaps market by
increasing the security of their positions as well as the financial
integrity of their counterparties. In this regard, the Commission notes
that the requirements proposed here are substantially the same as the
requirements that the prudential regulators are proposing.
In sum, the Commission believes that the benefits to the overall
financial system, and to the individual participants in the swaps
market, outweigh the costs to those participants.
Public Comment. The Commission invites public comment on its cost-
benefit considerations. Commentators are also 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 in 17 CFR Part 23
Swaps, Swap dealers, Major swap participants, Capital and margin
requirements.
For the reasons stated in this release, the Commission proposes to
amend 17 CFR part 23, as proposed to be added at 75 FR 71379, published
November 23, 2010, as follows:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
1. The authority citation for part 23 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.
2. Subpart E is added to read as follows:
Subpart E--Capital and Margin Requirements for Swap Dealers and Major
Swap Participants
Sec.
23.100-23.149 [Reserved]
23.150 Definitions applicable to margin requirements.
23.151 Documentation of credit support arrangements.
23.152 Margin treatment for uncleared swaps between covered swap
entities and swap dealers and major swap participants.
23.153 Margin treatment for uncleared swaps between covered swap
entities and financial entities.
23.154 Margin treatment for uncleared swaps between covered swap
entities and non-financial entities.
23.155 Calculation of initial margin.
23.156 Calculation of variation margin.
23.157 Forms of margin.
23.158 Custodial arrangements.
Subpart E--Capital and Margin Requirements for Swap Dealers and
Major Swap Participants
Sec. Sec. 23.100 through 23.149 [Reserved]
Sec. 23.150 Definitions applicable to margin requirements.
For the purposes of Sec. Sec. 23.150 through 23.158 of this part:
Asset class means a group of products that are based on similar
types of underlying assets. Swaps shall be grouped within the following
asset classes: agricultural, credit, currency, energy, equity, interest
rate, metals, and other.
Back test means a test that compares initial margin requirements
with historical price changes to determine the extent of actual margin
coverage.
Counterparty means the person opposite whom a covered swap entity
executes a swap.
Covered swap entity means a swap dealer or major swap participant
for which there is no prudential regulator.
Custodian means a person selected by the parties to a swap to hold
margin on their behalf.
Financial entity means a counterparty that is not a swap dealer or
a major swap participant and that is one of the following:
[[Page 23744]]
(1) A commodity pool as defined in Section 1a(5) of the Act,
(2) A private fund as defined in Section 202(a) of the Investment
Advisors Act of 1940,
(3) An employee benefit plan as defined in paragraphs (3) and (32)
of section 3 of the Employee Retirement Income and Security Act of
1974,
(4) A person predominantly engaged in activities that are in the
business of banking, or in activities that are financial in nature as
defined in Section 4(k) of the Bank Holding Company Act of 1956,
(5) A person that would be a financial entity described in
paragraph (1) or (2) if it were organized under the laws of the United
States or any State thereof;
(6) The government of any foreign country or a political
subdivision, agency, or instrumentality thereof; or
(7) Any other person the Commission may designate.
Initial margin means money, securities, or property posted by a
party to a swap as performance bond to cover potential future exposures
arising from changes in the market value of the position.
Liquidation time horizon means the time period needed to replace a
swap.
Minimum transfer amount means an initial margin or variation margin
amount that is less than $100,000.
Non-financial entity means a counterparty that is not a swap
dealer, a major swap participant, or a financial entity.
Regulatory capital means the amount of capital required under Sec.
23.101 of this part.
Significant swaps exposure means
(1) Swap positions that equal or exceed either of the following
thresholds:
(i) $2.5 billion in daily average aggregate uncollateralized
outward exposure; or
(ii) $4 billion in daily average aggregate uncollateralized outward
exposure plus daily average aggregate potential outward exposure.
(2) For purposes of this definition the terms daily average
aggregate uncollateralized outward exposure and daily average aggregate
potential outward exposure each has the meaning specified for that term
in Sec. 1.3(uuu) of this part for purposes of calculating substantial
counterparty exposure under that regulation.
State insurance regulator means an insurance authority of a State
that is engaged in the supervision of insurance companies under State
insurance law.
Stress test means a test that compares the impact of a potential
extreme price move, change in option volatility, or change in other
inputs that affect the value of a position, to the initial margin held
for that position to measure the adequacy of such initial margin.
