[Federal Register Volume 81, Number 242 (Friday, December 16, 2016)]
[Proposed Rules]
[Pages 91252-91334]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-29368]
[[Page 91251]]
Vol. 81
Friday,
No. 242
December 16, 2016
Part II
Commodity Futures Trading Commission
-----------------------------------------------------------------------
17 CFR Parts 1, 23, and 140
Capital Requirements of Swap Dealers and Major Swap Participants;
Proposed Rule
Federal Register / Vol. 81 , No. 242 / Friday, December 16, 2016 /
Proposed Rules
[[Page 91252]]
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 23, and 140
RIN 3038--AD54
Capital Requirements of Swap Dealers and Major Swap Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing to adopt new regulations and to amend existing
regulations to implement sections 4s(e) and (f) of the Commodity
Exchange Act (``CEA''), as added by section 731 of the Wall Street
Reform and Consumer Protection Act (``Dodd-Frank Act''). Section 4s(e)
requires the Commission to adopt capital requirements for swap dealers
(``SDs'') and major swap participants (``MSPs'') that are not subject
to capital rules of a prudential regulator. Section 4s(f) requires the
Commission to adopt financial reporting and recordkeeping requirements
for SDs and MSPs. The Commission also is proposing to amend existing
capital rules for futures commission merchants (``FCMs''), providing
specific capital deductions for market risk and credit risk for swaps
and security-based swaps entered into by an FCM. The Commission is
further proposing several technical amendments to the regulations.
DATES: Comments must be received on or before March 16, 2017.
ADDRESSES: You may submit comments, identified by RIN 3038-AD54 and
``Capital Requirements for Swap Dealers and Major Swap Participants'',
by any of the following methods:
CFTC Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: Send to Chris Kirkpatrick, Secretary, Commodity
Futures Trading Commission, 1155 21st Street, NW., Washington, DC
20581.
Hand delivery/Courier: Same as Mail above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Please submit your comments using only one of these methods.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that is exempt from disclosure under the Freedom of
Information Act, a petition for confidential treatment of the exempt
information may be submitted according to the procedures set forth in
Regulation 145.9 of the Commission's regulations.\1\
---------------------------------------------------------------------------
\1\ Commission regulations referred to herein are found at 17
CFR chapter 1. Commission regulations are accessible on the
Commission's Web site, http://www.cftc.gov.
---------------------------------------------------------------------------
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: Eileen T. Flaherty, Director, Division
of Swap Dealer and Intermediary Oversight, 202-418-5326,
[email protected]; Thomas Smith, Deputy Director, Division of Swap
Dealer and Intermediary Oversight, 202-418-5495, [email protected];
Jennifer C.P. Bauer, Special Counsel, Division of Swap Dealer and
Intermediary Oversight, 202-418-5472, [email protected]; Joshua Beale,
Special Counsel, Division of Swap Dealer and Intermediary Oversight,
202-418-5446, [email protected]; Rafael Martinez, Senior Financial Risk
Analyst, Division of Swap Dealer and Intermediary Oversight, 202-418-
5462, [email protected]; Paul Schlichting, Assistant General Counsel,
Office of the General Counsel, 202-418-5884, [email protected]; or
Lihong McPhail, Research Economist, 202-418-5722, [email protected],
Office of the Chief Economist; Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Statutory Authority
B. Previous Proposed Rulemaking
C. Consultation With U.S. Securities and Exchange Commission and
Prudential Regulators
II. Proposed Regulations and Amendments to Regulations
A. Capital
1. Introduction
2. Capital Requirements for Swap Dealers and Major Swap
Participants
i. Capital Requirements for Swap Dealers Under a Bank-Based
Capital Approach
a. Computation of Minimum Capital Requirement
b. Computation of Common Equity Tier 1 Capital To Meet Minimum
Capital Requirement
ii. Capital Requirement for Swap Dealers Under a Net Liquid
Assets Capital Approach
a. Computation of Minimum Capital Requirement
b. Computation of Net Capital To Meet Minimum Capital
Requirement
(1) Swap Dealers Computation of Tentative Net Capital and Net
Capital Without Approval To Use Internal Capital Models
(2) Swap Dealers Approved To Use Internal Capital Models
iii. Capital Requirement for Swap Dealers That Are
``Predominantly Engaged in non-Financial Activities''
a. Computation of Minimum Capital Requirement
b. Computation of Tangible Net Worth To Meet Minimum Capital
Requirement
iv. Capital Requirements for Major Swap Participants
3. Capital Requirements for FCMs
i. Introduction
ii. FCM Capital Charges for Swaps and Security-Based Swaps in
Computing Adjusted Net Capital
a. Standardized Market Risk and Credit Risk Capital Charges
b. Model-Based Market Risk and Credit Risk Capital Charges
iii. Market Risk and Credit Risk Capital Models for Futures
Commission Merchants That Are Not Alternative Net Capital Firms
iv. Liquidity Requirements
4. Model Approval Process
i. VaR Models
ii. Stressed VaR Models
iii. Specific Risk Models
iv. Incremental Risk Models
v. Comprehensive Risk Models
vi. Credit Risk Models
B. Swap Dealer and Major Swap Participant Liquidity Requirements
and Equity Withdrawal Restrictions
1. Liquidity Requirements
i. Swap Dealers Subject to the Bank-Based Capital Approach
ii. Swap Dealers Subject to the Net Liquid Assets Capital
Approach
2. Swap Dealer Equity Withdrawal Restrictions
C. Swap Dealer and Major Swap Participant Financial
Recordkeeping, Reporting and Notification Requirements
1. Swap Dealer and Major Swap Participant Financial
Recordkeeping and Financial Statement Reporting Requirements
2. Swap Dealer and Major Swap Participant Notice Requirements
3. Electronic Filing Requirements for Financial Reports and
Regulatory Notices
4. Swap Dealer and Major Swap Participant Reporting of Position
Information
5. Reporting Requirements for Swap Dealers Approved To Use
Internal Capital Models
[[Page 91253]]
6. Financial Reporting Requirements for Swap Dealers and Major
Swap Participants Subject to the Capital Rules of a Prudential
Regulator
7. Weekly Position and Margin Reporting
D. Comparability Determinations for Eligible Swap Dealers and
Major Swap Participants
E. Technical Amendments
1. Amendments to the Financial Reporting Requirements in
Regulations 1.10 and 1.16
2. Amendments to the Notice Provisions in Regulation 1.12
3. Commission Receivables for Certain Swap Transactions in
Regulation 1.17
4. Changes to Notice and Disclosure Requirements for Bulk
Transfers in Regulation 1.65
5. Conforming Amendments to Delegated Authority Provisions in
Regulation 140.91
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. New Information Collection Requirements and Related Burden
Estimates
i. Form SBS
ii. Notice of Failure to Maintain Minimum Financial Requirements
iii. Requests for Extensions of Time To File Financial
Statements
iv. Capital Requirements Elections
v. Application for Use of Models
vi. Liquidity Requirements
vii. Financial Recordkeeping, Reporting and Notification
Requirements for SDs and MSPs
viii. Capital Comparability Determinations
2. Information Collection Comments
IV. Cost Benefit Considerations
A. Background
B. Regulatory Capital
C. General Summary of Proposal
D. Baseline
E. Overview of Approaches
1. Bank Based Capital
2. Net Liquid Assets
3. Alternative Net Capital (``ANC'')
4. Tangible Net Worth
5. Substituted Compliance
F. Entities
1. Bank Subsidiaries
2. SD/BD (Without Models)
3. SD/BD/OTC Derivatives Dealers (Without Models)
4. SD/FCM (Without Models)
5. ANC Firms (SD/BD and/or FCMs That Use Models)
6. Stand-Alone SD (With and Without Models)
7. Non-Financial SD (With and Without Models)
8. MSP
9. Substituted Compliance
G. Liquidity and Funding Requirements
H. Reporting and Recordkeeping Requirements
I. Section 15(a) Factors
1. Protection of Market Participants and the Public
2. Efficiency, Competitiveness, and Financial Integrity of Swaps
Markets
3. Price Discovery
4. Sound Risk Management Practices
5. Other Public Interest Considerations
I. Introduction
A. Statutory Authority
Section 731 of the Dodd-Frank Act \2\ amended the CEA \3\ by adding
section 4s(e), which requires the Commission to adopt rules
establishing capital requirements for SDs and MSPs to help ensure the
safety and soundness of the SDs and MSPs.\4\ Section 4s(e) applies a
bifurcated approach requiring each SD and MSP subject to the capital
requirements of a prudential regulator to meet the capital requirements
adopted by the applicable prudential regulator, and requiring each SD
and MSP that is not subject to the capital requirements of a prudential
regulator to meet the capital requirements adopted by the
Commission.\5\ Therefore, SDs and MSPs that are not banking entities,
including nonbank subsidiaries of bank holding companies regulated by
the Federal Reserve Board, are subject to the Commission's capital
requirements.\6\ The Commission is also proposing in this release to
require SDs to meet defined liquidity and funding requirements and is
proposing certain limitations on the withdrawal of capital from SDs as
part of the SD capital requirements.
---------------------------------------------------------------------------
\2\ 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.
\3\ 7 U.S.C. 1 et seq.
\4\ See 7 U.S.C. 6s(e)(3)(A). Section 4s(e) also directs the
Commission to adopt regulations for SDs and MSPs imposing initial
and variation margin requirements on all swaps that are not cleared
by a registered clearing organization. The Commission adopted final
SD and MSP margin requirements for uncleared swap transactions on
December 18, 2015. See, Margin Requirements for Uncleared Swaps for
Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
\5\ The term ``prudential regulator'' is defined in section
1a(39) of the CEA for purposes of the section 4s(e) capital
requirements. Specifically, the term ``prudential regulator'' is
defined to mean the Board of Governors of the Federal Reserve System
(``Federal Reserve Board''); the Office of the Comptroller of the
Currency (``OCC''); the Federal Deposit Insurance Corporation; the
Farm Credit Administration; and the Federal Housing Finance Agency.
All references to an ``SD'' or an ``MSP'' in this proposal will mean
an SD or MSP that is subject to the Commission's capital rules,
unless otherwise specified.
\6\ The prudential regulators, including the Federal Reserve
Board and OCC which have capital responsibilities for SDs
provisionally-registered with the Commission, have adopted capital
rules that incorporate capital requirements for swap and security-
based swap transactions. In this regard, the Federal Reserve Board
and OCC have adopted revised capital rules to incorporate Basel III
capital adequacy requirements. See, Regulatory Capital Rules:
Regulatory Capital, Implementation of Basel III, Capital Adequacy,
Transition Provisions, Prompt Corrective Action, Standardized
Approach for Risk-weighted Assets, Market Discipline and Disclosure
Requirements, Advanced Approaches Risk-Based Capital Rule, and
Market Risk Capital Rule, 78 FR 62018 (Oct. 11, 2013).
---------------------------------------------------------------------------
The Commission is also required to adopt regulations to implement
provisions in section 4s related to financial reporting and
recordkeeping by SDs and MSPs. Section 4s(f)(2) of the CEA directs the
Commission to adopt rules governing financial condition reporting and
recordkeeping for SDs and MSPs, and section 4s(f)(1)(A) requires each
registered SD and MSP to make such reports as are required by
Commission rule or regulation regarding the SD's or MSP's financial
condition. The Commission is also proposing record retention and
inspection requirements consistent with the provisions of section
4s(f)(1)(B).\7\ Pursuant to the financial reporting provisions, the
Commission is proposing that SDs and MSPs submit periodic financial
information and swaps and security-based swaps position information to
the Commission, and that SDs and MSPs file written notices with the
Commission whenever defined reportable events are triggered.
---------------------------------------------------------------------------
\7\ The Commission previously finalized certain record retention
requirements for SDs and MSPs regarding their swap activities. See,
Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and
Duties Rules; Futures Commission Merchant and Introducing Broker
Conflicts of Interest Rules; and Chief Compliance Officer Rules for
Swap Dealers, Major Swap Participants, and Futures Commission
Merchants, 76 FR 20128 (Apr. 3, 2012).
---------------------------------------------------------------------------
In addition to proposing minimum capital and financial reporting
requirements for SDs and MSPs, the Commission is also proposing to
amend existing capital requirements for FCMs to include specific market
risk capital charges and credit risk capital charges for swaps and
security-based swaps transactions that are not cleared by clearing
organizations.\8\ Section 4s(a) of the CEA requires entities that
engage in swap dealing activities and otherwise meet the definition of
an SD to register with the Commission as SDs. The Commission expects
that certain FCMs will engage in swap dealing activities that requires
them to register as SDs. In addition, the Commission expects that other
FCMs may engage in a level of swap dealing activity that is below the
de minimis exception and, therefore, exempts the FCMs from registering
as SDs.\9\ Accordingly, the Commission is
[[Page 91254]]
proposing to amend Regulation 1.17 to establish specific capital
requirements for FCMs that engage in swaps or security-based swaps that
are not cleared by a clearing organization. These proposed capital
requirements would apply to all FCMs that enter into uncleared swaps or
security-based swaps. The Commission also is proposing technical
amendments to several regulations as part of the proposed capital and
financial recordkeeping and reporting requirements.
---------------------------------------------------------------------------
\8\ Section 4f(b) of the CEA authorizes the Commission to
establish minimum financial requirements for FCMs. The Commission
previously adopted minimum capital requirements for FCMs, which are
set forth in Commission Regulation 1.17.
\9\ Regulation 1.3(ggg) defines the term ``swap dealer'' and
contains a general exception from the definition for a person that
engages in a de minimis level of swap dealing activities. Regulation
1.3(ggg) generally defines the term ``de minimis'' to mean that the
swap dealing activities of a person, or any other entity
controlling, controlled by or under common control with the person,
over the preceding 12 months have an aggregate gross notional amount
of no more than $3 billion (subject to a phase in level of $8
billion) and an aggregate notional amount of no more than $25
million with regard to swaps in which the counterparty is a
``special entity'' as defined in section 4s(h)(2)(C) of the CEA and
Commission Regulation 23.401(c).
---------------------------------------------------------------------------
B. Previous Proposed Rulemaking
The Commission previously proposed capital and financial reporting
rules for SDs and MSPs in 2011.\10\ The Commission received comments
from a broad spectrum of market participants, industry representatives,
and other interested parties. The commenters addressed numerous topics
including the permissible use of models for computing capital and the
need for harmonization of the Commission's rules with capital rules of
the prudential regulators and the Securities and Exchange Commission
(``SEC'').\11\
---------------------------------------------------------------------------
\10\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 76 FR 27802 (May 12, 2011).
\11\ Comments received on the Commission's May 12, 2011 proposed
capital and financial reporting rules are available on the
Commission's Web site. Commenters included financial services
associations, agricultural associations, energy associations,
insurance associations, banks, brokerage firms, investment managers,
insurance companies, pension funds, commercial end users, law firms,
public interest organizations, and other members of the public.
---------------------------------------------------------------------------
The Commission elected to defer consideration of final capital
rules until the Commission adopted final regulations governing margin
requirements for SDs and MSPs engaging in uncleared swap transactions.
The Commission adopted the final margin requirements for uncleared
swaps in December 2015.\12\
---------------------------------------------------------------------------
\12\ See 81 FR 636 (Jan. 6, 2016).
---------------------------------------------------------------------------
The Commission has considered the comments it received from its
initial capital proposal in developing this proposal. In addition, and
as discussed below, the Commission also has considered capital rules
adopted by the prudential regulators and capital rules proposed by the
SEC for security-based swap dealers (``SBSDs'') and major security-
based swap participants (``MSBSPs'') in developing this proposal. The
Commission further considered the impact of the final margin rules for
uncleared swaps and the final rules addressing the cross-border
application of the margin requirements for uncleared swaps in
developing this proposal.\13\
---------------------------------------------------------------------------
\13\ The Commission adopted final regulations addressing the
cross-border application of the uncleared swaps margin rules. See,
Margin Requirements for Uncleared Swaps for Swap Dealers and Major
Swap Participants--Cross-Border Application of the Margin
Requirements, 81 FR 34818 (May 31, 2016).
---------------------------------------------------------------------------
C. Consultation With U.S. Securities and Exchange Commission and
Prudential Regulators
Section 4s(e)(3)(D) of the CEA provides that the CFTC, SEC, and
prudential regulators (collectively, the ``Agencies'') shall, to the
maximum extent practicable, establish and maintain comparable minimum
capital requirements for SDs and MSPs. Further, section 4s(e)(3)(D)
directs staff of the Agencies to meet periodically, but no less
frequently than annually, to consult on minimum capital requirements.
Accordingly, staff from each of the Agencies had the opportunity to
provide oral and/or written comments to the capital and financial
reporting regulations for SDs and MSPs contained in this proposing
release, and the proposal reflects certain elements of their comments.
II. Proposed Regulations and Amendments to Regulations
A. Capital
1. Introduction
Broadly speaking, in developing the proposed capital requirements
for SDs and MSPs, the Commission strived to advance the statutory goal
of helping to protect the safety and soundness of SDs and MSPs, while
also taking into account the diverse nature of entities participating
in the swaps market and the existing capital regimes that apply to
these entities and/or their financial group. To that end, the
Commission is proposing three alternative capital approaches for SDs
and MSPs, which are intended to minimize competitive advantages that
might otherwise arise if the Commission were to impose a singular
capital approach in light of the different corporate and operating
structures of the entities. The Commission further considered the
degree to which its proposed capital requirements would be consistent
with an existing regulatory framework (if any) to which these entities
are already subject and the statutory objective of the capital
requirements, to help ensure the safety and soundness of SD and MSP
registrants.