Swap trading relationship documentation means the documentation
described in Sec. 23.504 of this part.
Threshold means an amount below which initial margin or variation
margin that otherwise would be due is not required to be paid.
Uncleared swap means a swap executed after the effective date of
this rule that is not submitted for clearing to a derivatives clearing
organization.
Variation margin means a payment made by a party to a swap to cover
the current exposure arising from changes in the market value of the
position since the trade was executed or the previous time the position
was marked to market.
Sec. 23.151 Documentation of credit support arrangements.
(a) Each covered swap entity shall execute with each counterparty
swap trading relationship documentation regarding credit support
arrangements that complies with the requirements of Sec. 23.504 of
this part and this subpart E.
(b) The credit support arrangements shall specify the following:
(1) The methodology to be used to calculate initial margin for
uncleared swaps entered into between the covered swap entity and the
counterparty;
(2) The methodology to be used to calculate variation margin for
uncleared swaps entered into between the covered swap entity and the
counterparty;
(3) To the extent that the alternative method is used pursuant to
Sec. 23.155(c), the parties shall specify the reference contracts to
be used;
(4) Any thresholds below which initial margin need not be posted by
the counterparty; and
(5) Any thresholds below which variation margin need not be paid by
the counterparty.
Sec. 23.152 Margin treatment for uncleared swaps between covered swap
entities and swap dealers or major swap participants.
(a) Initial margin. (1) On or before the date of execution of an
uncleared swap between a covered swap entity and a swap dealer or major
swap participant, each covered swap entity shall require the
counterparty to post initial margin equal to or greater than an amount
calculated pursuant to Sec. 23.155 of this part with a custodian
selected pursuant to Sec. 23.158 of this part.
(2) Until such an uncleared swap is liquidated, each covered swap
entity shall require the counterparty to maintain initial margin equal
to or greater than an amount calculated pursuant to Sec. 23.155 of
this part with a custodian selected pursuant to Sec. 23.158 of this
part.
(3) If the credit support arrangements with a counterparty require
the counterparty to post and/or maintain an amount greater than the
amount calculated pursuant to Sec. 23.155 of this part, the covered
swap entity shall require the counterparty to post and/or maintain such
greater amount.
(4) Each covered swap entity shall require the counterparty to post
and maintain the entire initial margin amount required under this
paragraph (a) unless the amount is less than the minimum transfer
amount. There shall be no other exceptions for amounts below a
threshold.
(b) Variation margin. (1) For each uncleared swap between a covered
swap entity and a swap dealer or major swap participant, each covered
swap entity shall require the counterparty to pay variation margin as
calculated pursuant to Sec. 23.156 of this part directly to the
covered swap entity or to a custodian selected pursuant to Sec. 23.158
of this part. Such payments shall start on the business day after the
swap is executed and continue each business day until the swap is
liquidated.
(2) For each uncleared swap between a covered swap entity and a
swap dealer or major swap participant, each covered swap entity shall
require the counterparty to pay the entire variation margin amount as
calculated pursuant to Sec. 23.156 of this part when due unless the
amount is less than the minimum transfer amount. There shall be no
other exceptions for amounts below a threshold.
(3) To the extent that more than one uncleared swap is executed
pursuant to swap trading relationship documentation between a covered
swap entity and its counterparty, a covered swap entity may calculate
and comply with the variation margin requirements of this paragraph on
an aggregate basis with respect to all uncleared swaps governed by such
agreement, so long as the covered swap entity complies with these
variation margin requirements with respect to all uncleared swaps
governed by such agreement regardless of whether the uncleared swaps
were entered into on or after the effective date.
(4) A covered swap entity shall not be deemed to have violated its
obligation to collect variation margin from a counterparty if:
(i) The counterparty has refused or otherwise failed to provide the
required variation margin to the covered swap entity; and
[[Page 23745]]
(ii) The covered swap entity has:
(A) Made the necessary efforts to attempt to collect the required
variation margin, including the timely initiation and continued pursuit
of formal dispute resolution mechanisms, or has otherwise demonstrated
upon request to the satisfaction of the Commission that it has made
appropriate efforts to collect the required variation margin; or
(B) Commenced termination of the swap or security-based swap with
the counterparty.
Sec. 23.153 Margin treatment for uncleared swaps between covered swap
entities and financial entities.