The Commission has, to a great extent, drawn on existing CFTC,
prudential regulator, and SEC capital rules in developing the proposed
capital requirements for SDs and MSPs. Also, as discussed in this
release, the Commission's proposed capital requirements for SDs and
MSPs are consistent in many respects with the SEC's proposed capital
requirements for SBSDs and MSBSPs, and the prudential regulators'
capital requirements for banks and bank holding companies.\14\
Specifically, the proposal, depending on the characteristics of the
registered entity, would: (i) Permit SDs to elect a capital requirement
that is based on existing bank holding company capital rules adopted by
the Federal Reserve Board (the ``bank-based capital approach''); (ii)
permit SDs to elect a capital requirement that is based on the existing
CFTC FCM capital rule, the existing SEC broker-dealer (``BD'') capital
rule, and the SEC's proposed capital requirements for SBSDs, (the ``net
liquid assets capital approach''); or (iii) permit SDs that meet
defined conditions designed to ensure that they are ``predominantly
engaged in non-financial activities'' to compute their minimum
regulatory capital based upon the firms' tangible net worth (the
``tangible net worth capital approach'').
---------------------------------------------------------------------------
\14\ Section 15F(e) of the Exchange Act (15 U.S.C. 78o-
10(e)(1)(B)) provides that the SEC shall prescribe capital and
margin requirements for SBSDs and nonbank MSBSPs that do not have a
prudential regulator. The SEC proposed capital requirements for
SBSDs and MSBSPs in November 2012. See Capital, Margin, and
Segregation Requirements for Security-Based Swap Dealers and Major
Security-Based Swap Participants, 77 FR 70214 (Nov. 23, 2012). The
prudential regulators adopted amendments to the capital rules for
banks and bank holding companies to incorporate certain requirements
set forth in the Dodd-Frank Act. See, 78 FR 62018 (Oct. 11, 2013).
---------------------------------------------------------------------------
With respect to MSPs, the Commission is proposing a minimum
regulatory capital requirement based upon the tangible net worth of the
MSP. This tangible net worth approach is consistent with the SEC's
proposed capital rule for MSBSPs as discussed in section II.A.2.iii of
this release.
The Commission's proposed SD and MSP capital requirements are set
forth in new Regulation 23.101, and are discussed in section II.A.2 of
this release. Proposed Regulation 23.101 details the minimum capital
requirements for each of the three capital approaches and the
eligibility criteria (as applicable), and further
[[Page 91255]]
defines the capital computations for each approach, including various
market risk and credit risk charges, whether using models or otherwise,
to determine whether an SD satisfies the minimum capital requirements.
The proposal also defines a minimum capital requirement for MSPs and
defines the capital computation for MSPs.
The Commission is also proposing several amendments to Regulation
1.17, which governs the capital requirements for FCMs. The proposed
amendments would establish specific market risk and credit risk capital
charges for swap and security-based swap positions, and would provide a
process for an FCM that is dually-registered as an SD to seek approval
from the Commission or from the registered futures association
(``RFA'') of which the FCM is a member to use internal capital models
to compute market risk and credit risk capital charges.\15\ The
discussion of the proposed FCM capital amendments is contained in
section II.A.3 of this release.
---------------------------------------------------------------------------
\15\ Section 3 of the CEA states that a purpose of the CEA is to
establish a system of effective self-regulation under the oversight
of the Commission. Consistent with the self-regulatory concept
established under section 3, section 17 of the CEA provides a
process whereby an association of persons may register with the
Commission as a registered futures association (``RFA''). Currently,
the National Futures Association (``NFA'') is the only RFA under
section 17 of the CEA.
---------------------------------------------------------------------------
2. Capital Requirements for Swap Dealers and Major Swap Participants
The Commission is proposing capital requirements for SDs and MSPs
in order to help ensure the safety and soundness of the SDs and MSPs by
requiring such firms to maintain a minimum level of financial resources
that is based upon the activities of the firms. Adequate levels of
capital will allow SDs and MSPs to meet their obligations to swap and
security-based swap counterparties and general creditors.
The Commission's proposed SD capital requirements in Regulation
23.101 are comprised of two components. First, an SD must compute the
minimum amount of capital that the SD is required to maintain under
proposed Regulation 23.101. Second, the SD must compute, based upon its
balance sheet and certain adjustments including market risk and credit
risk charges on its swaps, security-based swaps and other proprietary
positions, the actual amount of capital that the SD maintains. The SD's
actual capital must be equal to or greater than the SD's minimum
capital requirement. This section discusses the proposed minimum amount
of capital required to be maintained by an SD or MSP under the proposal
and the proposed regulations governing the computation of the amount of
capital that an SD or MSP actually maintains.
To provide SDs with flexibility given the diverse nature of their
corporate structures and operations, the Commission is proposing a
bank-based capital approach, a net liquid assets capital approach, and
a tangible net worth capital approach for SDs. And as described below,
SDs which are subject to existing capital requirements that would
adequately address their swaps transactions may choose to remain under
those existing requirements. The Commission believes that providing
this flexibility is appropriate as both the bank-based capital approach
and the net liquid assets capital approach are based on
internationally-recognized and accepted approaches for establishing
strong minimum capital requirements for financial institutions. Both of
these approaches are designed to ensure that SD's meet their financial
obligations and to help ensure that safety and soundness of the SD.
Although there are differences between the bank-based and net liquid
assets based capital approaches, they are structurally similar in that
they evaluate the composition of the SD's balance sheet and are
formulated to ensure the SD's ability to continue its operations in
times of financial stress. The option to use the tangible net worth
approach is appropriate because it would be available only for SDs that
are predominantly engaged in non-financial activities. These SDs are
primarily involved in commercial activities and engage in a relatively
insignificant amount of financial transactions when compared to their
entire operations, as described below. As the Commission has previously
noted, financial firms generally present a higher level of systemic
risk than commercial firms as the profitability and viability of
financial firms is more tightly linked to the health of the financial
system than commercial firms.\16\
---------------------------------------------------------------------------
\16\ See 81 FR 636, 640 (Jan. 6, 2016).
---------------------------------------------------------------------------
In addition, as noted above, the Commission based the proposal on
existing regulatory capital regimes. The Commission recognizes that
certain of the current registered SDs are nonbank subsidiaries of bank
holding companies that are already subject to the Federal Reserve
Board's bank-based capital requirements for bank holding companies. The
Commission anticipates that SDs that are nonbank subsidiaries of bank
holding companies may elect the bank-based capital approach as the
firms consolidate into bank holding companies that are subject to the
Federal Reserve Board's bank-based capital requirements. The
Commission's proposed bank-based capital approach would allow an SD
that consolidates into a bank holding company to maintain books and
records, and perform capital computations, in a manner that is
consistent with its holding company parent entity.
Furthermore, several of the current provisionally-registered SDs
are also dually-registered with the Commission as FCMs or dually-
registered with the SEC as BDs or ``OTC derivatives dealers,'' and
several of the current provisionally-registered SDs are anticipated to
register with the SEC as SBSDs.\17\ FCMs, BDs, and OTC derivatives
dealers currently are subject to a net liquid assets capital
requirement, and the SEC is proposing a net liquid assets capital
requirement for SBSDs.\18\ The Commission believes that permitting
dually-registered SDs/SBSDs or SDs/OTC derivatives dealers to use a
uniform CFTC-SEC net liquid assets capital approach would simplify the
SDs recordkeeping obligations and allow them to use existing accounting
and financial reporting systems. This approach is also consistent with
the Commission's long-standing practice of maintaining a uniform
capital rule for dually-registered FCM/BDs, while also imposing a
strong capital requirement on the SDs to help ensure the safety and
soundness of the firms.
---------------------------------------------------------------------------
\17\ An OTC derivatives dealer is a limited purpose BD
established by SEC regulations. An OTC derivatives dealer's
securities activities are limited to engaging in eligible OTC
derivative instruments that are securities and other enumerated
activities. See 17 CFR 240.3b-12.
\18\ FCM capital requirements are set forth in CFTC Regulation
1.17. SEC Rule 15c3-1 (17 CFR 240.15c3-1) governs the capital
requirements for BDs. SEC proposed Rule 18a-1 would govern the
capital requirements for SBSDs that are not registered as BDs. (See
77 FR 70214).
---------------------------------------------------------------------------
In addition to the bank-based capital approach and the net liquid
assets capital approach, the Commission is also proposing to permit SDs
that are ``predominantly engaged in non-financial activities,'' as
defined below, to elect a capital approach that is based on the SD's
tangible net worth.\19\ The Commission is proposing the tangible net
worth capital approach in recognition that not all SDs will be
principally engaged in traditional dealing and other financial
activities. The Commission anticipates that a small number of SDs will
be substantially engaged in commercial operations that would make
meeting a traditional bank-based capital approach or net liquid
[[Page 91256]]
assets capital approach extremely challenging, if at all possible,
without substantial corporate restructuring. The Commission's proposal
to use the tangible net worth approach would be limited to SDs that are
predominantly engaged in non-financial (i.e., commercial) activities.
---------------------------------------------------------------------------
\19\ See proposed Regulation 23.101(a)(2).
---------------------------------------------------------------------------
The Commission's proposed approach of recognizing existing capital
requirements on firms that register as SDs and the Commission's further
recognition that not all SDs will be traditional financial firms offers
potential benefits to swap market participants by encouraging more
firms to act as SDs and to make markets in swaps. An approach that
would impose a standardized capital requirement on firms that otherwise
are subject to existing capital regimes that differ substantially from
the standardized capital requirement or that would require substantial
corporate reorganization to satisfy the standardized capital
requirement would increase costs of swap transactions for swap dealers
and their counterparties, including commercial end users and other non-
financial market participants. A standardized capital requirement may
also impose significant disincentives for certain SDs to remain in the
market as dealers in swaps, which would concentrate dealing activities
in a smaller number of firms. The Commission's proposal implements
strong capital requirements to help ensure the safety and soundness of
the SDs, while at the same time offers an appropriate degree of
flexibility, recognizing that a single, standardized capital approach
is not appropriate for all SDs which could result in significant
burdens on all swap market participants.
Proposed Regulation 23.101 also is consistent with the statutory
requirements under section 4s(e), which effectively provides that SDs
subject to the capital rule of a prudential regulator are not subject
to the Commission's capital rules.\20\ Proposed Regulation 23.101(a)(3)
would provide that an SD subject to the capital rules of a prudential
regulator is not subject to the Commission's capital rules.
---------------------------------------------------------------------------
\20\ See section 4s(e)(1) and (2).
---------------------------------------------------------------------------
Proposed Regulation 23.101(a)(4) also provides that certain SDs
that are otherwise currently subject to the Commission's capital rules
are not subject to Regulation 23.101. Specifically, proposed Regulation
23.101(a)(4) would provide that an SD that is also registered as an FCM
with the Commission is subject to the Commission's FCM capital
requirements contained in Regulation 1.17.\21\ These SDs would be
subject to the FCM capital requirements, which the Commission is
proposing to amend in order to better reflect the specific risks of
engaging in uncleared swaps and security-based swap transactions. The
Commission is requiring an SD that is dually-registered as an FCM to
meet the FCM capital requirements as such requirements reflect the
Commission's long experience in regulating the financial requirements
of FCMs. For example, the FCM capital requirement, which requires an
FCM to hold at least one dollar of liquid assets to meet each dollar of
liabilities (except certain subordinated debt), is designed to ensure
that an FCM has adequate liquid resources to effectively operate as a
market intermediary by having resources to pay customers' requests to
withdraw funds and by satisfying its customers' obligations to clearing
organizations. The Commission proposed amendments for FCMs are
discussed in section II.A.3 of this release.
---------------------------------------------------------------------------
\21\ The Commission, as discussed in section II.A.3 of this
release, also is proposing to amend Regulation 1.17 to specifically
address capital requirements for FCMs that carry swaps and/or
security-based swaps positions.
---------------------------------------------------------------------------
Lastly, proposed Regulation 23.101(a)(5) would contain a provision
of ``substituted compliance'' for capital and financial reporting
requirements for SDs that are: (1) Not organized under the laws of the
U.S., and (2) not domiciled in the U.S. The proposal would permit these
non-U.S. organized and domiciled SDs (or a regulatory authority in the
SDs' home country jurisdictions) to petition the Commission to satisfy
the Commission's capital and financial reporting requirements through
substituted compliance with the capital and financial reporting
requirements of the SDs' respective home country jurisdiction.\22\ The
proposed substituted compliance provisions and the Commission program
of conducting comparability determinations of foreign jurisdictions
capital requirements are discussed in section II.D of this release.
---------------------------------------------------------------------------
\22\ Proposed Regulations 23.101(a)(5) and 23.106.
---------------------------------------------------------------------------
i. Capital Requirement for Swap Dealers Under a Bank-Based Capital
Approach
a. Computation of Minimum Capital Requirement
The Commission is proposing to provide SDs with an option to elect
the bank-based capital approach based on the capital requirements
adopted by the Federal Reserve Board for bank holding companies. The
Federal Reserve Board's bank holding company capital requirements are
consistent with the bank capital framework adopted by the Basel
Committee on Banking Supervision (``BCBS'').\23\ The BCBS framework is
an internationally-recognized framework for setting capital
requirements for banks and bank holding companies. The Commission
believes that proposing capital requirements using the Federal Reserve
Board's capital framework is appropriate as the framework specifically
reflects swaps and security-based swaps in the capital requirements,
and the framework was developed to provide prudential standards to help
ensure the safety and soundness of bank and bank holding companies. In
addition, as noted above, the proposal to allow SDs an option to elect
this approach would provide efficiencies for several of the
provisionally registered SDs that are part of a bank holding company
structure, and have developed recordkeeping, accounting, and financial
reporting systems that are designed to comply with existing prudential
requirements.
---------------------------------------------------------------------------
\23\ BCBS is the primary global standard-setter for the
prudential regulation of banks and provides a forum for cooperation
on banking supervisory matters. Institutions represented on the BCBS
include the Federal Reserve Board, the European Central Bank,
Deutsche Bundesbank, Bank of France, Bank of England, Bank of Japan,
and Bank of Canada.
---------------------------------------------------------------------------
The Commission's bank-based capital approach is set forth in
proposed Regulation 23.101(a)(1)(i), and would require an SD to
maintain a minimum level of regulatory capital that is equal to or in
excess of the greater of the following four criteria:
(1) $20 million of common equity tier 1 capital, as defined under
the bank holding company regulations in 12 CFR 217.20, as if the SD
itself were a bank holding company subject to 12 CFR part 217; \24\
---------------------------------------------------------------------------
\24\ Common equity tier 1 capital is defined in 12 CFR 217.20 of
the Federal Reserve Board's rules. Common equity tier 1 capital
generally represents the sum of a bank holding company's common
stock instruments and any related surpluses, retained earnings, and
accumulated other comprehensive income.
---------------------------------------------------------------------------
(2) common equity tier 1 capital, as defined under the bank holding
company regulations in 12 CFR part 217.20, equal to or greater than
eight percent of the SD's risk-weighted assets computed under the bank
holding company regulations in 12 CFR part 217 as if the SD were a bank
holding company subject to 12 CFR part 217;
(3) common equity tier 1 capital, as defined under 12 CFR 217.20,
equal to or greater than 8 percent of the sum of:
(a) The amount of ``uncleared swaps margin'' (as that term is
defined in
[[Page 91257]]
proposed Regulation 23.100) for each uncleared swap position open on
the books of the SD, computed on a counterparty by counterparty basis
pursuant to Regulation 23.154; \25\
---------------------------------------------------------------------------
\25\ The term ``uncleared swap margin'' is defined in Regulation
23.100 to mean the amount of initial margin that a swap dealer would
be required to collect from each swap counterparty pursuant to the
margin rules for uncleared swap transactions (Regulation 23.154).
The term ``uncleared swap margin'' includes all uncleared swaps that
an SD is required to collect margin for under the margin
regulations, and also includes all uncleared swaps that are exempt
or excluded from the margin requirements including swaps with
commercial end users, swaps entered into prior to the respective
compliance dates of the Commission's margin requirements set forth
in Regulation 23.161 (i.e., legacy swaps), and excluded swaps with
an affiliated entity.
---------------------------------------------------------------------------
(b) the amount of initial margin that would be required for each
uncleared security-based swap position open on the books of the SD,
computed on a counterparty-by-counterparty basis pursuant to proposed
SEC Rule 18a-3(c)(1)(i)(B), without regard to any initial margin
exemptions or exclusions that the rules of the SEC may provide to such
security-based swap positions; and
(c) the amount of initial margin required by a clearing
organization for cleared proprietary futures, foreign futures, swaps,
and security-based swap positions open on the books of the SD; or
(4) the capital required by an RFA of which each SD is a member.
Each of the proposed minimum capital criteria is discussed below.
The first criterion under the Commission's proposal is that all SDs
that elect the bank-based capital approach must maintain a minimum of
$20 million of common equity tier 1 capital. The Commission believes
that given the role that SDs play in the financial markets by engaging
in swap dealing activities that it is appropriate to require that all
SDs maintain a minimum level of capital, stated as an absolute dollar
amount that does not fluctuate with the level of the firms' dealing
activities to help ensure the safety and soundness of SDs.
The proposed $20 million of minimum capital is consistent with the
minimum regulatory capital requirements proposed by the Commission in
this release for SDs that elect the net liquid assets capital approach
or the tangible net worth capital approach discussed in sections
II.A.2.ii and II.A.2.iii, respectively, of this release. The $20
million minimum capital requirement is also consistent with the net
capital requirement proposed by the SEC for SBSDs, and is consistent
with the current minimum net capital requirements for OTC derivatives
dealers registered with the SEC.\26\
---------------------------------------------------------------------------
\26\ The SEC proposed capital requirements for SBSDs would
impose a minimum net capital requirement of $20 million for SBSDs
that are not approved to use internal capital models and a $100
million dollar tentative net capital and $20 million net capital
requirement for SBSDs that are approved to use internal capital
models. See 77 FR 70214 (Nov. 23, 2012). SEC Rule 15c3-1(a)(5) (17
CFR 240.15c3-1(a)(5)) currently requires an OTC derivatives dealer
that has obtained approval to use capital models to maintain a
minimum of $100 million of tentative net capital and $20 million of
net capital.