(a) Initial margin. (1) On or before the date of execution of an
uncleared swap between a covered swap entity and a financial entity,
the covered swap entity shall require the financial entity to post
initial margin equal to or greater than an amount calculated pursuant
to Sec. 23.155 of this part. Upon request of the financial entity, the
initial margin shall be held at a custodian selected pursuant to Sec.
23.158 of this part.
(2) Until such an uncleared swap is liquidated, the covered swap
entity shall require the financial entity to maintain initial margin
equal to or greater than an amount calculated pursuant to Sec. 23.155
of this part.
(3) If the credit support arrangements with a financial entity
require the financial entity to post and/or maintain an amount greater
than the amount calculated pursuant to Sec. 23.158 of this part, the
covered swap entity shall require the financial entity to post and/or
maintain such greater amount.
(4) Except as provided in paragraph (c) of this section each
covered swap entity shall require each financial entity to post and
maintain the entire initial margin amount required under this paragraph
(a) unless the amount is less than the minimum transfer amount.
(5) On or before the date of execution of an uncleared swap between
a covered swap entity and a financial entity, the covered swap entity
shall post any initial margin that may be required pursuant to the
credit support arrangement between them.
(6) Until such an uncleared swap is liquidated, the covered swap
entity shall maintain any initial margin that may be required pursuant
to the credit support arrangement between them.
(7) The credit support arrangements between a covered swap entity
and a financial entity may provide for a threshold below which the
covered swap entity is not required to post initial margin.
(b) Variation margin. (1) For each uncleared swap between a covered
swap entity and a financial entity, each covered swap entity shall
require the financial entity to pay variation margin as calculated
pursuant to Sec. 23.156 of this part directly to the covered swap
entity or to a custodian selected pursuant to Sec. 23.158 of this
part. Such payments shall start on the business day after the swap is
executed and continue each business day until the swap is liquidated.
(2) Except as provided in paragraph (c) of this section, for each
uncleared swap between a covered swap entity and a financial entity,
each covered swap entity shall require the financial entity to pay the
entire variation margin amount as calculated pursuant to Sec. 23.156
of this part when due unless the amount is less than the minimum
transfer amount.
(3) For each uncleared swap between a covered swap entity and a
financial entity, each covered swap entity shall pay any variation
margin that may be required pursuant to the credit support arrangements
between them.
(4) The credit support arrangements between a covered swap entity
and a financial entity may provide for a threshold below which the
covered swap entity is not required to pay variation margin.
(5) To the extent that more than one uncleared swap is executed
pursuant to swap trading relationship documentation between a covered
swap entity and its counterparty that permits netting, a covered swap
entity may calculate and comply with the variation margin requirements
of this paragraph on an aggregate basis with respect to all uncleared
swaps governed by such agreement, provided that the covered swap entity
complies with these variation margin requirements for all uncleared
swaps governed by such agreement regardless of whether the uncleared
swaps were entered into on or after the effective date.
(6) A covered swap entity shall not be deemed to have violated its
obligation to collect variation margin from a counterparty if:
(i) The counterparty has refused or otherwise failed to provide the
required variation margin to the covered swap entity; and
(ii) The covered swap entity has:
(A) Made the necessary efforts to attempt to collect the required
variation margin, including the timely initiation and continued pursuit
of formal dispute resolution mechanisms, or has otherwise demonstrated
upon request to the satisfaction of the Commission that it has made
appropriate efforts to collect the required variation margin; or
(B) Commenced termination of the swap or security-based based swap
with the counterparty.
(7) For risk management purposes, each covered swap entity shall
calculate each day a hypothetical variation margin requirement for each
such uncleared swap as if the counterparty were a swap dealer and
compare that amount to any variation margin required pursuant to the
credit support arrangements.
(c) Thresholds. (1) A covered swap entity may apply a threshold to
the initial margin and variation margin requirements of a counterparty
that is a financial entity if the counterparty makes the following
representations to the covered swap entity in connection with entering
into an uncleared swap with the covered swap entity:
(i) The counterparty is subject to capital requirements established
by a prudential regulator or State insurance regulator;
(ii) The counterparty does not have a significant uncleared swaps
exposure; and
(iii) The counterparty predominantly uses uncleared swaps to hedge
or mitigate the risks of its business activities, including interest
rate, or other risk arising from the business of the counterparty.
(2) The initial margin threshold shall be the lesser of [$15 to 45]
million or [0.1 to 0.3]% of the covered swap entity's regulatory
capital.
(3) The variation margin threshold shall be the lesser [$15 to 45]
million or [0.1 to 0.3]% of the covered swap entity's regulatory
capital.
Sec. 23.154 Margin treatment for uncleared swaps between covered swap
entities and non-financial entities.
(a) Initial margin. (1) On or before the date of execution of an
uncleared swap between a covered swap entity and a non-financial
entity, the covered swap entity shall require such non-financial entity
to post any initial margin that may be required pursuant to the credit
support arrangement between them.
(2) Until such an uncleared swap is liquidated, the covered swap
entity shall require the counterparty to maintain any initial margin
that may be required pursuant to the credit support arrangement between
them.
(3) The credit support arrangements between a covered swap entity
and a non-financial entity may provide for a threshold below which the
non-financial entity is not required to post initial margin.
(4) On or before the date of execution of an uncleared swap between
a covered swap entity and a non-financial entity,
[[Page 23746]]
the covered swap entity shall post any initial margin that may be
required pursuant to the credit support arrangement between them.
(5) Until such an uncleared swap is liquidated, the covered swap
entity shall maintain any initial margin that may be required pursuant
to the credit support arrangement between them.
(6) The credit support arrangements between a covered swap entity
and a non-financial entity may provide for a threshold below which the
covered swap entity is not required to post initial margin.
(7) For risk management and capital purposes, each covered swap
entity shall calculate each day a hypothetical initial margin
requirement for each such uncleared swap as if the counterparty were a
swap dealer and compare that amount to any initial margin required
pursuant to the credit support arrangements.
(b) Variation margin. (1) For each uncleared swap between a covered
swap entity and a non-financial entity, each covered swap entity shall
require the non-financial entity to pay any variation margin that may
be required pursuant to the credit support arrangements between them.
(2) The credit support arrangements between a covered swap entity
and a non-financial entity may provide for a threshold below which the
non-financial entity is not required to pay variation margin.
(3) For each uncleared swap between a covered swap entity and a
non-financial entity, each covered swap entity shall pay any variation
margin that may be required pursuant to the credit support arrangements
between them.
(4) The credit support arrangements between a covered swap entity
and a non-financial entity may provide for a threshold below which the
covered swap entity is not required to pay variation margin.
(5) To the extent that more than one uncleared swap is executed
pursuant to swap trading relationship documentation between a covered
swap entity and its counterparty that permits netting, a covered swap
entity may calculate and comply with the variation margin requirements
of this paragraph on an aggregate basis with respect to all uncleared
swaps governed by such agreement, provided that the covered swap entity
complies with these variation margin requirements for all uncleared
swaps governed by such agreement regardless of whether the uncleared
swaps were entered into on or after the effective date.
(6) For risk management purposes, each covered swap entity shall
calculate each day a hypothetical variation margin requirement for each
such uncleared swap as if the counterparty were a swap dealer and
compare that amount to any variation margin required pursuant to the
credit support arrangements.
Sec. 23.155 Calculation of initial margin.
(a) Means of calculation. (1) Each covered swap entity shall
calculate initial margin using the methodology specified in the credit
support arrangements with the counterparty provided that the
methodology shall be consistent with the requirements of this section.
(2) Each covered swap entity shall calculate initial margin for
itself and for each counterparty that is a swap dealer, major swap
participant, or financial entity, using either:
(i) A risk-based model that meets the requirements of paragraph (b)
of this section; or
(ii) The alternative method set forth in paragraph (c) of this
section.
(b) Models. (1) Eligibility. To be eligible for use by a covered
swap entity, a model shall meet the standards set forth in paragraph
(b)(2) of this section, be filed with the Commission by a covered swap
entity pursuant to paragraph (b)(3), be approved by the Commission
pursuant to paragraph (b)(4) of this section and either be:
(i) Currently used by a derivatives clearing organization for
margining cleared swaps;
(ii) Currently used by an entity subject to regular assessment by a
prudential regulator for margining uncleared swaps; or
(iii) Made available for licensing to any market participant by a
vendor.