---------------------------------------------------------------------------
The second criterion of the minimum capital requirement for SDs
that elect the bank-based capital approach is that the SD must maintain
common equity tier 1 capital equal to or greater than eight percent of
the SD's risk-weighted assets computed under the bank holding company
regulations in 12 CFR part 217 as if the SD were a bank holding
company. In effect, this provision of Regulation 23.101(a)(1)(i)
imposes a capital approach on a SD that is generally consistent with
the approach that the Federal Reserve Board imposes on bank holding
companies.\27\ The Commission believes it is important to include this
criterion so that an SD would maintain a level of common equity tier 1
capital that is comparable to the level it would have to maintain if it
were subject to the capital rules of the Federal Reserve Board.
---------------------------------------------------------------------------
\27\ As discussed further below, the Commission's proposal
differs from the rules of the Federal Reserve Board in that the
Commission's proposal would require an SD to add to its risk
weighted assets the market risk capital charges computed in
accordance with Regulation 1.17 if the SD has not obtained approval
from the Commission or from an RFA to use internal market risk and
credit risk models.
---------------------------------------------------------------------------
The Commission is also proposing to measure the required minimum
amount of regulatory capital in terms of a minimum ratio of total
qualifying capital to risk-weighted assets of eight percent, in a
manner that is comparable to the Federal Reserve Board's capital rules
for bank holding companies.\28\ For purposes of the Commission's
proposal, as is also the case for the Federal Reserve Board's minimum
ratio requirement, the assets and off-balance sheet transactions or
exposures of the bank holding company are weighted relative to their
risk.\29\ Thus, under the Commission's proposal, the greater the
perceived risk of the assets and the off-balance sheet items, the
greater the weighting for the risk and the greater the amount of
capital necessary to cover eight percent of the risk-weighted
assets.\30\
---------------------------------------------------------------------------
\28\ See 12 CFR 217.10.
\29\ See 12 CFR 217 subparts D, E, and F.
\30\ Large, complex banks also must make further adjustments to
these risk-weighted assets for the additional capital they must hold
to reflect the market risk of their trading assets See 12 CFR 217
subpart F. The market risk requirements generally apply to Federal
Reserve Board-regulated institutions with aggregate trading assets
and trading liabilities equal to 10 percent or more of total assets
or one billion dollars or more.
---------------------------------------------------------------------------
Proposed Regulation 23.101(a)(1)(i) would require an SD that elects
a bank-based capital approach to compute its risk-weighted assets in
accordance with the Federal Reserve Board's capital requirements
contained in 12 CFR part 217. The proposal includes the two general
approaches to computing risk-weighted assets under 12 CFR part 217. The
first approach is for SDs that have not obtained Commission or RFA
approval to calculate their risk-weighted assets using internal credit
risk and market risk models. Proposed Regulation 23.103 would require
these SDs to use a standardized, or rules-based, approach to computing
their risk-weighted assets. Under this approach, these SDs would use
the credit risk charges from the Federal Reserve Board's standardized
approach under subpart D of 12 CFR 217 and the market risk charges that
are set forth in Regulation 1.17.\31\ Regulation 1.17 contains the
standard market risk capital charges that have been imposed on FCMs for
many years. Generally, market risk charges are determined by
multiplying the notional value or market value of an asset by a fixed
percentage set forth in the regulations.\32\ The market risk charges
are then multiplied by a factor of 12.5 and added to the total risk-
weighted assets of the SD.\33\
---------------------------------------------------------------------------
\31\ The Federal Reserve Board's standardized approach under
subpart D of 12 CFR 217 applies only to credit risk charges; the
Federal Reserve Board has not adopted standardized market risk
charges. Bank and bank holding companies that are subject to market
risk charges are required to use internal models and, accordingly,
subpart D of 12 CFR 217 does not include a standardized approach for
computing market risk charges. To address this issue, the Commission
is proposing that an SD that has not obtained Commission or RFA
approval to use internal market risk models must apply the rules-
based market risk capital charges contained in Regulation 1.17 in
computing its total risk-weighted assets.
\32\ For example, U.S. Treasuries are subject to capital charges
of between zero and six percent depending on the time to maturity of
each treasury instrument, and readily marketable equity securities
are subject to a 15 percent capital charge. See Regulation
1.17(c)(5)(v), which references SEC Rule 15c3-1(c)(2)(vi) (17 CFR
240.15c3-1(c)(2)(vi)). SEC Rule 15c3-1(c)(2)(vi)(A)(1) provides that
a BD shall take a capital charge on U.S. Treasuries of between zero
and six percent of the fair market value of the instrument depending
upon the time to maturity. Rule 15c3-1(c)(2)(vi)(j) provides a
capital charge for equities equal to 15 percent of the fair market
value of the securities.
\33\ The 12.5 multiplication factor is necessary to ensure that
the SD maintains common equity tier 1 capital at level to cover the
full amount of the market risk charge. Since the SD is required to
maintain common equity tier 1 capital equal to or in excess of eight
percent of the risk-weighted assets, the market risk charge is
multiplied by 12.5, which effectively requires the SD to hold common
equity tier 1 capital in an amount equal to the full amount of the
market risk charge. This approach is consistent with the Federal
Reserve Board's approach to bank holding companies.
---------------------------------------------------------------------------
[[Page 91258]]
The second approach to computing risk-weighted assets allows SDs
that have obtained Commission or RFA approval of internal credit risk
and market risk models to use those models to calculate their risk-
weighted assets. For SDs that have been approved to use internal models
to compute market risk and credit risk, the models would have to meet
the qualitative and quantitative requirements set forth in proposed
Regulation 23.102 and Appendix A to Regulation 23.102, which are based
upon the Federal Reserve Board's qualitative and quantitative
requirements in 12 CFR 217.\34\ The proposed qualitative and
quantitative requirements for the models, and the proposed model
submission process, are discussed in section II.4 of this release.
---------------------------------------------------------------------------
\34\ Federal Reserve Board model-based capital charges for
credit risk and market risk are set forth in 12 CFR part 217
subparts E and F, respectively.
---------------------------------------------------------------------------
The third criterion that comprises the SD minimum capital
requirement under the proposed bank-based capital approach would
require an SD to maintain common equity tier 1 capital equal to or in
excess of eight percent of the sum of: (1) The SD's uncleared swaps
margin requirements for uncleared swaps transactions, (2) the initial
margin that would be required for each uncleared security-based swap
transactions pursuant to SEC's proposed Rule 18a-3(c)(1)(i)(B), without
regard for any amounts or security-based swaps that may be exempted or
excluded under the SEC's proposal, (3) the risk margin required on the
SD's cleared futures, foreign futures, and swaps positions, and (4) the
amount of initial margin required by a clearing organization that
clears the SD's proprietary security-based swaps. Each of these
elements is discussed below.
This criterion is intended to ensure that an SD maintains a minimum
level of capital that is correlated to the risk associated with the
SD's trading activities. The Commission believes that this approach
would be appropriate for SDs as the minimum capital requirement would
be correlated with the ``risk'' of the SD's futures, foreign futures,
swaps, and security-based swaps positions as measured by the margin
required on the positions. Specifically, the SD's minimum capital
requirement would increase or decrease as the amount of margin
necessary to support the SD's futures, foreign futures, swaps and
security-based swaps positions increased or decreased. This approach is
consistent with the Commission's current approach to establishing a
minimum capital requirement for FCMs.\35\
---------------------------------------------------------------------------
\35\ FCMs are required to maintain a minimum level of adjusted
net capital that is equal to or greater than eight percent of the
margin required on futures, foreign futures, and cleared swaps
positions carried by the FCM in customer and noncustomer accounts.
See Regulation 1.17(a)(1)(i)(B).
---------------------------------------------------------------------------
As noted above, the term ``uncleared swaps margin'' is defined in
proposed Regulation 23.100 and would mean the amount of initial margin
that the SD would be required to collect from a swap counterparty
pursuant to the Commission's margin rules for uncleared swap
transactions in Commission Regulations 23.150 through 23.161, subject
to certain adjustments to incorporate an amount for the initial margin
for swaps that are otherwise exempt or excluded from the Commission's
margin requirements. The SD would compute the uncleared margin amount
on a portfolio basis for each of its counterparties. Similarly, the
Commission would also require the SD to compute, again on a portfolio
basis, the amount of initial margin that would be required for each
uncleared security-based swap pursuant to SEC's proposed Rule 18a-
3(c)(1)(i)(B) without regard for any exemptions or exclusions that may
be provided by the SEC's proposal. The term ``risk margin'' is defined
in Regulation 1.17(b)(8), and generally refers to the amount of margin
required by clearing organizations that clear futures, foreign futures,
and swaps transactions. Similarly, the proposed rules would also
include the amount of initial margin required by clearing organizations
for an SD's cleared security-based swaps.
The proposal would require an SD to include all swaps and security-
based swaps in the computation, including swaps that are excluded from
the Commission's margin rules for uncleared swaps and any security-
based swaps that the SEC may exclude from its margin rules when adopted
as final. Specifically, the proposal would provide that an SD must
include in its computation of the uncleared swaps margin each
outstanding swap, including swaps exempt from the scope of the
Commission's swaps margin rules by Regulation 23.150 (``TRIPRA
Exemption''),\36\ foreign exchange swap as the term is defined in
Regulation 23.151, or netting set of swaps or foreign exchange swaps,
for each counterparty, as if that counterparty were an unaffiliated SD.
---------------------------------------------------------------------------
\36\ Title III of the Terrorism Risk Insurance Program
Reauthorization Act of 2015 amended sections 731 and 764 of the
Dodd-Frank Act to provide that the Commission's margin requirements
shall not apply to a swap in which a counterparty: (1) Qualifies for
an exception under section 2(h)(7)(A) of the CEA; (2) qualifies for
an exemption issued under section 4(c)(1) of the CEA for cooperative
entities as defined in such exemption; or (3) satisfies the criteria
in section 2(h)(7)(D) of the CEA. See Public Law 114-1, 129 Stat. 3.
---------------------------------------------------------------------------
The Commission's proposal also would require an SD to include the
initial margin for all swaps that would otherwise fall below the $50
million initial margin threshold amount or the $500,000 minimum
transfer amount, as defined in Regulation 23.151, for purposes of
computing the uncleared swap margin amount. As such, the uncleared swap
margin amount would be the amount that an SD would have to collect from
a counterparty, assuming that the exclusions and exemptions for
collecting initial margin for uncleared swaps set forth in Regulations
23.150-161 would not apply, and also assuming that the thresholds under
which initial margin and/or variation margin would not need to be
exchanged would not apply. Accordingly, uncleared swaps that are not
subject to the margin requirement such as those executed prior to the
compliance date for margin requirements (``legacy swaps''), inter-
affiliate swaps, and TRIPRA Exemption swaps would have to be taken into
account in determining the capital requirement.
The Commission is proposing to include these swaps and comparable
security-based swaps in the computation as it believes that it would be
appropriate to require an SD to maintain capital for unmargined swap
and security-based swap exposures to counterparties, so that capital
would be available to cover the ``residual'' risk of a counterparty's
uncleared swaps and security-based swap positions. The Commission
believes that its approach is consistent with its statutory mandate--
helping to ensure the safety and soundness of the SDs subject to its
jurisdiction--to require an SD to reserve capital for all of its
uncollateralized exposures, including the exposures that have been
excluded or exempted from the Commission's margin requirements. This
includes swaps where the counterparty is a commercial end user or an
affiliate of the SD, as the uncollateralized exposures from these
counterparties present risk to the financial condition of the SD.
The Commission's proposal to require an SD to reserve capital for
uncollateralized exposures to swap and security-based swap
counterparties is not inconsistent with the Commission's
[[Page 91259]]
regulations exempting or excluding uncleared swaps with certain
counterparties from margin requirements.\37\ Initial margin is a
transaction-based financial resource. Initial margin protects
counterparties to a swap transaction as well as the overall financial
system. Initial margin serves both as a check on risk-taking that might
exceed a counterparty's financial capacity and as a resource that can
limit losses when there is a failure by a counterparty to meet its
obligations. If a swap counterparty defaults, the other party may use
initial margin to cover some or all of the loss.
---------------------------------------------------------------------------
\37\ See Regulation 23.150.
---------------------------------------------------------------------------
In developing its proposed margin requirements for uncleared swap
transactions, the Commission recognized that different categories of
counterparties present different levels of risk.\38\ The Commission
stated its belief that financial firms generally present a higher level
of risk than non-financial firms due to the profitability and viability
of financial firms being more tightly linked to the health of the
financial system than non-financial firms.\39\ Non-financial end users,
however, generally use swaps to hedge commercial risk and were deemed
to pose less risk to SDs.\40\ Due to the differences in perceived risk
and potential systemic effects, and consistent with Congressional
intent, the Commission excluded non-financial end users from the margin
requirements.
---------------------------------------------------------------------------
\38\ See Margin Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants; Proposed Rule 79 FR 59898 (Oct.
3, 2014).
\39\ Id.
\40\ Id.
---------------------------------------------------------------------------
Capital, however, serves as an overall financial resource for the
SD and is intended to cover potential risks that are not adequately
covered by other risk management programs (i.e., ``residual risk'')
including margin on uncleared swaps. Capital is intended to help ensure
the safety and soundness of the SD by providing financial resources to
allow an SD to absorb unanticipated losses and declines in asset values
from all aspects of its business operations, including swap dealing
activities, while also continuing to meet its financial obligations.
The Commission is proposing to require that an SD reserve capital
against all uncollateralized swaps exposures, as such exposures pose
residual risk not covered by other assets of the SD. Accordingly,
capital is necessary to provide a financial cushion to protect an SD
from financial exposures, including uncollateralized exposures to swap
counterparties.
The Commission's proposal would not require an SD to reserve
capital equal to the full amount of its uncollateralized swap
exposures. The Commission's proposal would require an SD to reserve
capital equal to a percentage of its uncollateralized exposures. In
this respect, the Commission's capital requirement would not have the
same impact on the SD with respect to such uncollaterized swaps (e.g.,
an SD's funding or pricing of swaps) as would the application of the
Commission's margin requirements to such swaps. The Commission's
proposal should also not have the same impact on the cost to commercial
end users who are counterparties to such uncollaterized swaps as would
imposition of margin requirements on such swaps, because of the
different impact on an SD's funding or pricing of swaps and because
margin requirements impose specific transactional costs on
counterparties (e.g., establishment of custodial arrangements,
documentation requirements) that are not generated by SD capital
requirements. The Commission's proposed approach regarding the
inclusion of uncollateralized swap exposures in the SD's capital
requirements is also consistent with the approach adopted by the
prudential regulators in setting capital requirements for SDs subject
to their jurisdiction and is consistent with the approach proposed by
the SEC for SBSDs.
The proposed capital requirement would require an SD to include in
the eight percent calculation the amount of margin required by a
clearing organization for the SD's proprietary cleared swaps, security-
based swaps, futures, and foreign futures positions. The Commission
notes that while the proposed minimum capital requirement based on
eight percent of margin on cleared and uncleared swaps is consistent
with the SEC's proposal for SBSDs, the SEC approach would require an
SBSD to maintain a minimum level of net capital equal to or greater
than eight percent of the risk margin required on cleared and uncleared
security-based swaps only. The Commission's proposal would expand the
products included in the SD's minimum capital requirement to include
swaps, security-based swaps, futures and foreign futures positions. The
Commission is expanding the products beyond the SEC proposal as it
believes that it is appropriate for SDs to maintain a minimum level of
capital that reflects the extent of the risks posed by the full, broad
range of the SDs' proprietary positions.
The fourth criterion of the proposed minimum capital requirements
would require an SD to maintain the minimum level of capital required
by an RFA of which the SD is a member. The proposed minimum capital
requirement based on membership requirements of an RFA is consistent
with current FCM capital requirements under Regulation 1.17, and
reflects Commission regulations that require each SD to be a member of
an RFA.\41\ The proposal also is consistent with section 17(p)(2) of
the CEA, which provides, in relevant part, that an RFA must adopt rules
establishing minimum capital and other financial requirements
applicable to the RFA's members for which such requirements are imposed
by the Commission.\42\ As noted above, the NFA currently is the only
RFA. The proposal recognizes that the NFA would be required by section
17 of the CEA to adopt SD capital rules once the Commission imposes
capital requirements on SDs, and would incorporate the NFA minimum
capital requirements into the Commission's regulation.
---------------------------------------------------------------------------
\41\ See Regulations 1.17(a)(1)(i)(C) and 170.16.
\42\ See section 17(p)(2) of the CEA, which requires RFAs to
adopt rules establishing minimum capital and other financial
requirements applicable to its members for which such requirements
are imposed by the Commission, provided that such requirements may
not be less stringent than the requirements imposed by the CEA or by
Commission regulations.
---------------------------------------------------------------------------
b. Computation of Common Equity Tier 1 Capital To Meet Minimum Capital
Requirement
Each SD subject to the bank-based capital approach is required to
maintain a level of common equity tier 1 capital that is equal to or in
excess of the highest of the three criteria listed in section II.A.2.i
above. The Commission is proposing to limit the SD's capital that
qualifies to satisfy the SD's minimum capital requirement to common
equity tier 1 capital. This limitation would be different from the
Federal Reserve Board's requirements, which allow a bank holding
company to meet its minimum capital requirements with a combination of
common equity tier 1 capital, additional tier 1 capital, and tier 2
capital.\43\
---------------------------------------------------------------------------
\43\ Under the Federal Reserve Board's rules, a bank holding
company's total capital must equal or exceed at least eight percent
of its risk-weighted assets. In addition, at least six percent of
the bank holding company's capital must be in the form of tier 1
capital, and at least 4.5 percent of the tier 1 capital must qualify
as common equity tier 1 capital. The remaining two percent of
capital may be comprised of tier 2 capital.