(2) Standards. Each model shall conform to the following standards:
(i) The valuation of each uncleared swap shall be determined
consistent with the requirements of Sec. 23.504(b) of this part;
(ii) The model shall have a sound theoretical basis and significant
empirical support;
(iii) The model shall use factors sufficient to measure all
material risks;
(iv) To the extent available, the model shall use at least one year
of historic price data and must incorporate a period of significant
financial stress appropriate to the uncleared swaps to which the model
is applied;
(v) Any portfolio offsets or reductions shall have a sound
theoretical basis and significant empirical support;
(vi) The model shall set margin to cover at least 99% of price
changes by product and by portfolio over at least a 10-day liquidation
time horizon;
(vii) The model must be validated by an independent third party
before being used and annually thereafter;
(viii) The methodology shall be stated with sufficient specificity
to allow the counterparty, the Commission, and any applicable
prudential regulator to calculate the margin requirement independently;
(ix) The covered swap entity shall monitor margin coverage each
day;
(x) The covered swap entity shall conduct back tests at least
monthly;
(xi) The covered swap entity shall conduct stress tests at least
monthly;
(xii) The covered swap entity shall document all material aspects
of its valuation procedures and initial margin model; and
(xiii) If an uncleared swap or portfolio is available for clearing
by a derivatives clearing organization but is not subject to mandatory
clearing, the model shall include a factor requiring that the initial
margin shall be equal to or greater than an amount that would be
required by the derivatives clearing organization.
(3) Filing with the Commission. (i) Each covered swap entity shall
file each model that it uses with the Commission.
(ii) The filing shall include a complete explanation of:
(A) The manner in which the model meets the requirements of this
section;
(B) The mechanics of the model;
(C) The theoretical basis of the model;
(D) The empirical support for the model; and
(E) Any independent third party validation of the model.
(4) Commission action. (i) 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 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.
(ii) The Commission may at any time require a covered swap entity
to provide further data or analysis concerning a model.
(iii) The Commission may at any time require a covered swap entity
to modify a model to address potential vulnerabilities.
(iv) At any time after the effective date of this rule, the
Commission may in its sole discretion determine by written order that
covered swap entities may apply for approval under this section to
[[Page 23747]]
calculate initial margin using proprietary models.
(c) Alternative Method. If a model meeting the standards set forth
in paragraph (b) of this section is not used, initial margin shall be
calculated in accordance with this paragraph.
(1) General rule. Initial margin shall be calculated as follows:
(i) The covered swap entity shall identify in the credit support
arrangements the swap cleared by a derivatives clearing organization in
the same asset class as the uncleared swap for which the terms and
conditions most closely approximate the terms and conditions of the
uncleared swap. If there is no cleared swap whose terms and conditions
closely approximate the uncleared swap, the covered swap entity shall
identify in the credit support arrangements the futures contract
cleared by a derivatives clearing organization in the same asset class
as the uncleared swap which most closely approximates the uncleared
swap and would be most likely to be used to hedge the uncleared swap.
(ii) The covered swap entity shall calculate the number of units of
the cleared swap or cleared futures contract necessary to equal the
size of the uncleared swap.
(iii) The covered swap entity shall ascertain the margin the
derivatives clearing organization would require for a position of the
size indentified in paragraph (c)(1)(ii) of this section.
(iv) The covered swap entity shall multiply the amount ascertained
in paragraph (c)(1)(iii) of this section for a cleared swap by 2.0 in
order to determine the margin required for the uncleared swap or
multiply the amount ascertained in paragraph (c)(1)(iii) of this
section for a cleared futures contract by 4.4 in order to determine the
margin required for the uncleared swap.
(2) Portfolio-based reductions. (i) Reductions in margin based on
offsetting risk characteristics of products shall not be applied across
asset classes except that reductions may be applied between the
currency asset class and the interest rate asset class.
(ii) Any reductions in margin based on offsetting risk
characteristics of products within an asset class shall have a sound
theoretical basis and significant empirical support.
(iii) No reduction shall exceed 50% of the amount that would be
required for the uncleared swap in the absence of a reduction.
(3) Modifications for particular products or positions. Each
covered swap entity shall monitor the coverage provided by margin
established pursuant to this paragraph (c) and collect additional
margin if appropriate to address the risk posed by particular products
or positions.
(4) Commission action. (i) The Commission may at any time require a
covered swap entity to post or collect additional margin because of
additional risk posed by a particular product.
(ii) The Commission may at any time require a covered swap entity
to post or collect additional margin because of additional risk posed
by a particular party to the uncleared swap.
Sec. 23.156 Calculation of variation margin.
(a) Means of calculation. (1) Each covered swap entity shall
calculate variation margin using a methodology specified in the credit
support arrangements with the counterparty.
(2) Each covered swap entity shall calculate variation margin for
itself and for each counterparty that is a swap dealer, major swap
participant, or financial entity using a methodology that meets the
requirements of paragraph (b) of this section.
(b) Methodology. Each methodology shall conform to the following
standards:
(1) The valuation of each swap shall be determined consistent with
the requirements of Sec. 23.504(b) of this part;
(2) The variation methodology must be stated with sufficient
specificity to allow the counterparty, the Commission, and any
applicable prudential regulator to calculate the margin requirement
independently.
(c) Commission action. (1) The Commission may at any time require
covered swap entity to provide further data or analysis concerning the
methodology, including:
(i) An explanation of the manner in which the methodology meets the
requirements of this section;
(ii) A description of the mechanics of the methodology;
(iii) The theoretical basis of the methodology; and
(iv) The empirical support for the methodology.
(2) The Commission may at any time require a covered swap entity to
modify the methodology to address potential vulnerabilities.
Sec. 23.157 Forms of margin.
(a) Initial margin. (1) Each covered swap entity shall post and
accept as initial margin only assets specified in the credit support
arrangements with the counterparty.
(2) Each covered swap entity shall post and accept as initial
margin only the following assets if the counterparty is a swap dealer,
a major swap participant, or a financial entity:
(i) Immediately available cash funds denominated in U.S. dollars or
the currency in which payment obligations under the swap are required
to be settled;
(ii) Any obligation which is a direct obligation of, or fully
guaranteed as to principal and interest by, the United States or an
agency of the United States; or
(iii) Any senior debt obligation of the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, a Federal Home
Loan Bank, the Federal Agricultural Mortgage Corporation, or any
obligation that is an ``insured obligation,'' as that term is defined
in 12 U.S.C. 2277a(3), of a Farm Credit System bank.
(3) Each covered swap entity shall accept as initial margin from
non-financial entities only assets for which the value is reasonably
ascertainable on a periodic basis in a manner agreed to by the parties
in the credit support arrangements.
(4) A covered swap entity may not collect, as initial margin or
variation margin required by the part, any asset that is an obligation
of the counterparty providing such asset.
(b) Variation margin. (1) Each covered swap entity shall pay and
collect as variation margin only assets specified in the credit support
arrangements with the counterparty.
(2) Each covered swap entity shall pay and collect as variation
margin only cash or United States Treasury securities if the
counterparty is a swap dealer, a major swap participant, or a financial
entity.
(3) Each covered swap entity shall accept as variation margin from
non-financial entities only assets for which the value is reasonably
ascertainable on a periodic basis in a manner agreed to by the parties
in the credit support arrangements.
(c) Haircuts. (1) Each covered swap entity shall apply haircuts to
any asset posted or received as margin as specified in the credit
support arrangements with the counterparty.
(2) Each covered swap entity shall apply haircuts to any asset
received as margin that reflect the credit and liquidity
characteristics of the asset.
(3) Each covered swap entity shall apply haircuts, at a minimum, to
assets received as margin if the counterparty is a swap dealer, a major
swap participant, or a financial entity in accordance with the
following table:
[[Page 23748]]
Margin Value Ranges for Non-Cash Collateral
[% of market value]
------------------------------------------------------------------------
Duration (years)
--------------------------------------
0-5 5-10 > 10
------------------------------------------------------------------------
(i) U.S. Treasuries and Fully
Guaranteed Agencies:
(A) Bills/Notes/Bonds/ [98-100] [95-99] [94-98]
Inflation Indexed...........
(B) Zero Coupon, STRIPs..... [97-99] [94-98] [90-94]
(ii) FHFA-Regulated Institutions
Obligations and Insured
Obligations of FCS Banks:
(A) Bills/Notes/Bonds....... [96-100] [94-98] [93-97]
(B) Zero Coupon............. [95-99] [93-97] [89-93]
------------------------------------------------------------------------
(d) Commission action. (1) The Commission may at any time require
a covered swap entity to provide further data or analysis concerning
any margin asset posted or received.
(2) The Commission may at any time require a covered swap entity to
replace a margin asset posted to a counterparty with a different margin
asset to address potential risks posed by the asset.