---------------------------------------------------------------------------
The Commission is proposing the stricter standard as common equity
tier 1 capital is a more conservative form of capital than additional
tier 1 or tier 2 capital, particularly as it relates to the
[[Page 91260]]
permanence of the capital and its availability to absorb unexpected
losses. As noted above, common equity tier 1 capital is defined in 12
CFR 217.20 to generally comprise the sum of a bank holding company's
common stock instruments and any related surpluses, retained earnings,
and accumulated other comprehensive income. Tier 1 capital includes
common equity tier 1 capital and further includes such instruments as
preferred stock. Tier 2 capital includes certain types of instruments
that include both debt and equity characteristics (e.g., certain
perpetual preferred stock instruments and subordinated term debt
instruments).\44\ The Commission also is proposing the stricter common
equity tier 1 requirement as it is not proposing to include in the SD's
minimum capital requirement certain of the prudential regulators'
capital add-ons, including the capital conservation buffer and the
countercyclical capital buffer.\45\ In order for the SD to meet its
minimum requirements, it must demonstrate that its common equity tier 1
capital equals or exceeds the highest of the minimum requirements set
forth in proposed Regulation 23.101(a)(1)(i) and discussed in section
II.A.2.i.a above.
---------------------------------------------------------------------------
\44\ See 12 CFR 217.10.
\45\ See 12 CFR 217.11. The capital conservation buffer and the
countercyclical capital buffer represent capital ``add-ons'' to the
standard bank capital requirements and are intended to require
entities subject to the rules to have certain levels of capital in
order to make capital distributions and discretionary bonuses.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of the proposed
bank-based capital approach. In addition, the Commission requests
comment, including empirical data in support of comments, in response
to the following questions:
1. Is the proposed $20 million fixed amount of minimum tier 1
capital appropriate? If not, explain why not. If the minimum fixed-
dollar amount should be set at a level greater or lesser than $20
million, explain what that greater or less amount should be and explain
why that is a more appropriate amount.
2. Is the proposed minimum capital requirement based upon an SD's
common equity tier 1 capital appropriate? If not, explain why, and
suggest what modifications the Commission should make to the
regulation. For example, should the proposal include tier 1 capital
other than common equity tier 1 capital? Are there specific elements of
tier 1 capital that the Commission should include in addition to common
equity tier 1 capital? Are there specific elements of tier 2 capital
that the Commission should include in the regulation?
3. Is the proposed minimum capital requirement based upon eight
percent of the SD's risk weighted assets appropriate? If not, explain
why not. Is the proposed requirement that the SD add to its risk-
weighted assets market risk capital charges computed in accordance with
Regulation 1.17 if the SD has not obtained the approval of the
Commission or of an RFA to use internal models appropriate? Are there
other options to compute market risk charges when models are not
approved? Should the 8 percent be set at a higher or lower level? If
so, what percent should the Commission consider?
4. Is the proposed minimum capital requirement based upon eight
percent of the margin required on the SD's cleared and uncleared swaps
and security-based swaps, and the margin required on the SD's futures
and foreign futures appropriate? If not, explain why not. Should the
percentage be set at a higher or lower level? Please explain your
response. Is including in the computation margin for swaps and
security-based swaps that are exempt or excluded from the uncleared
margin requirements (e.g., legacy swaps and security-based swaps, and
swaps with commercial end users) appropriate? If not, explain why these
uncollateralized exposures do not result in risk to the SD without
capital to address that risk.
5. Commodity Exchange Act section 4s(e)(3)(A) only cites the risk
of uncleared swaps in setting standards for capital. Additionally, in
the Commission's final swap dealer definition rule, it said it will
``in connection with promulgation of final rules relating to capital
requirements for swap dealers and major swap participants, consider
institution of reduced capital requirements for entities or individuals
that fall within the swap dealer definition and that execute swaps only
on exchanges, using only proprietary funds.'' \46\ Given these
pronouncements, should the Commission exclude cleared swaps from the
capital calculation requirements?
---------------------------------------------------------------------------
\46\ 77 FR 30596, 30610 fn. 199 (May 23, 2012).
---------------------------------------------------------------------------
6. In addition to swaps, the proposal includes security-based
swaps, futures, and foreign futures in the capital calculation
requirements. The SEC's capital proposal only included security-based
swaps. Given the statements above in question 5 and the narrower scope
of the SEC's proposal, should the Commission limit its capital
calculation requirements to uncleared swaps only?
7. If the swap dealer de minimis level falls to $3 billion, what
impact would the proposed capital rule have on any new potential
registrants? Please provide any quantitative estimates.
ii. Capital Requirement for Swap Dealers Under a Net Liquid Assets
Capital Approach
a. Computation of Minimum Capital Requirement
Proposed Regulation 23.101(a)(ii) would permit an SD to elect to be
subject to a net liquid assets capital approach. The net liquid assets
capital approach is consistent with the Commission's current capital
approach for FCMs, and is consistent with the SEC's proposed capital
rule for SBSDs and the SEC's current capital requirements for BDs and
OTC derivatives dealers.\47\ Harmonization of the CFTC and SEC capital
requirements benefit firms that are dually-registered (including
dually-registered SDs and SBSDs) as such firms should be able to meet
the regulatory requirements of both the CFTC and SEC with a uniform set
of books and records, and one capital computation. This concept of a
harmonized capital approach is consistent with the Commission's and
SEC's long standing uniform capital rule for FCMs and BDs. An SD that
elects the proposed net liquid assets capital rule contained in
Regulation 23.101(a)(1)(ii) would be required to comply with proposed
SEC Rule 18a-1 as if the SD were a SBSD registered with the SEC,
subject to several modifications discussed below.\48\
---------------------------------------------------------------------------
\47\ The SEC has proposed a net liquid assets capital
requirement for SBSDs that is set forth in proposed SEC Rule 18a-1.
See 77 FR 70214 (Nov. 23, 2012).
\48\ See SEC proposed Rule 18a-1(a)(1) (77 FR 70214).
---------------------------------------------------------------------------
SDs that elect to comply with the proposed net liquid assets
capital approach would be required to maintain a minimum level of net
capital \49\ equal to or greater than the highest of the following
criteria:
---------------------------------------------------------------------------
\49\ Net capital is generally defined to mean the SD's liquid
assets (less deductions for potential decreases in value of the
assets) less all of the SD's liabilities (excluding qualifying
subordinated debt).
---------------------------------------------------------------------------
(1) $20 million;
(2) net capital equal to or greater than eight percent of the sum
of:
(a) The amount of ``uncleared swaps margin'' (as that term is
defined in proposed Regulation 23.100) for each uncleared swap position
open on the books of the SD, computed on a counterparty by counterparty
basis pursuant to Regulation 23.154;
[[Page 91261]]
(b) the amount of initial margin that would be required for each
uncleared security-based swap position open on the books of the SD,
computed on a counterparty-by-counterparty basis pursuant to proposed
SEC Rule 18a-3(c)(1)(i)(B), without regard for any amounts that may be
excluded or exempted under the SEC's rules;
(c) the amount of ``risk margin requirement'' (as that term is
defined in Regulation 1.17(b)(8)) for the SD's cleared futures, foreign
futures, and swaps positions open on the books of the SD; and
(d) the amount of initial margin required by a clearing
organization for proprietary cleared security-based swaps positions
open on the books of the SD; or
(3) the capital required by the RFA of which the SD is a member.
In addition, the proposal provides that an SD that has received
approval from the Commission, or from an RFA of which the SD is a
member, to use internal models to compute market risk and credit risk
capital charges for its swaps and/or security-based swaps and other
proprietary positions when computing its capital, as described in
section II.A.4 of this release, must maintain a minimum level of
tentative net capital equal to $100 million and net capital of $20
million.\50\ The proposal is consistent with the SEC's proposed
requirement that SBSDs that have obtained approval to use internal
capital models must maintain tentative net capital of $100 million and
net capital of $20 million.\51\
---------------------------------------------------------------------------
\50\ SEC Rules generally define ``tentative net capital'' as the
registrant's assets less liabilities (excluding certain qualifying
subordinated debt), and ``net capital'' as tentative net capital
less certain capital deductions such as market risk and credit risk
deductions. See 17 CFR 240.15c3-1.
\51\ See SEC proposed Rule 18a-1(a)(2), (77 FR 70214, 70333).
---------------------------------------------------------------------------
The first criterion of proposed Regulation 23.101(a)(1)(ii) would
require the SD to maintain a minimum of $20 million of net capital.
This requirement is consistent with the minimum requirements proposed
for SDs under the bank-based capital approach discussed in section
II.A.2.i.a of this release. As discussed in section II.A.2.i.a above,
the Commission believes that given the role that SDs play in the
financial markets by engaging in swap dealing activities that it is
appropriate to require that all SDs maintain a minimum level of
capital, stated as an absolute dollar amount that does not fluctuate
with the level of the firms' dealing activities to help ensure the
safety and soundness of the SDs. Furthermore, the proposed $20 million
minimum capital requirement is consistent with the SEC's current
minimum capital requirement for OTC derivatives dealers and the SEC
proposed minimum capital requirement for SBSDs.
The second criterion under the net liquid assets capital approach
would require an SD to maintain a minimum level of net capital equal to
or greater than eight percent of the sum of: (1) The amount of
``uncleared swap margin'' (as that term is proposed to be defined in
Regulation 23.100) for each uncleared swap position open on the books
of the SD, computed on a counterparty by counterparty basis pursuant to
Regulation 23.154; (2) the amount of initial margin that would be
required for each uncleared security-based swap position open on the
books of the SD, computed on a counterparty by counterparty basis
pursuant to SEC proposed Rule 18a-3(c)(1)(i)(B) without regard to any
initial margin exemptions or exclusions that the rules of the SEC may
provide to such security-based swap positons; (3) the amount of ``risk
margin'' (as defined in Regulation 1.17(b)(8)) required by a clearing
organization for the SD's futures, swaps, and foreign futures positions
that are open on the books of the SD; and (4) the amount of initial
margin required by a clearing organization for security-based swaps
that are open on the books of the SD.
Consistent with the requirements for SDs that elect the bank-based
capital approach discussed in section II.A.2.a above, an SD that elects
the net liquid assets approach would have to include all swaps and
security-based swaps in its computation of the margin for uncleared
swaps subject to the eight percent calculation, including any swaps
positions that are not included in the Commission's margin requirements
in Regulations 23.150 through 23.161 and any security-based swaps
positions that may be exempt or excluded from the SEC's proposed margin
requirements in Rule 18a-3(c)(1)(i)(B).
Consistent with the bank-based capital approach discussed in
section II.A.2.a above, this minimum capital requirement is generally
comparable to the SEC's proposed minimum capital requirement for SBSDs,
with the exception that the SEC proposal only requires a SBSD to
compute its minimum capital requirement based upon eight percent of the
initial margin required on cleared and uncleared security-based swaps.
The Commission is proposing to require that an SD expand the positions
subject to the eight percent initial margin minimum capital requirement
to include the SD's proprietary swaps, futures, and foreign futures
positions. The Commission believes that the minimum capital requirement
should reflect these additional positions to more fully reflect the
potential exposure from all of the SD's swaps, security-based swaps,
futures and foreign futures positions. Accordingly, the Commission's
proposal has adjusted the calculation to include these additional
positions of the SD.
The proposed third criterion would require an SD to maintain net
capital that is equal to or greater than the amount of net capital
required by the RFA of which is a member. As discussed more fully in
section II.A.2.i.a above, this provision recognizes that an RFA is
required to adopt minimum capital requirements for SDs pursuant to
Commission Regulation 170.16 and section 17(p)(2) of the CEA.
b. Computation of Net Capital To Meet Minimum Capital Requirement
Each SD that elects the proposed net liquid assets capital approach
would be required to maintain net capital in excess of the highest of
the three criteria listed above. The second component of the proposed
capital requirement would require an SD to compute its net capital,
including applicable charges for market and credit risk on its swaps
and security-based swaps positions and other proprietary positions
(including debt instruments such as U.S. treasury instruments and
municipal bonds, and equity instruments), and determine if such net
capital equals or exceeds the highest level required under the three
criteria discussed in section II.A.2.ii.a above.
Proposed Regulation 23.101(a)(1)(ii) would require each SD electing
the net liquid assets capital approach to compute its tentative net
capital and net capital in accordance with the SEC's proposed
computation of tentative net capital and net capital for SBSDs under
proposed Rule 18a-1 as if the SD were a SBSD, subject to several
adjustments. Under proposed SEC Rule 18a-1, a SBSD that has not
received permission to use models to compute its market risk and credit
risk capital charges, as described below, must maintain net capital of
not less than the greater of $20 million or eight percent of the risk
margin amount on cleared and uncleared security-based swaps positions.
For a SBSD that has received permission from the SEC to use internal
models to compute its market risk and credit risk capital charges, the
SBSD must at all times maintain tentative net capital of not less than
$100 million and adjusted net capital of not less than the greater of
$20 million or eight percent
[[Page 91262]]
of the risk margin amount on cleared and uncleared security-based swaps
positions. The Commission is proposing the SEC's general approach with
the adjustments to include an SD's swaps, security-bases swaps, futures
and foreign futures positions in its calculation of the eight percent
minimum capital requirement as discussed above.
(1) Swap Dealers Computation of Tentative Net Capital and Net Capital
Without Approval To Use Internal Capital Models
The Commission is proposing that an SD electing the net liquid
assets capital approach which has not obtained Commission or RFA
approval to use internal models to compute its market risk and credit
risk charges for positions in swaps, security-based swaps, and other
proprietary positions must use the standardized capital charges set
forth in proposed SEC Rule 18a-1 and the appendices thereto. The use of
standardized capital charges would be consistent with the SEC's
proposal for SBSDs that have not obtained SEC approval to use internal
capital models to compute market risk and credit risk capital charges.
The Commission anticipates that this consistency would promote parity
between SDs and SBSDs, as well as efficiency for an entity that is
dually-registered as both an SBSD and SD.
Under the Commission's proposal, an SD would be required to compute
a market risk capital charge for swaps and security-based swaps by
multiplying the notional amount or fair market value of the swap or the
security-based swap by a specified percentage set forth in proposed
Rule 18a-1. The resulting market risk charge would be deducted from the
SD's tentative net capital to arrive at the firm's net capital.
SDs would also be required to compute standardized credit risk
charges pursuant to proposed Rule 18a-1. Rule 18a-1 generally provides
that a SBSD's unsecured receivables are subject to a 100 percent credit
risk capital charge (i.e., the SBSD would have to deduct 100 percent of
any unsecured receivable balance from tentative net capital in
computing its net capital). The Commission, however, is modifying the
SEC approach in proposed Regulation 23.101(a)(1)(ii) by providing that
an SD may recognize as a secured receivable, and not take a capital
charge for, the amount of initial margin that the SD has deposited with
a third party custodian for uncleared swap transactions pursuant to the
Commission's margin rules at Regulations 23.150 through 23.161 or
margin deposited with a third party custodian for uncleared security-
based swap transactions pursuant to the SEC's proposed margin
rules.\52\ Regulation 23.157 provides that each SD that posts margin
with a third party custodian must enter into an agreement with the
custodian that, in relevant part: (1) Prohibits the custodian from
rehypothecating, repledging, reusing, or otherwise transferring the
collateral held by the custodian; and (2) is a legally binding and
enforceable agreement under the laws of all relevant jurisdictions
including in the event of bankruptcy, insolvency, or similar
proceeding.
---------------------------------------------------------------------------
\52\ Under the SEC's proposed Rule 18a-1, a SBSD would not be
permitted to include margin funds deposited with a third party
custodian as a current asset in computing the SBSD's net capital.
---------------------------------------------------------------------------
(2) Swap Dealers Approved To Use Internal Capital Models
The Commission is proposing to permit an SD that elects a net
liquid assets capital approach to seek Commission or RFA approval to
use internal models to compute market risk and credit risk capital
charges on its swaps, security-based swaps and other proprietary
positions in lieu of the standardized deductions contained in the SEC's
proposed Rule 18a-1. In order to be considered for approval, the SD's
models would have to meet the qualitative and quantitative requirements
set forth in proposed Regulation 23.102 and Appendix A to Regulation
23.102.
The Federal Reserve Board has adopted quantitative and qualitative
requirements for internal models used by bank holding companies to
compute market risk and credit risk capital charges.\53\ In developing
the proposed market risk and credit risk requirements for SDs,
including the proposed quantitative and qualitative requirements, the
Commission has incorporated the market risk and credit risk model
requirements adopted by the Federal Reserve Board. The Commission's
proposed model requirements are also comparable to the SEC's model
requirements. The model requirements and the process for obtaining
Commission or RFA review is set forth in section II.4 of this release.
---------------------------------------------------------------------------
\53\ See, 12 CFR 217, subparts E and F.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of the proposed net
liquid assets capital approach. In addition, the Commission requests
comment, including empirical data in support of comments, in response
to the following questions:
1. Is the proposed minimum $20 million fixed-dollar amount of net
capital appropriate for SDs that elect a net liquid assets capital
approach? If not, explain why not. If the minimum fixed-dollar amount
should be set at a level greater or lesser than $20 million, explain
what that amount should be and why that is a more appropriate amount.
2. Is the proposed minimum $100 million fixed dollar amount of
tentative net capital appropriate for SDs that use market risk and
credit risk models approved by the Commission or by an RFA? If not,
explain why not. If the minimum fixed-dollar amount should be set at a
level greater or lesser than $100 million, explain what that amount
should be and explain why that is more appropriate.
3. Is the proposed minimum capital requirement based upon eight
percent of the margin required on the SD's cleared and uncleared swaps
and security-based swaps, and the margin required on the SD's futures
and foreign futures appropriate? If not, explain why not. Should the
percentage be set at a higher or lower level? Is so, what percent
should the Commission consider? Please explain your response. Is
including in the computation margin for swaps and security-based swaps
that are exempt or excluded from the uncleared margin requirements
(e.g., legacy swaps and security-based swaps, and swaps with commercial
end users) appropriate? If not, explain why these uncollateralized
exposures would not result in an SD that is not adequately capitalized.
4. Is the proposed requirement for an SD to compute its capital in
accordance with the SEC proposed capital rules for stand-alone SBSDs
(i.e., SEC proposed Rule 18a-1) appropriate? If not, explain why not.
What other alternatives approaches should the Commission consider?
5. Is the proposal to allow SDs to recognize as current assets
margin funds deposited with third-party custodians as margin for
uncleared swaps or security-based swaps in accordance with the
Commission's margin rules or the SEC's proposed margin rules
appropriate? If not, explain why not.
6. Are there other adjustments to the SEC's proposed capital rules
for SBSDs that the Commission should consider in adopting such
requirements for SDs that elect the net liquid asset capital approach?
Is so, explain such adjustments and why the Commission should consider
such adjustments.
7. If the swap dealer de minimis level falls to $3 billion, what
impact would the capital rule have on any new
[[Page 91263]]
potential registrants? Please provide any quantitative estimates.
iii. Capital Requirement for Swap Dealers That Are ``Predominantly
Engaged in non-Financial Activities''
a. Computation of the Minimum Capital Requirement
The Commission is proposing that SDs that are ``predominantly
engaged in non-financial activities'', as defined below, would be
permitted to elect a capital requirement based upon the SD's tangible
net worth.\54\ An SD eligible to elect the tangible net worth approach
would have to maintain tangible net worth in an amount equal to or in
excess of the greatest of:
---------------------------------------------------------------------------
\54\ See proposed Regulation 23.101(a)(2)(ii).
---------------------------------------------------------------------------
(1) $20 million plus the amount of the SD's market risk exposure
requirement and credit risk exposure requirement associated with the
SD's swap and related hedge positions that are part of the SD's swap
dealing activities;
(2) Eight percent of the sum of:
(a) The amount of uncleared swap margin (as that term is defined in
Regulation 23.100) for each uncleared swap position open on the books
of the SD, computed on a counterparty by counterparty basis pursuant to
Regulation 23.154 without regard to any initial margin exemptions or
thresholds that the Commission's margin rules may provide;
(b) the amount of initial margin that would be required for each
uncleared security-based swap position open on the books of the SD,
computed on a counterparty by counterparty basis pursuant to 17 CFR
240.18a-3(c)(1)(i)(B) without regard to any initial margin exemptions
or exclusions that the rules of the SEC may provide to such security-
based swap positions; and
(c) the amount of initial margin required by clearing organizations
for cleared proprietary futures, foreign futures, swaps and security-
based swaps positions open on the books of the SD; or
(3) the amount of net capital required by the registered futures
association of which the SD is a member.
The Commission is proposing that in order to be eligible to elect
the tangible net worth capital approach, an SD's overall financial
activities would have to be insignificant in relation to its other
overall non-financial activities. Accordingly, proposed Regulation
23.101(a)(2) would define the term ``predominantly engaged in non-
financial activities'' by referencing the definition of the term
``financial activities'' under the Federal Reserve Board's regulations
establishing criteria for determining if a nonbank financial company is
predominantly engaged in financial activities.\55\ For purposes of the
proposal, an entity would be considered ``primarily engaged in non-
financial activities'' if: (1) The consolidated annual gross financial
revenues of the entity in either of its two most recently completed
fiscal years represents less than 15 percent of the entity's
consolidated gross revenue in that fiscal year (``15% revenue test''),
and (2) the consolidated total financial assets of an entity at the end
of its two most recently completed fiscal years represents less than 15
percent of the entity's consolidated total assets as of the end of the
fiscal year (``15% asset test''). For purposes of the 15% revenue test,
consolidated annual gross financial revenues means that portion of the
consolidated total revenue of the entity that are related to activities
that are financial in nature. For purposes of the 15% asset test,
consolidated total financial assets means that portion of the
consolidated total assets of the entity that are related to activities
that are financial in nature.
---------------------------------------------------------------------------
\55\ See, 12 CFR 242.3. The Financial Stability Oversight
Council will use the criteria when it considers the potential
designation of a nonbank financial company for consolidated
supervision by the Federal Reserve Board.
---------------------------------------------------------------------------
The Commission is proposing to define the financial activities
covered by the 15% revenue test and 15% asset test by reference to the
listed financial activities set forth in Appendix A of 12 CFR part 242,
which covers an extensive range of financial activities and services.
The financial activities include, among other things: (1) Lending,
exchanging, transferring, investing for others, or safeguarding money
or securities; (2) insuring, guaranteeing, or indemnifying against loss
or harm, damage or death in any state; (3) providing financial,
investment, or economic advisory services; (4) issuing or selling
interests in a pool; (5) underwriting, dealing in, or making a market
in securities; and (6) engaging as principal in the investment and
trading of certain financial instruments. The Commission, however, is
proposing to explicitly provide that accounts receivable from non-
financial activities, which may meet the definition of financial
activities under 12 CFR part 242, may be excluded by the SD from the
computation of its financial activities. The purpose of providing this
exclusion is to prevent the SD's non-financial activities from becoming
part of the computation of the firm's financial activities merely on
the basis that the non-financial activities result in the SD
recognizing receivables.
The Commission is proposing an option to use a tangible net worth
capital approach as it recognizes that certain entities that engage
primarily in non-financial activities may currently or in the future
meet the statutory and regulatory definition of the term ``swap
dealer'' and, therefore, will be required to register as such with the
Commission.\56\ However, while these entities may engage in dealing
activities, they are primarily commercial entities and differ from
financial entities in various ways, including the composition of their
balance sheet (e.g., the types of assets they hold), the types of
transactions they enter into, and the types of market participants and
swap counterparties that they deal with. Because of these differences,
the Commission believes that application of the bank-based or net
liquid assets capital approaches to these SDs could result in
inappropriate capital requirements that would not be proportionate to
the risk associated with them, and, therefore, these SDs should have
the option to apply a tangible net worth approach.\57\
---------------------------------------------------------------------------
\56\ The term ``swap dealer'' is defined by section 1a(49) of
the CEA and Sec. 1.3(ggg) of the Commission's regulations. Section
1.3(ggg)(3) provides that an entity may apply to limit its
designation as an SD to specified categories of swaps or specified
activities in connection with swaps.
\57\ Furthermore, as a SD, the firm is subject to the
Commission's final swaps margin requirements.
---------------------------------------------------------------------------
b. Computation of Tangible Net Worth To Meet Minimum Capital
Requirement
Proposed Regulation 23.101(a)(2) would require an SD to maintain
tangible net worth in an amount equal to or in excess of the greater of
the tangible net worth of the SD plus the market risk capital charges
and credit risk capital charges associated with the SD's dealing swaps
and related hedging, or eight percent of the initial margin required on
the SD's proprietary swaps, security-based swaps, futures, and foreign
futures. The term ``tangible net worth'' is proposed to be defined as
the net worth of an SD as determined in accordance with generally
accepted accounting principles in the United States, excluding goodwill
and other intangible assets.\58\ The proposal would further require an
SD in computing its tangible net worth to include all liabilities or
obligations of a subsidiary or affiliate that the SD guarantees,
endorses, or assumes either directly or indirectly to ensure that the
tangible net worth of the SD reflects the full extent
[[Page 91264]]
of the SD's potential financial obligations.\59\ The proposed
definition would further provide that in determining net worth, all
long and short positions in swaps, security-based swaps and related
positions must be marked to their market value to ensure that the
tangible net worth reflects the current market value of the SD's swaps
and security-based swaps, including any accrued losses on such
positions.\60\
---------------------------------------------------------------------------
\58\ See proposed Regulation 23.100.
\59\ See proposed definition of ``tangible net worth'' in
Regulation 23.100.
\60\ Id.
---------------------------------------------------------------------------
In proposing this approach and as discussed above, the Commission
recognizes that SDs that predominantly engage in non-financial
activities may differ from financial entities. However, the Commission
also recognizes that capital should account for all the activities
entered into by the entity and not just its swap dealing activities in
order to help ensure the safety and soundness of the SD.\61\ By
requiring the SD electing this approach to maintain tangible net worth
equal to its liabilities and swaps market risk and credit risk
exposures, the Commission believes that its approach would impose a
sufficient level of capital (i.e., unencumbered tangible assets) to
help ensure the safety and soundness of an SD and that the SD can meet
its swap-related obligations to its swap counterparties.
---------------------------------------------------------------------------
\61\ Section 4s(e)(2)(C) of the CEA states that for SDs that are
designated as SDs for one single class or category of swap or
activities, the Commission shall take into account the risks
associated with other types of swaps or classes of swaps or
categories of swaps engaged in and the other activities conducted by
that person that are not otherwise subject to regulation applicable
to that person by virtue of the status of the person as an SD.
---------------------------------------------------------------------------
Pursuant to the proposal, the SD would have to compute its market
risk charges and credit risk charges associated with its dealing swaps
and related hedges. Proposed Regulation 23.101(a)(2)(i)(A) provides
that the SD may use internal capital models to compute its market risk
and credit risk capital charges if the SD has obtained the approval of
the Commission or an RFA. If the SD has not obtained approval to use
internal capital models, the SD must use the standardized deductions
under Regulation 1.17.
Request for Comment
The Commission requests comment on all aspects of the proposed
tangible net worth capital approach for SDs that are predominantly
engaged in non-financial activities. In addition, the Commission
requests comment, including empirical data in support of comments, in
response to the following questions:
1. Is the proposed minimum net capital requirement of $20 million
plus the amount of the SD's market risk and credit risk charges for its
dealing swaps appropriate for SDs that are eligible and elect the
tangible net worth net capital approach? If not, explain why not. If
the minimum dollar amount should be set at a level greater or lesser
than $20 million, explain what that amount should be and explain why
that is more appropriate.
2. Should the market risk and credit risk associated with the SD's
security-based swap positions be added to the market risk and credit
risk associated with the SD's swap positions in setting the minimum
capital requirement under proposed Regulation 23.101(a)(2)(A)? Explain
why or why not such security-based swap positions should or should not
be included in the minimum capital requirement. Provide any empirical
data to support your analysis.
3. Is the proposed minimum capital requirement based upon eight
percent of the margin required on the SD's cleared and uncleared swaps
and security-based swaps, and the margin required on the SD's futures
and foreign futures appropriate? If not, explain why not. Should the
percentage be set at a higher or lower level? Please explain your
response. Is including in the computation margin for swaps and
security-based swaps that are exempt or excluded from the uncleared
margin requirements (e.g., legacy swaps and security-based swaps, and
swaps with commercial end users) appropriate? If not, explain why these
uncollateralized exposures would not result in an SD that is not
adequately capitalized.
4. Is the Commission's proposed 15% revenue test and 15% asset test
appropriate for determining whether an SD is predominantly engaged in
non-financial activities? If not, explain why not. What other
alternatives should the Commission consider? If the approach is
appropriate, should the Commission consider raising or lowering the
percentages in the 15% revenue test and the 15% asset test?
5. Is the Commission's proposed reference to the definition of the
term ``financial activities'' in Rule 242.3 of the Federal Reserve
Board (12 CFR 242.3) to define whether an SD's activities are
``financial activities'' for purposes of computing the 15% revenue test
and 15% asset test appropriate? If not, explain why not. Provide other
alternatives that the Commission should consider.
6. Is the Commission's adjustment in the application of Rule 242.3
to permit SDs to exclude receivables resulting from non-financial
activities from the term ``financial activities'' in computing the 15%
revenue and 15% asset tests appropriate? If not, explain why not. Are
there other adjustments that the Commission should consider in the
application of the 15% revenue and 15% asset tests? If yes, explain
what those adjustments are and why it is appropriate for the Commission
to make such adjustments.
iv. Capital Requirements for Major Swap Participants
Proposed new Regulation 23.101(b) would establish capital
requirements for MSPs that are not subject to the capital rules of a
prudential regulator.\62\ An MSP is by definition a person that is not
a swap dealer and that: (1) Maintains a substantial position in swaps,
excluding positions held to hedge or mitigate commercial risk; (2) has
outstanding swaps that create substantial counterparty exposures that
could have serious adverse effects on the financial stability of the
U.S. banking system or financial markets; or (3) is a financial entity
that is highly leveraged, is not subject to capital requirements of a
prudential regulator, and has a substantial position in swaps,
including positions used to hedge and mitigate commercial risk.\63\
---------------------------------------------------------------------------
\62\ There are currently no MSPs provisionally registered with
the Commission.
\63\ See Regulation 1.3(hhh).
---------------------------------------------------------------------------
Under proposed Regulation 23.101(b), an MSP would be required to
maintain positive tangible net worth or the amount of capital required
by the RFA of which the MSP is a member. A tangible net worth standard
is being proposed for MSPs, rather than the net liquid assets capital
approach or the bank-based capital approach, as the Commission
anticipates that entities that register as MSPs may engage in a diverse
range of business activities different from, and broader than, the
activities engaged in by SDs. For example, MSPs may engage in
commercial activities that require them to have substantial fixed
assets to support manufacturing and/or result in them having
significant assets comprised of non-current assets as defined in the
Regulations. In addition, MSPs typically use swaps for different
purposes (e.g., hedging or investing) than SDs, which engage in swaps
as a dealing activity. The Commission believes requiring MSPs to comply
with the proposed net liquid assets capital approach or bank-based
capital approach could result in MSPs having to obtain significant
additional capital or engage in costly restructuring.
[[Page 91265]]
The term ``tangible net worth'' is proposed to be defined as the
net worth of an MSP as determined in accordance with generally accepted
accounting principles in the United States, excluding goodwill and
other intangible assets.\64\ The proposal would further require an MSP
in computing its tangible net worth to include all liabilities or
obligations of a subsidiary or affiliate that the MSP guarantees,
endorses, or assumes either directly or indirectly to ensure that the
tangible net worth of the MSP reflects the full extent of the MSP's
potential financial obligations.\65\ The proposed definition would
further provide that in determining net worth, all long and short
positions in swaps, security-based swaps and related positions must be
marked to their market value to ensure that the tangible net worth
reflects the current market value of the MSP's swaps and security-based
swaps, including any accrued losses on such positions.\66\
---------------------------------------------------------------------------
\64\ See proposed Regulation 23.100.
\65\ See proposed Regulation 23.100.
\66\ Id.
---------------------------------------------------------------------------
In developing the proposed positive tangible net worth requirement
for MSPs, the Commission also considered the impact of its recent
margin rules for uncleared swap transactions. Under the margin rules,
MSPs are required to post and collect initial margin and variation
margin with SDs, other MSPs, and financial end users (subject to
certain thresholds and minimum transfer amounts). The exchanging of
variation margin and the posting of initial margin by MSPs will
substantially reduce their uncollateralized exposures, which will
mitigate the possibility that MSPs could destabilize the financial
markets or present systemic risk. Lastly, the Commission's proposed MSP
capital standard and definitions are comparable with the SEC's proposal
for MSBSPs, and are intended to require an MSP to maintain a sufficient
level of assets to meet its obligations to counterparties and creditors
and to help ensure the safety and soundness of the MSP.
Request for Comment
The Commission requests comment on the proposed capital
requirements for MSPs. In addition, the Commission requests comment,
including empirical data in support of comments, in response to the
following questions:
1. Is a tangible net worth test an appropriate standard for MSPs?
If not, explain why not. Would the net liquid assets approach or bank-
based capital approach be a more appropriate method for establishing
capital requirements for MSPs? If so, please state which approach is
more appropriate and describe the rationale for such approach. What
other capital approaches should the Commission consider for MSPs?
2. Should the proposed minimum capital requirement for MSPs include
a minimum fixed-dollar amount of tangible net worth, for example, equal
to $20 million or some greater or lesser amount? Is so, explain the
merits of imposing a fixed-dollar amount and identify the recommended
fixed-dollar amount.
3. Should proposed Regulation 23.101(b) require an MSP to maintain
positive tangible net worth in an amount in excess of the market risk
and credit risk charges on the MSP's swaps and security-based swap
positions? If so, please explain why. Should any other adjustments be
made to the MSP's minimum capital requirement? If so, please explain
why.
3. Capital Requirements for FCMs
i. Introduction
Section 4s(e)(3)(B)(i) of the CEA provides that the requirements
applicable to SDs and MSPs under section 4s do not limit the
Commission's authority with respect to FCM regulatory requirements.\67\
The Commission's current capital requirements for FCMs are contained in
Regulation 1.17, and are designed to require a minimum level of
``liquid assets'' in excess of the FCM's liabilities to provide
resources for the FCM to meet its financial obligations as a market
intermediary in the regulated futures and cleared swaps markets.
Specifically, an FCM is required to hold at all times more than one
dollar of highly liquid assets for each dollar of unsubordinated
liabilities (e.g., money owed to customers, counterparties and
creditors). The capital requirements also are intended to ensure that
an FCM maintains a sufficient level of liquid assets to wind-down its
operations by transferring customer accounts to other FCMs in the event
that the FCM decides, or is forced, to cease operations.
---------------------------------------------------------------------------
\67\ Section 4s(e)(3)(B)(i) states that nothing in section 4s(e)
imposing capital and margin requirement on SDs and MSPs limits, or
shall be construed to limit, the authority of the Commission to set
financial responsibility rules for FCMs pursuant to section 4f(a).
---------------------------------------------------------------------------
Regulation 1.17(a) specifies the minimum amount of adjusted net
capital that an FCM is required to maintain as the greatest of: (1) $1
million; (2) for an FCM that engages in off-exchange foreign currency
transactions with retail forex customers,\68\ $20 million, plus five
percent of the FCM's liabilities to the retail forex customers that
exceed $10 million; (3) eight percent of the sum of the risk margin of
futures, options on futures, foreign futures, and swap positions
cleared by a clearing organization and carried by the FCM in customer
and non-customer accounts; \69\ (4) the amount of adjusted net capital
required by the RFA of which the FCM is a member; and (5) for an FCM
that also is registered with the SEC as a BD, the amount of net capital
required by the rules of the SEC.
---------------------------------------------------------------------------
\68\ Regulation 5.1(k) defines the term ``retail forex
customer'' as a person, other than an eligible contract participant
as defined in section 1a(18) of the CEA, acting on its own behalf in
any account agreement, contract or transaction described in section
2(c)(2)(B) or 2(c)(2)(C) of the CEA.
\69\ The term ``risk margin'' is defined in Regulation
1.17(b)(8).
---------------------------------------------------------------------------
Regulation 1.17(c)(5) defines the term ``adjusted net capital'' as
an FCM's ``current assets'' (i.e., current, liquid assets excluding,
however, most unsecured receivables), less all of the FCM's liabilities
(except certain qualifying subordinated debt). An FCM is further
required to impose certain prescribed capital deductions (``capital
charges'' or ``haircuts'') from the current market value of the FCM's
proprietary positions (e.g., futures positions, securities, debt
instruments, money market instruments, and commodities) in computing
its adjusted net capital to reflect potential market risk and credit
risk of the firm's current assets.
An FCM, in computing its adjusted net capital, is required to
compute a capital charge to reflect the potential market risk
associated with uncleared swap and security-based swap positions.
Regulation 1.17(c)(5) establishes specific capital charges for market
risk for an FCM's proprietary positions in physical inventory, forward
contracts, fixed price commitments, and securities. Regulation
1.17(c)(5) does not explicitly address uncleared swap or security-based
swap positions. The Commission, however, requires an FCM to use the
capital charges specified in Regulation 1.17(c)(5)(ii), or the capital
charges established by SEC Rule 15c3-1 for dually registered FCM-BDs,
to compute its capital charges for uncleared swap and security-based
swap positions.
The Commission is proposing to amend the minimum adjusted net
capital requirements for FCMs that are also registered as SDs. In this
regard, the Commission is proposing amendments to Regulation 1.17(a)
that would require an FCM that is also an SD to maintain
[[Page 91266]]
adjusted net capital that is equal to or greater than the highest of:
(1) $20 million;
(2) Eight percent of the sum of the following:
(a) The total risk margin (as defined in Regulation 1.17(b)(8)) for
positions carried by the FCM in customer and non-customer accounts;
(b) the total initial margin that the FCM is required to post with
a clearing agency or broker for security-based swaps positions carried
in customer and non-customer accounts;
(c) the total uncleared swaps margin as defined in Regulation
23.100;
(d) the total initial margin that the FCM is required to post with
a broker or clearing organization for all proprietary cleared swap
positions carried by the FCM;
(e) the total initial margin computed pursuant to SEC Rule 18a-
3(c)(1)(i)(B) (17 CFR 240.181-3(c)(1)(i)(B)) for all proprietary
uncleared security-based swap positions carried by an FCM, without
regard to any exemptions or exclusions that may be available to the FCM
under the SEC's proposal; and
(f) the total initial margin that the FCM is required to post with
a broker or clearing agency for proprietary cleared security-based
swaps;
(3) the amount of net capital required by the SEC if the FCM was a
BD; or
(4) the amount of capital required by the RFA of which the FCM was
a member.
The Commission's proposed increase in the FCM's minimum capital
requirement from $1 million to $20 million is consistent with the
Commission's proposal to adopt a minimum $20 million capital
requirement for SDs and MSPs, and is necessary and appropriate given
the change and increase in risk when the FCM is registered as an SD and
engaging in uncleared swap activities. The Commission also notes that
the proposed minimum dollar amount of $20 million is consistent with
the current minimum dollar amount of adjusted net capital imposed by
Regulation 1.17(a) on FCMs that engage in OTC forex transactions with
counterparties that do not qualify as ECPs, and is consistent with the
minimum dollar amount of net capital proposed by the SEC for SBSDs.\70\
---------------------------------------------------------------------------
\70\ The SEC proposed capital requirements for SBSDs and MSBSPs
was proposed in 2012. See Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and Major Security-
Based Swap Participants and Capital Requirements for Broker-Dealers,
77 FR 70214 (Nov. 23, 2012).
---------------------------------------------------------------------------
The Commission is also proposing amendments to Regulation 1.17(a)
to require an FCM to include eight percent of the uncleared swaps
margin in its adjusted net capital. Currently FCMs must maintain
adjusted net capital in excess of eight percent of the risk margin on
futures, foreign futures and cleared swaps positions carried in
customer and noncustomer accounts. The proposed amendments would also
include in the FCM's minimum capital requirements eight percent of the
``uncleared swaps margin'' for uncleared swaps and the initial margin
for uncleared security-based swaps position for which the FCM is a
counterparty. The term ``uncleared swaps margin'' is defined in
proposed new Regulation 23.100 as the amount of initial margin that an
SD would be required to collect pursuant to the Commission's uncleared
swaps margin rules for each outstanding swap.\71\ The ``uncleared swaps
margin'' would include both swaps that an SD is required to collect
margin for under the margin rules as well as swaps that are exempt from
the margin rules. For example, the FCM would be required to compute the
amount of initial margin that an SD would be required to collect from
commercial end users and affiliated counterparties as if the swaps were
not exempt from the scope of the Commission's margin requirements. In
addition, the FCM would have to compute the initial margin requirements
for exempt foreign exchange swaps and foreign exchange forwards as if
the transactions were not exempt from the Commission's margin
requirements. Finally, the ``uncleared swaps margin'' amount would not
exclude initial margin that was below the initial margin threshold
amount or the minimum margin transfer amounts defined in Regulation
23.151. Not excluding these amounts in determining the capital
requirement is consistent with the approach as described above for
those SDs that elect to apply a net capital standard as these
uncollateralized exposures may present risk to the SD for which it
should maintain capital. Similarly, the Commission would require an FCM
to include in its initial margin amounts for security-based swap
positions both the amounts that an SD would be required to collect and
the amounts that the SD would not be required to collect if the SD were
treated as an SBSD under SEC's proposed rule 18a-3(c)(1)(i)(B) due to
the SEC provided an exemption or exclusion on the requirement to post
or collect initial margin.
---------------------------------------------------------------------------
\71\ See Regulations 23.150, 23.152, and 23.154.
---------------------------------------------------------------------------
As discussed above, the capital rule is intended to help ensure the
safety and soundness of the SD. Accordingly, the FCM's capital should
reflect uncollateralized exposures to swap counterparties.
ii. FCM Capital Charges for Swaps and Security-Based Swaps in Computing
Adjusted Net Capital
As noted in section II.A.3.i above, in computing its adjusted net
capital, an FCM is required to take certain market risk and credit risk
capital charges on its proprietary positions. Regulation 1.17(c)
provides two approaches for an FCM to take capital charges in computing
its adjusted net capital. The first approach is a rules-based approach
of standardized haircuts that are set forth in Regulation 1.17(c)(5).
The second approach is an approved model approach that is currently
available only to FCMs that are dual-registered FCM/BDs that have been
approved by the SEC to use internal models to compute market risk and
credit risk capital charges in lieu of standardized capital charges.
These dually-registered FCM/BDs are referred to as Alternative Net
Capital Firms (``ANC Firms'').
a. Standardized Market Risk and Credit Risk Capital Charges
Currently, Regulation 1.17(c)(5) does not explicitly define market
risk capital charges for swaps, and the Commission has imposed the
general standardized haircuts that are applicable to inventory, fixed
price commitments, and forward contracts to swaps. For example, an
energy swap that is not offset by a futures contract is considered a
fixed price commitment under Regulation 1.17(c)(5) and the FCM is
required to take a market risk capital charge equal to 20 percent of
the notional value of the energy swap. The purpose of the capital
charge is to require an FCM to reserve a minimum level of capital to
cover potential future losses in the value of the swap, which may have
to be paid to the swap counterparty in the form of variation margin or
otherwise.
The Commission recognizes that the current market risk capital
charges, which were not explicitly designed for swaps or security-based
swaps, should be amended to provide specific capital charges.
Accordingly, the Commission is proposing to amend Regulation
1.17(c)(5)(iii) to provide a schedule of standardized market risk
capital deductions for positions in credit default swaps, interest rate
swaps, foreign exchange swaps, commodity swaps, and all other uncleared
swaps. This schedule of standardized capital deductions is the same as
the standardized market risk capital deduction proposed by the SEC for
such positions in SEC Rule 15c3-1 (17 CFR
[[Page 91267]]
240.15c3-1).\72\ The Commission is also proposing to amend Regulation
1.17(c)(5)(iv) to provide that the FCM must impose the standardized
market risk capital deduction set forth in SEC Rule 15c3-1 (17 CFR
240.15c3-1) for any security-based swap positions.
---------------------------------------------------------------------------
\72\ See 77 FR 70214 (Nov. 23, 2012).
---------------------------------------------------------------------------
Except for credit default swaps as described below, the proposed
standardized market risk capital deductions would be the deduction
currently prescribed in 17 CFR 240.15c3-1 or proposed amended
Regulation 1.17 applicable to the instrument referenced by the swap
multiplied by the contract's notional amount.
The proposed standardized market risk deductions for swaps that are
credit default swaps are designed to account for the unique attributes
of these positions. Credit default swaps are generally defined by the
reference asset or entity, the notional amount, the duration of the
contract, and credit events. Therefore, the Commission believes that
proposing a schedule of deductions for credit default swaps based on a
``maturity grid'' approach would be appropriate, as the Commission
currently applies a maturity grid approach in setting standardized
capital deductions for debt instruments.\73\ Under the proposal, the
market risk capital deductions for credit default swaps would be based
on two variables: The length of time to maturity and the amount of the
current offered basis point spread on the credit default swap. The
Commission's proposed standardized deductions are consistent with the
SEC's proposed amendments to its capital rule.
---------------------------------------------------------------------------
\73\ The capital deductions for debt instruments are
incorporated into Regulation 1.17 by cross reference to the SEC's
standardized capital charges for debt instruments. See Regulation
1.17(c)(5)(v).
---------------------------------------------------------------------------
The Commission would allow an FCM to net long and short positions
where the credit default swaps reference the same entity or obligation,
reference the same credit events that would trigger payment by the
seller of the protection, reference the same basket of obligations that
would determine the amount of payment by the seller of protection upon
the occurrence of a credit event, and are in the same or adjacent
maturity and spread categories (as long as the long and short positions
each have maturities within three months of the other maturity
category). In this case, the FCM would need to take the specified
percentage deduction only on the notional amount of the excess long or
short position.
The Commission would also allow limited netting in, for example,
long and short credit default swap positions in the same maturity and
spread categories and that reference corporate entities in the same
industry sector; where the FCM is long (short) the bond or asset and
long (short) protection through a credit default swap referencing the
same underlying bond or asset.
As noted above, the Commission is proposing the same market risk
haircut schedule for swaps as proposed by the SEC in its proposed
capital and margin rule for SBSDs. The Commission understands that the
proposed capital charges for credit default swaps are derived from the
SEC's experience with maturity grids for other securities. Given the
Commission's experience with FCMs and the financial transactions that
they may enter into, and also in recognition of the SEC's experience
with BDs and their financial products, the Commission believes that
these charges should account for the risks of engaging in these swaps
and security-based swaps. Further, the Commission believes that its
approach is appropriate, given its long history of referencing 17 CFR
240.15c3-1 in setting forth capital deductions for certain financial
instruments held by FCMs and the SEC's reciprocal practice of
referencing Regulation 1.17 when setting forth capital deductions for
certain CFTC-regulated products held by BDs. The Commission further
believes that this harmonized approach would benefit registrants that
are dually registered with the Commission and the SEC.
FCMs also are currently required to take a capital charge to
reflect credit risk associated with uncleared swap and security-based
swap transactions. Regulation 1.17(c)(2)(ii) requires an FCM to exclude
unsecured receivables, which includes any unsecured receivables from
swap and security-based swap counterparties and would include any
margin collateral for swap or security-based swap transactions that the
FCM deposits with a third-party custodian pursuant to the Commission's
or SEC's uncleared margin rules.
The Commission is proposing to amend Regulation 1.17(c)(2)(ii) to
permit FCM's to include margin deposited with third-party custodians
for swap and security-based swap transactions, provided that such
margin is held by the custodians in accordance with the requirements
established by the Commission and SEC rules, as applicable.
b. Model-Based Market Risk and Credit Risk Capital Charges
As noted in section II.A.3 above, the SEC has approved certain BDs
to use internal models for computing market risk capital charges in
lieu of the standardized haircuts in SEC Rule 15c3-1(c)(2)(vi) and
(vii) (17 CFR 240.15c3-1(c)(2)(vi) and (vii)) for their proprietary
positions in securities, debt instruments, futures, security-based
swaps and swaps and for computing credit risk charges associated with
exposures from swap and security-based swap counterparties in lieu of
the unsecured receivable capital charges in Rule 15c3-1(c)(2)(iv) (17
CFR 240.15c3-1(c)(2)(iv)). The BDs that have been approved to use these
internal models are referred to as ANC Firms. As described in section
II.A.3 above, ANC Firms may obtain SEC approval to use internal models
to compute their capital. Once approved by the SEC to use internal
models, the ANC Firms that are also registered as FCMs may use the same
models to compute market risk and credit risk charges under CFTC
Regulation 1.17.
The ANC Firms' market risk and credit risk models must satisfy
certain qualitative and quantitative requirements that are set forth in
the SEC's rules in order to be approved, and the firms are subject to
certain enhanced reporting requirements. The requirements for such
models are discussed in section II.A.4 of this release.
ANC Firms are subject to heightened SEC capital requirements in
order to qualify to use the market risk and credit risk models.
Currently, an ANC Firm must maintain tentative net capital of at least
$1 billion and net capital of at least $500 million in order to be
approved, and to continue to use market risk and credit risk
models.\74\ The SEC also requires an ANC Firm to provide notice to the
SEC if the ANC Firm's tentative net capital falls below $5 billion.\75\
In such situations, the SEC may impose restrictions on the ANC Firm,
including limiting its use of the market risk and/or credit risk
models.\76\
---------------------------------------------------------------------------
\74\ 17 CFR 240.15c3-1(a)(2)(7)(i).
\75\ 17 CFR 240.15c3-1(a)(2)(7)(ii).
\76\ See Alternative Net Capital Requirements for Broker-Dealers
That Are Part of Consolidated Supervised Entities, 69 FR 34428 (Jun
21, 2004).
---------------------------------------------------------------------------
As previously noted, CFTC Regulation 1.17(c)(6) currently provides
that an FCM that is also an ANC Firm, may use the same market risk and
credit risk models approved by the SEC in lieu of the standardized
capital charges in Regulation 1.17(c)(5). The Commission is proposing
to retain this provision in Regulation 1.17(c)(6). Accordingly, FCMs
that are ANC Firms that have obtained SEC approval to use market risk
and credit risk models may continue to use such models in lieu of
[[Page 91268]]
taking the standardized capital chares in Regulation 1.17(c).
Maintaining this provision would allow ANC Firms to engage in swap and
security-based swap transactions under the existing regulatory
structure, including the current capital requirements.
The Commission notes that the SEC has proposed various changes to
its regulations as part of its proposed capital requirements for SBSDs
that, if adopted, would impact the ANC Firm's CFTC and SEC capital
requirements. In this connection, the SEC is proposing to increase the
amount of tentative net capital that an ANC Firm must maintain from $1
billion to $5 billion, and the amount of net capital that the ANC Firm
must maintain from $500 million to $1 billion.\77\ The early warning
threshold for an ANC Firm also would be increased from $5 billion to $6
billion.\78\
---------------------------------------------------------------------------
\77\ See proposed amendments to Rule 15c3-1(a)(7)(ii), 77 FR
70214, 70329.
\78\ Id.
---------------------------------------------------------------------------
The SEC is also proposing to subject ANC Firms to liquidity risk
management requirements.\79\ Under the SEC's proposal, ANC Firms would
need to perform a liquidity stress test at least monthly that takes
into account certain assumed conditions lasting for 30 consecutive
days.\80\ The results of the liquidity stress test would need to be
provided within ten business days of the month end to senior management
responsible for overseeing risk management at the firm.\81\ In
addition, the assumptions underlying the liquidity stress test would
need to be reviewed at least quarterly by senior management responsible
for overseeing risk management at the firm and at least annually by
senior management of the firm.\82\ The Commission is also proposing
similar liquidity requirements for SDs, which are discussed in section
II.B of this release.
---------------------------------------------------------------------------
\79\ See proposed new paragraph (f) to Rule 15c3-1, 77 FR 70214,
70331.
\80\ Id.
\81\ Id.
\82\ Id.
---------------------------------------------------------------------------
In addition, the SEC is proposing to amend its regulations to limit
an ANC Firm's use of credit risk models to credit exposures solely from
counterparties that are commercial end users.\83\ Currently, an ANC
Firm is permitted to compute its credit charges for swaps and security-
based swaps from all counterparties. This amendment would result in the
uncollateralized receivables from counterparties that are non-
commercial end users being subject to a 100 percent charge to capital.
---------------------------------------------------------------------------
\83\ 77 FR 70214 at 70329.
---------------------------------------------------------------------------
Since those ANC Firms that are also registered as FCMs will be
subject to both the capital requirements of the SEC and CFTC, the SEC
proposed amendments, if adopted, would be applicable to the ANC Firm's
computation of net capital under CFTC Regulation 1.17(c)(6).
iii. Market Risk and Credit Risk Capital Models for Futures Commission
Merchants That Are Not Alternative Net Capital Firms
As noted in section II.A.3 above, currently only FCMs that are
registered with the SEC as ANC Firms and that have obtained SEC
approval may use market risk and credit risk models in lieu of
standardized haircuts on their swaps, security-based swaps and other
proprietary positions in computing net capital. The Commission is
proposing to amend current Regulation 1.17(c)(6) to extend the use of
capital models to FCMs that are dually-registered as SDs and are not
otherwise registered with the SEC as BDs.\84\ An FCM/SD that would seek
to use capital models would have to obtain approval for the models from
the Commission or from an RFA of which the FCM/SD is a member. The
Commission is also proposing to amend Regulation 1.17(a)(1)(ii) to
provide that any FCM/SD that seeks approval to use market risk and/or
credit risk models must maintain a minimum level of net capital of $100
million and a minimum level of adjusted net capital equal to $20
million.
---------------------------------------------------------------------------
\84\ If an FCM or SD is also a registered BD, it may only use
market risk and credit risk capital models if the SEC approves the
firm as an ANC Firm. Accordingly, the Commission's proposal to
extend models to other FCMs would only apply to FCMs that are not
also subject to the SEC's capital requirements.
---------------------------------------------------------------------------
Proposed Regulation 1.17(c)(6)(v) would require an FCM/SD to apply
in writing to the Commission or RFA of which the FCM/SD is a member for
approval to use internal models to compute market risk and credit risk
capital deductions in lieu of the standardized charges contained in
Regulation 1.17(c)(2) and (5). The models must meet certain qualitative
and quantitative requirements proposed to be established by the
Commission in new Regulation 23.102 and Appendix A to new Regulation
23.102. The qualitative and quantitative requirements for the models
are discussed in detail in section II.A.4 of this release.
The Commission is proposing the higher minimum net capital
requirement of $100 million for FCM/SDs that have received permission
to model their credit and market risk charges to account for the
limitations that may be inherent in a model. The Commission notes that
the $100 million minimum net capital requirement is the same as the
SEC's proposed minimum net capital requirement for stand-alone SBSDs
that receive SEC approval to use internal models to compute their
market and credit risk capital deductions, and is consistent with the
Commission's proposed requirement for SDs that elect to use a net
capital approach as discussed in section II.A.2.ii of this release. The
proposed $100 million net capital requirement for FCM/SDs, however, is
not consistent with the SEC's current approach for BDs approved to use
internal capital models (i.e., ANC Firms), nor is it consistent with
the SEC's proposed capital requirements for SBSDs/ANC Firms approved to
use internal models. As noted above, ANC Firms are subject under SEC
rules to substantial capital requirements of a $5 billion ``early
warning'' requirement, a $1 billion tentative net capital requirement,
and a $500 million net capital requirement.\85\
---------------------------------------------------------------------------
\85\ As noted above, the SEC has proposed to increase the
``early warning'' requirement to $6 billion, the tentative net
capital requirement to $5 billion, and the net capital requirement
to $1 billion.
---------------------------------------------------------------------------
The Commission believes, however, that FCM/SDs that are not BDs do
not raise the same types of risks as ANC firms. ANC firms represent the
largest BDs and engage in significant brokerage business including
providing customer financing for securities transactions, engaging in
repurchase transactions and other activities. FCMs generally have
limited proprietary futures trading and operate primarily as market
intermediaries for customers trading futures and foreign futures
transactions. In this capacity, FCMs receive and hold customer funds in
segregated accounts that are used to satisfy the customers' financial
obligations to derivatives clearing organizations (``DCOs''). FCMs also
collect and hold funds from affiliates for futures trading.
The Commission also expects that FCMs that are not registered as
BDs and that register as SDs will provide a market in swaps for
customers that may not be able to trade with larger SDs. The FCM/SDs
may be more willing to provide swaps markets in commodities to
agricultural firms and smaller commercial end users such as farmers and
ranchers that might not otherwise be able to use such markets to manage
risks in their businesses or might have to pay higher fees to engage in
swaps if the number of SDs was limited. The Commission further believes
that given the nature of the business operations of FCM/SDs, the
proposed minimum capital requirement of $100 million of
[[Page 91269]]
adjusted net capital is consistent with section 4s(e) of the CEA.
The Commission believes that setting the same amount of minimum
required capital would ensure a level playing field for SDs and FCMs
that engage in swaps. However, to the extent that an FCM is dually
registered as a BD and has received permission to use internal models
for its credit and market risk charges, the FCM would follow the SEC's
requirements with respect to the minimum capital it needs to maintain.
iv. Liquidity Requirements
The Commission is further proposing to require an FCM that is also
registered as an SD to comply with the liquidity requirements in
Proposed Rule 23.104(b)(1). The Commission recognizes that an FCM that
acts as an SD is acting as a counterparty rather than as an
intermediary between its customer and another counterparty. Therefore,
for all the reasons discussed further below in section 3, the
Commission is proposing to require FCMs that are also SDs to comply
with the liquidity requirement set forth in Proposed Rule 23.104(b)(1).
Request for Comment
The Commission requests comment on all aspects of the proposed
amendments to the FCM capital requirements. In addition, the Commission
requests comment, including empirical data in support of comments, in
response to the following questions:
1. Is the proposed minimum adjusted net capital requirement of $20
million appropriate for an FCM that is dually-registered as an SD? If
not, explain why not. If the minimum dollar amount should be set at a
level greater or lesser than $20 million, explain what that greater or
lesser amount should be and explain why that is a more appropriate
amount.
2. Is the proposed minimum net capital requirement of $100 million
appropriate for an FCM that is dually-registered as an SD, and has been
approved to use internal models to compute market risk and credit risk?
If not, explain why not. If the minimum dollar amount should be set at
a level greater or lesser than $100 million, explain what that greater
or lesser amount should be and explain why that is a more appropriate
amount.
3. The proposal's minimum capital requirement based on 8% of
margin, includes swaps exempt or excluded from the CFTC's margin
requirements, such as inter-affiliate swaps. Please provide comment on
the breadth of the definition. Should the scope be narrowed? If so,
how?
4. Should the 8 percent of margin capital requirement be set at a
higher or lower level? If it should be adjusted, what percent should
the Commission consider? Please provide analysis in support of the
adjustment.
4. Model Approval Process
Under the proposal as discussed above, SDs subject to the bank-
based capital approach, the net liquid assets capital approach, or the
tangible net worth capital approach are subject to market risk and
credit risk capital charges on their swaps, security-based swaps and
other proprietary positions in computing their regulatory capital. The
Commission is proposing in Regulation 23.102 to permit SDs to compute
market risk and credit risk capital charges using internal models in
lieu of the standardized rules-based capital charges. The Commission
recognizes that internal models, including value-at-risk models, can
provide a more effective means of measuring economic risk from complex
trading strategies involving uncleared swaps and other investment
instruments.
The Commission, however, is concerned, given the number of SDs and
the likely complexity of the capital models, that it may not be able to
review models as thoroughly and expeditiously as would be necessary
with its limited resources. In addition, the Commission recognizes that
with its current resources it would be challenged to perform
appropriate ongoing monitoring and assessment of the capital models to
ensure that such models operate as designed. Accordingly, the
Commission is proposing in Regulation 23.102 to permit an SD to use
internal capital models that have been approved by the Commission or by
an RFA of which the SD is a member to compute market risk and credit
risk capital charges in lieu of standardized deductions.\86\
---------------------------------------------------------------------------
\86\ See proposed Regulation 23.102(b).
---------------------------------------------------------------------------
As previously noted, NFA currently is the only RFA. Allowing an SD
to use internal capital models that have been approved by NFA is
consistent with the Commission's recent approach with respect to margin
models for uncleared swap transactions.\87\ Specifically, Commission
Regulation 23.154(b) allows an SD to obtain NFA's approval to use a
model to calculate the initial margin requirement for uncleared swaps
and security-based swap positions. NFA has established a process, and
is reviewing the margin models submitted by SDs.
---------------------------------------------------------------------------
\87\ See 81 FR 636, 654 (Jan. 6, 2016). As an RFA, NFA also is
required to establish minimum capital requirements for its members,
including SDs and MSPs, that are at least as stringent as the
capital rules imposed by the Commission. The Commission anticipates
that NFA's capital rules will permit SDs to use NFA approved capital
models in computing regulatory capital.
---------------------------------------------------------------------------
Capital models, however, would pose different challenges for
regulators, including NFA. Unlike the approach for initial margin,
where SDs jointly developed a standardized initial margin model for
swaps and security-based swaps that would be available for use by
market participants, each SD seeking NFA approval would submit for
review several individually developed capital models to compute the
market risk for the full portfolio of trading positions, including
swaps and security-based swaps, and counterparty credit risk charges
that are discussed below. Therefore, reviewing capital models would
significantly increase the number of models that NFA would need to
review and approve relative to the margin models.\88\ In addition, NFA
would have to perform ongoing supervision over the models to assess the
effective operation and implementation.
---------------------------------------------------------------------------
\88\ In many instances, SDs whose capital models would be
subject to NFA review would be affiliates of SDs whose capital
models are subject to review by one of the prudential regulators, or
affiliates of foreign SDs whose capital models are reviewed by a
foreign regulatory authority. The Commission expects that a
prudential regulator's or foreign regulator's review and approval of
capital models that are used throughout the corporate family would
be a significant factor in NFA determining the scope of its review,
provided that appropriate information would be available to the
Commission and NFA.
---------------------------------------------------------------------------
The SD's application to use internal models must be in writing and
must be filed with the Commission and with an RFA in accordance with
the applicable instructions. The model application must include
specified information regarding the models, which is contained in
proposed Appendix A to Regulation 23.102. For example, proposed
Appendix A would require an SD to submit: (1) A list of categories of
positions the SD holds in its proprietary accounts and a brief
description of the methods the SD would use to calculate deductions for
market risk and credit risk on those categories of positions; (2) a
description of the mathematical models to be used to price positions
and to compute deductions for market risk, including those portions of
the deductions attributable to specific risk, if applicable, and
deductions for credit risk; (3) a description of how the SD will
calculate current exposure and potential future exposure for it credit
risk charges, and (4) a description of how the SD
[[Page 91270]]
would determine internal credit risk weights of counterparties, if
applicable.
The Commission or RFA may also require the SD to submit
supplemental information relating to its models. If any information in
an application is found to be or becomes inaccurate before the
Commission or RFA approves the application, the SD must notify the
Commission and RFA promptly and provide the Commission and RFA with a
description of the circumstances in which the information was
inaccurate along with updated accurate information. As part of the
approval process, and on an ongoing basis, an SD would be required to
demonstrate to the Commission or RFA that the models reliably account
for the risks that are specific to the types of positions the SD
intends to include in the model computations. The Commission or RFA may
approve, in whole or in part, an application or an amendment to the
application, subject to any conditions or limitations the Commission or
RFA may require.
After receiving approval of its models, an SD would be required to
amend and submit to the Commission or RFA for approval its application
before materially changing its models or its internal risk management
control system. Further, an SD would be required to notify the
Commission or the RFA 45 days before it ceases using models to compute
its capital. The Commission or the RFA may revoke an SD's ability to
use models to compute capital if either the Commission or the RFA finds
that the use of the models by the SD is no longer appropriate. If the
Commission or the RFA revokes an SD's ability to use models to compute
capital, the SD would need to use the standardized haircuts for all of
its positions.
In developing the proposed market risk and credit risk
requirements, including the proposed quantitative and qualitative
requirements discussed below, the Commission has incorporated in the
proposed requirements the market risk and credit risk model
requirements adopted by the Federal Reserve Board for bank holding
companies, including the value at risk (``VaR''), stressed VaR,
specific risk, incremental risk, and comprehensive risk qualitative and
quantitative standards and requirements. The Commission's proposed
qualitative and quantitative requirements for capital models also are
comparable to the SEC's existing capital model requirements for OTC
derivatives dealers and ANC BDs.
i. VaR Models
Proposed Regulation 23.102 would require that a VaR model's
quantitative criteria include the use of a VaR-based measure based on a
99 percent, one-tailed confidence interval. The VaR-based measure must
be based on a price shock equivalent to a ten business-day movement in
rates or prices. Price changes estimated using shorter time periods
must be adjusted to the ten-business-day standard. The minimum
effective historical observation period for deriving the rate or price
changes is one year and data sets must be updated at least quarterly or
more frequently if market conditions warrant. For many types of
positions it is appropriate for an SD to update its data positions more
frequently than quarterly. In all cases, an SD must have the capability
to update its data sets more frequently than quarterly in anticipation
of market conditions that would require such updating.
The SD would not need to employ a single internal capital model to
calculate its VaR-based measure. An SD may use any generally accepted
approach, such as variance-covariance models, historical simulations,
or Monte Carlo simulations. However, the level of sophistication of the
SD's internal capital model must be commensurate with the nature and
size of the positions the model covers. The internal capital model must
use risk factors sufficient to measure the market and credit risk
inherent in all positions. The risk factors must address the risks
including interest rate risk, credit spread risk, equity price risk,
foreign exchange risk, and commodity price risk. For material positions
in the major currencies and markets, modeling techniques must
incorporate enough segments of the yield curve--in no case less than
six--to capture differences in volatility and less than perfect
correlation of rates along the yield curve.
The internal capital model may incorporate empirical correlations
within and across risk categories, provided that the SD validates and
demonstrates the reasonableness of its process for measuring
correlations. If the internal capital model does not incorporate
empirical correlations across risk categories, the SD must add the
separate measures from its internal capital models for the appropriate
risk categories as listed above to determine its aggregate VaR-based
measure of capital.
The VaR-based measure must include the risks arising from the
nonlinear price characteristics of options positions or positions with
embedded optionality and the sensitivity of the fair value of the
positions to changes in the volatility of the underlying rates, prices
or other material factors. An SD with a large or complex options
portfolio must measure the volatility of options positions or positions
with embedded optionality by different maturities and/or strike prices,
where material.
The internal capital model must be subject to back-testing
requirements that must be calculated no less than quarterly. An SD must
compare its daily VaR-based measure for each of the preceding 250
business days against its actual daily trading profit or loss, which
includes realized and unrealized gains and losses on portfolio
positions as well as fee income and commissions associated with its
activities. If the quarterly backtesting shows that the SD's daily net
trading loss exceeded its corresponding daily VaR-based measure, a
backtesting exception has occurred. If an SD experiences more than four
backtesting exceptions over the preceding 250 business days, it is
generally required to apply a multiplication factor in excess of three
when it calculates its capital requirements.
The qualitative requirements would specify, among other things,
that: (1) Each VaR model must be integrated into the SD's daily
internal risk management system; (2) each VaR model must be reviewed
periodically by the firm's internal audit staff and annually by a third
party service provider; and (3) the VaR measure computed by the model
must be multiplied by a factor of at least three but potentially a
greater amount if there are exceptions to the measure resulting from
quarterly back-testing results.
An SD would also be subject to on-going supervision by staff of the
Commission and or RFA with respect to its internal risk management,
including its use of VaR models.
ii. Stressed VaR Models
The Commission is proposing a stressed VaR component for SDs that
have permission to use VaR models to compute market risk capital
deductions. The stressed VaR measure supplements the VaR measure, as
the VaR measure's inherent limitations produced an inadequate amount of
capital to withstand the losses sustained by many financial
institutions in the financial crisis of 2007-2008.\89\ The stressed VaR
measure should also contribute to a
[[Page 91271]]
more appropriate measure of the risks of an SD's positions, as it
should account for more volatile and extreme price changes.
---------------------------------------------------------------------------
\89\ See Revisions to the Basel II market risk framework,
published by the Basel Committee on Banking Supervision for an
explanation of the implementation of the stressed VaR requirement.
---------------------------------------------------------------------------
An SD would be required to use the same model that it uses to
compute its VaR measure for its stressed VaR measure. The model inputs
however would be calibrated to reflect historical data from a
continuous 12-month period that reflects a period of significant
financial stress appropriate to the SD's portfolio. The stressed VaR
measure must be calculated at least weekly and be no less than the VaR
measure. The Commission would expect that the stressed VaR measure
would be substantially greater than the VaR measure.
The Commission would require the stress tests to take into account
concentration risk, illiquidity under stressed market conditions, and
other risks arising from the SD's activities that may not be captured
adequately in the SD's internal models. For example, it may be
appropriate for the SD to include in its stress testing large price
movements, one-way markets, nonlinear or deep out-of-the-money
products, jumps-to-default, and significant changes in correlation.
Relevant types of concentration risk include concentration by name,
industry, sector, country, and market.
The SD must maintain policies and procedures that describe how it
determines the period of significant financial stress used to compute
its stressed VaR measure and be able to provide empirical support for
the period used. These policies and procedures must address: (1) How
the SD links the period of significant financial stress used to
calculate the stressed VaR-based measure to the composition and
directional bias of the SD's portfolio; and (2) the SD's process for
selecting, reviewing, and updating the period of significant financial
stress used to calculate the stressed VaR measure and for monitoring
the appropriateness of the 12-month period in light of the SD's current
portfolio. Before making material changes to these policies and
procedures, an SD must obtain approval from the Commission or RFA. The
Commission or the RFA may also require the SD to use a different period
of stress to compute its stressed VaR measure.
iii. Specific Risk Models
The Commission's proposal would allow SDs to model their specific
risk. Under the proposal, the specific risk model must be able to
demonstrate the historical price variation in the portfolio, be
responsive to changes in market conditions, be robust to an adverse
environment, and capture all material aspects of specific risk for its
positions. The Commission would require that an SD's models capture
event risk (such as the risk of loss on equity or hybrid equity
positions as a result of a financial event, such as the announcement or
occurrence of a company merger, acquisition, spin-off, or dissolution)
and idiosyncratic risk, capture and demonstrate sensitivity to material
differences between positions that are similar but not identical, and
to changes in portfolio composition and concentrations. If an SD
calculates an incremental risk measure for a portfolio of debt or
equity positions under paragraph (I) of 23.102 Appendix A, the SD is
not required to capture default and credit migration risks in its
internal models used to measure the specific risk of these portfolios.
The Commission understands that not all debt, equity, or
securitization positions (for example, certain interest rate swaps)
have specific risk. Therefore, there would be no specific risk capital
requirement for positions without specific risk. An SD must have clear
policies and procedures for determining whether a position has specific
risk.
The Commission believes that an SD should develop and implement
VaR-based models for both market risk and specific risk. An SD's use of
different approaches to model specific risk and general market risk
(for example, the use of different models) will be reviewed to ensure
that the overall capital requirement for market risk is commensurate
with the risks of the SD's covered positions.
iv. Incremental Risk Models
The Commission is proposing an incremental risk requirement for SDs
that measures the specific risk of a portfolio of debt positions using
internal models. Incremental risk consists of the default risk and
credit migration risk of a position. Default risk means the risk of
loss on a position that could result from the failure of an obligor to
make timely payments of principal or interest on its debt obligation,
and the risk of loss that could result from bankruptcy, insolvency, or
similar proceeding. Credit migration risk means the price risk that
arises from significant changes in the underlying credit quality of the
position. An SD may also include portfolios of equity positions in the
incremental risk model with the prior permission from the Commission or
RFA, provided that the SD consistently includes such equity positions
in how it internally measures and manages the incremental risk for such
positions at the portfolio level. Default is assumed to occur with
respect to an equity position that is included in its incremental risk
model upon the default of any debt of the issuer of the equity
position.
v. Comprehensive Risk Models
Under the proposal, an SD would be required to compute all material
price risks of one or more portfolios of correlation trading positions
using an internal model. The Commission would require the model to
measure all price risk consistent with a one-year time horizon at a
one-tail, 99.9 percent confidence level, under the assumption either of
a constant level of risk or of constant positions. The Commission would
expect that the SD remains consistent in its choice of constant level
or risk or positions, once it makes a selection. Also, the SD's choice
of a liquidity horizon must be consistent between its calculation of
its comprehensive and incremental risk.
The Commission would require an SD's comprehensive risk model to
capture all material price risk, including, but not limited to: (1) The
risk associated with the contractual structure of cash flows of each
position, its issuer, and its underlying exposures (for example, the
risk arising from multiple defaults, including the ordering of defaults
in tranched products); (2) credit spread risk, including nonlinear
price risks; (3) volatility of implied correlations, including
nonlinear price risks such as the cross-effect between spreads and
correlations; (4) basis risks; (5) recovery rate volatility as it
relates to the propensity for recovery rates to affect tranche prices;
and (6) to the extent that comprehensive risk measure incorporates
benefits from dynamic hedging, the static nature of the hedge over the
liquidity horizon. The Commission notes that additional risks that are
not explicitly discussed but are a material source of price risk must
be included in the comprehensive risk measure.
The Commission would require an SD to have sufficient market data
to ensure that it fully captures the material price risks of the
correlation trading positions in its comprehensive risk measure.
Moreover, an SD must be able to demonstrate that its model is an
appropriate representation of comprehensive risk in light of the
historical price variation of its correlation trading positions. An SD
would also be required to inform the Commission and RFA if the SD plans
to extend the use of a model that has been
[[Page 91272]]
approved to an additional business line or product type.
The comprehensive risk measure must be calculated at least weekly.
In addition, an SD must at least weekly apply to its portfolio of
correlation trading positions a set of specific stressed scenarios that
capture changes in default rates, recovery rates, and credit spreads,
and various correlations. An SD must retain and make available to the
Commission and the RFA the results of the stress testing, including
comparisons with capital comparisons generated by the SD's
comprehensive risk model. An SD must promptly report to the Commission
or the RFA any instances where the stress tests indicate any material
deficiencies in the comprehensive risk model.
vi. Credit Risk Models
Swap dealers that obtain Commission or RFA approval to use internal
models to compute credit risk would be required to submit credit risk
models that satisfy the quantitative and qualitative requirements set
forth in Appendix A to proposed Regulation 23.102. With respect to OTC
derivatives contracts, an SD would need to determine an exposure charge
for each OTC derivatives counterparty. The exposure charge for a
counterparty that is insolvent, in a bankruptcy proceeding, or in
default of an obligation on its senior debt, is the net replacement
value of the OTC derivatives contracts with the counterparty (i.e., the
net amount of uncollateralized current exposure to the counterparty).
The counterparty exposure charge for all other counterparties is the
credit equivalent amount of the SD's exposure to the counterparty
multiplied by an applicable credit risk weight factor multiplied by
eight percent. The credit equivalent amount is the sum of the SD's (1)
maximum potential exposure (``MPE'') multiplied by a back-testing
determined factor; and (2) current exposure to the counterparty. The
MPE amount is a charge to address potential future exposure and is
calculated using the VaR model as applied to the counterparty's
positions after giving effect to a netting agreement, taking into
account collateral received, and taking into account the current
replacement value of the counterparty's positions.
The Commission in its margin requirements (see Regulations 23.150
through 23.161) has set forth the requirements for eligible collateral
for uncleared swaps. In order to account for collateral in its VaR
model for the credit risk charges, the Commission would expect an SD to
account for only the collateral that complies with Regulation 23.156
and is held in accordance with Regulation 23.157 for uncleared swaps
that are subject to the Commission's margin rules. An SD would be able
to take into consideration in its VaR calculation collateral that does
not comply with Regulation 23.156 and is not held in accordance with
Regulation 23.157 for uncleared swaps that are not subject to the
Commission's margin rules.
The Commission is allowing SDs to use internal methodologies to
determine the appropriate credit risk weights to apply to
counterparties, if it has received the Commission's or the RFA's
approval. A higher percentage credit risk weight factor would result in
a larger counterparty exposure charge amount. The Commission expects
that the counterparty credit risk weight should be based on an
assessment of the creditworthiness of the counterparty.
The second component to the credit risk charge would be a
counterparty concentration charge. This charge is intended to account
for the additional risk resulting from a relatively large exposure to a
single counterparty. This charge is triggered if an SD's current
exposure to a counterparty exceeds five percent of the tier 1 or
tentative net capital of the SD. In this case, an SD must take a
counterparty concentration charge equal to: (1) Five percent of the
amount by which the current exposure exceeds five percent of the tier 1
or tentative net capital of the SD for a counterparty with a credit
risk weight of 20 percent or less; (2) 20 percent of the amount by
which the current exposure exceeds five percent of the tentative net
capital for a counterparty with a risk weight factor of greater than 20
percent and less than 50 percent; and (3) 50 percent of the amount by
which the current exposure exceeds five percent of the tier 1 or
tentative net capital for a counterparty with a risk weight factor of
50 percent or more.
The Commission is also proposing a portfolio concentration charge
to address the risk of having a large amount of exposure relative to
the capital of the SD. This charge is triggered when the aggregate
current exposure of the SD to all counterparties exceed 50 percent of
the SD's common equity tier 1capital or tentative net capital. In this
case, the portfolio concentration charge would be equal to 100 percent
of the amount by which the aggregate current exposure exceeds 50
percent of the SD's common equity tier 1capital or tentative net
capital.
The Commission believes that its approach to calculating credit
risk charges is appropriate given that its requirements are based on a
method of computing capital charges for credit risk exposures in the
international capital standards for banking institutions. Since credit
risk is the risk that a counterparty could not meet its obligations on
an OTC derivatives contract in accordance with agreed terms (such as
failing to pay), the considerations that inform an SD's assessment of a
counterparty's credit risk should be broadly similar across the various
relationships that may arise between the dealer and the counterparty.
Therefore, the Commission believes that its approach should be a
reasonable model, as the SEC also uses a similar approach for its ANC
broker-dealers or security-based SDs using models.
SDs that are subject to the bank-based capital requirement could
also request Commission or RFA approval to use the Federal Reserve
Board's internal ratings-based and advanced measurement model
approaches to compute risk-weighted assets for the credit exposures
listed in subpart E of 12 CFR 217. The SD would have to include such
exposures in its application to the Commission and RFA, and explain how
its proposed models are consistent with the Federal Reserve Board's
model criteria in subpart E of 12 CFR 217.
Request for Comment
The Commission requests comment on all aspects of the proposed
model approval process and the computation of the credit risk charges.
In addition, the Commission requests comment, including empirical data
in support of comments, in response to the following questions:
1. Do the proposed models appropriately account for the market and
credit risk of swaps and security-based swaps? If not, explain why and
provide alternatives that the Commission should consider.
2. Is the proposed model review process appropriate? If not,
explain why not and provide alternatives that the Commission should
consider.
3. The proposal states that the Commission expects that a
prudential regulator's or foreign regulator's review and approval of
capital models that are used in the corporate family of an SD would be
a significant factor in NFA determining the scope of its review,
provided that appropriate information sharing agreements are in place.
Given the number and complexity of the model review process, please
provide comments on the viability of the proposed model review process?
What other alternatives should the Commission consider?
[[Page 91273]]
4. Should the Commission provide for automatic approval or
temporary approval of capital models already approved by a prudential
or foreign regulator? If so, please provide information regarding on
what conditions such models should be approved?
5. What factors should the Commission consider in setting an
effective date for the capital rules given the application process and
the model approval process? Are most SDs that would be subject to the
rule already using models that are consistent with the proposed
regulations?
6. Are there other approaches available to facilitate the timely
review of applications from SDs to use internal models? For example,
could a more limited review be performed of models that have been
approved by another regulator? If so, what conditions, if any, should
the Commission consider prior to approving the model?
7. How much implementation time is needed for the Commission's
proposed model review and approval process?
8. Are the proposed methods of computing the credit risk charge
appropriate for nonbank SDs? If not, explain why not. For example, are
there differences between FCM/BDs that are also SDs and standalone SDs
that would make the method of computing the credit risk charge
appropriate for the former but not the latter. If so, identify the
differences and explain why they would make the credit risk charge not
appropriate for nonbank SDs. What modifications should be made in that
case?
9. Is the method of computing the counterparty exposure charge
appropriate for nonbank SDs? If not, explain why not. For example, is
the calculation of the credit equivalent amount (i.e., the sum of the
MPE and the current exposure to the counterparty) a workable
requirement for nonbank SDs? If not, explain why not.
10. Are the conditions for taking collateral into account when
calculating the credit equivalent amount appropriate for nonbank SDs?
If not, explain why not.
11. Are the conditions for taking netting agreements into account
when calculating the credit equivalent amount appropriate for nonbank
SDs? If not, explain why not.
12. Are the standardized risk weight factors (20%, 50%, and 150%)
proposed for calculating the credit equivalent amount appropriate for
nonbank SDs? If not, explain why not.
13. Is the method of computing the counterparty concentration
charge appropriate for nonbank SDs? If not, explain why not.
14. Is the method of computing the portfolio concentration charge
appropriate for SDs? If not, explain why not.
B. Swap Dealer and Major Swap Participant Liquidity Requirements and
Equity Withdrawal Restrictions
1. Liquidity Requirements
The Commission is proposing liquidity requirements for SDs that
elect a bank-based capital approach under proposed Regulation
23.101(a)(1)(i) or a net liquid assets capital approach under proposed
Regulation 23.101(a)(1)(ii). The Commission also is proposing liquidity
requirements for SDs that are registered FCMs. The Commission's
proposed liquidity requirements are designed to address the potential
risk that an SD may not be able to efficiently meet both expected and
unexpected current and future cash flow and collateral needs as a
result of adverse events impacting the SD's daily operations or
financial condition. The proposed liquidity requirements for SDs
subject to the bank-based capital approach are consistent with existing
liquidity requirements adopted by the Federal Reserve Board for bank
holding companies.\90\ The proposed liquidity requirements for SDs
subject to the net liquid assets capital approach are consistent with
liquidity requirements proposed by the SEC for SBSDs.\91\
---------------------------------------------------------------------------
\90\ See 12 CFR part 249.
\91\ See SEC proposed Rule 18a-1(f), 77 FR 226 (Nov. 23, 2012).
---------------------------------------------------------------------------
SDs that are subject to the capital requirements of a prudential
regulator, would not be subject to the Commission's proposed liquidity
requirements as such SDs are subject to regulation by the prudential
regulators, including liquidity requirements established by the
prudential regulators. The Commission also is not proposing liquidity
requirements for SDs that are eligible to use the tangible net worth
capital approach under proposed Regulation 23.101(a)(2)(i). SDs that
are eligible to use the net worth capital approach are required to be
primarily engaged in commercial activities, with their financial
activities limited by the 15% asset test or 15% revenue tests discussed
in section II.A.2.iii of this release. Accordingly, the business
operations of SDs that are eligible to use the tangible net worth
capital approach are significantly different from the traditional
business activities of financial firms and financial market
intermediaries whose need for access to liquidity is crucial to meet
their obligations to make daily payments to their clients and to meet
other daily funding obligations. In contrast, the liquidity needs of
SDs that are eligible to use the tangible net worth approach would
encompass the daily funding and payment obligations of the non-
financial business with which the SD is connected.
i. Swap Dealers Subject to the Bank-Based Capital Approach
Proposed Regulation 23.104(a)(1) would provide that an SD that
elects the bank-based capital approach would need to meet the liquidity
coverage ratio requirements set forth in 12 CFR part 249, and apply
such requirements as if the SD were a bank holding company subject to
12 CFR part 249. The proposed liquidity coverage ratio would require
the SD to maintain each day an amount of high quality liquid assets
(``HQLAs''), as defined in 12 CFR 249.20, that is no less than 100
percent of the SDs total net cash outflows over a prospective 30
calendar-day period.\92\
---------------------------------------------------------------------------
\92\ See 12 CFR 249.10. Federal Reserve Board rules require a
regulated institution to maintain a liquidity coverage ratio of HQLA
to net cash outflows that is equal to or greater than 1.0 on each
business day.
---------------------------------------------------------------------------
HQLAs are assets that are unencumbered by liens and other
restrictions on the ability of the SD to transfer the assets.\93\ There
are three categories of HQLAs (level 1 and levels 2A and 2B),\94\ and
there are haircuts and concentration restrictions on the level 2A and
level 2B assets.\95\ Specifically, level 2A and level 2B assets are
valued at 85 percent and 50 percent, respectively, of the fair value of
the assets.\96\ The HQLA categories are designed so that the assets
that are HQLAs could be converted quickly into cash without reasonably
expecting to incur losses in excess of the applicable haircuts during a
stress period.
---------------------------------------------------------------------------
\93\ See 12 CFR 249.22(b).
\94\ See 12 CFR 249.20.
\95\ See 12 CFR 249.21. Level 2A liquid assets are subject to a
15 percent haircut, and level 2B liquid assets are subject to a 50
percent haircut. The concentration limits on level 2A and 2B assets
are set forth in 12 CFR 249.21(d), and effectively provide that
level 2A and level 2B assets may not comprise more than 40 percent
and 15 percent, respectively, of an entity's HQLAs.
\96\ See 12 CFR 249.21(a).
---------------------------------------------------------------------------
An SD's total net cash outflow amount would be determined by
applying outflow and inflow rates, which reflect certain standardized
stressed assumptions, against the balances of an SD's funding sources,
obligations, transactions, and assets over a prospective 30 day
period.\97\ Inflows that can be included to offset outflows are limited
to 75 percent of the outflows
[[Page 91274]]
to ensure that the SD is maintaining sufficient liquidity and is not
overly reliant on inflows. The stressed assumptions include events such
as a partial loss of secured, short-term financing with certain
collateral and counterparties and losses from derivatives positions and
the collateral supporting those positions.
---------------------------------------------------------------------------
\97\ See 12 CFR 249.32.
---------------------------------------------------------------------------
The Commission recognizes that certain portions of 12 CFR part 249
may not be applicable to a particular SD. For example, an SD may not
have certain of the instruments listed in 12 CFR part 249 as an asset
or may not have certain of the cash inflows and outflows listed in the
regulation.\98\ However, the Commission believes that the portion of
the regulations applicable to derivative transactions would be
applicable to an SD. Therefore, the SD would be required to apply the
portions of 12 CFR part 249 that are applicable to it, based on its
balance sheet and the composition of its assets and liabilities.
---------------------------------------------------------------------------
\98\ The Commission is also proposing to explicitly include an
SD's cash deposits that are readily available to meet the general
obligations of the SD as a level 1 liquid asset. The Commission is
also modifying the proposal to provide that SDs organized and
domiciled outside of the U.S. may include in its HQLAs held outside
of the U.S. (See proposed Regulation 23.104(a)(1)).
---------------------------------------------------------------------------
Furthermore, the Commission is proposing to adjust the Federal
Reserve Board's liquidity coverage ratio to better reflect the business
of an SD. Specifically, the proposal would explicitly include an SD's
cash deposits that are readily available to meet the general
obligations of the SD as a level 1 liquid asset in computing its
liquidity coverage ratio.\99\ The Commission is also modifying the
proposal to provide that an SD organized and domiciled outside of the
U.S. may include in its HQLAs assets held in it home country
jurisdiction.\100\ The Commission believes that these adjustments are
appropriate to better align the liquidity coverage ratio with the
expected operations of certain SDs.
---------------------------------------------------------------------------
\99\ See proposed Regulation 23.104(a)(1).
\100\ Id.
---------------------------------------------------------------------------
The Commission also believes that the results of stress tests play
a key role in shaping an SD's liquidity risk contingency planning.
Thus, stress testing and contingency planning are closely intertwined.
Under proposed Regulation 23.104(a)(4), an SD would be required to
establish a contingency funding plan. The contingency funding plan
would need to clearly set out the strategies and funding sources for
addressing liquidity shortfalls in emergency situations and would need