(3) The Commission may at any time require a covered swap entity to
require a counterparty that is a swap dealer, a major swap participant,
or a financial entity to replace a margin asset posted with the covered
swap entity with a different margin asset to address potential risks
posed by the asset.
(4) The Commission may at any time require a covered swap entity to
provide further data or analysis concerning margin haircuts.
(5) The Commission may at any time require a covered swap entity to
modify a margin haircut applied to an asset received from a swap
dealer, a major swap participant, or a financial entity to address
potential risks posed by the asset.
Sec. 23.158 Custodial arrangements.
(a) Location of assets. (1) Each covered swap entity shall specify
in the credit support arrangements with each counterparty where margin
assets will be held.
(2) Each covered swap entity shall offer each counterparty the
opportunity to select a custodian that is not affiliated with the swap
dealer or major swap participant.
(3) Each covered swap entity shall hold initial margin received
from a counterparty that is a swap dealer or major swap participant at
a custodian that is independent of the covered swap entity and of the
counterparty.
(4) Each covered swap entity that posts initial margin with a
counterparty that is a swap dealer or major swap participant shall
require that the counterparty hold initial margin received at a
custodian that is independent of the covered swap entity and of the
counterparty.
(5) The independent custodian shall be located in a jurisdiction
that applies the same insolvency regime to the custodian as would apply
to the covered swap entity.
(b) Use of assets. (1) For each uncleared swap between a covered
swap entity and a swap dealer, major swap participant, or a financial
entity, the covered swap entity shall enter into a tri-party custodial
agreement with the counterparty and the custodian that provides that:
(i) Neither the covered swap entity nor the counterparty may
rehypothecate margin assets;
(ii) The custodian may not rehypothecate margin assets;
(iii) The custodian may not reinvest any margin held by the
custodian in any asset that would not qualify as eligible collateral
under Sec. 23.157(a) of this part;
(iv) Upon certification in accordance with 23.602(b)(1) by one of
the parties that it is entitled to control of the margin under the
agreement, the custodian shall release the margin to the certifying
party; and
(v) The certifying party shall indemnify the custodian against any
claim that the margin assets should not have been released.
(2) Upon receipt of initial margin from a counterparty, no covered
swap entity shall post such assets as margin for a swap, a security-
based swap, a commodity for future delivery, a security, a security
futures product, or any other product subject to margin.
(c) Commission action. (1) The Commission may at any time require a
covered swap entity to provide further data or analysis concerning any
custodian.
(2) The Commission may at any time require a covered swap entity to
move assets held on behalf of a counterparty to another custodian to
address risks posed by the original custodian.
Issued in Washington, DC, on April 12, 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 Swap Dealer and Major Swap Participant Margin
Requirements for Uncleared Swaps--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.
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rulemaking. Margin requirements for swaps
that are not cleared between financial entities help ensure the
safety and soundness of swap dealers and major swap participants.
The proposed rules would address margin requirements for
uncleared swaps entered into by nonbank swap dealers or major swap
participants. The prudential regulators today are proposing margin
rules for the dealers that they regulate. For trades between swap
dealers (or major swap participants), the rules would require paying
and collecting initial and variation margin for each trade. For
trades between swap dealers (or major swap participants) and
financial entities, the rules would require the dealer (or major
swap participant) to collect, but not pay, initial and variation
margin for each trade, subject in certain circumstances to
permissible thresholds. The proposed rule allows thresholds for
margin for financial entities where they are subject to capital
requirements established by a prudential regulator or a State
insurance regulator and they are using their uncleared swaps to
hedge or mitigate risk of their business activities.
The proposed rule would not require margin to be paid or
collected on transactions involving non-financial end-users hedging
or mitigating commercial risk. Congress recognized the different
levels of risk posed by transactions between financial entities and
those that involve non-financial entities, as reflected in the non-
financial end-user exception to clearing. Transactions involving
[[Page 23749]]
non-financial entities do not present the same risk to the financial
system as those solely between financial entities. The risk of a
crisis spreading throughout the financial system is greater the more
interconnected financial companies are to each other.
Interconnectedness among financial entities allows one entity's
failure to cause uncertainty and possible runs on the funding of
other financial entities, which can spread risk and economic harm
throughout the economy.
CFTC staff worked very closely with prudential regulators to
establish initial and variation margin requirements that are
comparable to the maximum extent practicable.
[FR Doc. 2011-9598 Filed 4-27-11; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: April 28, 2011
See Also:
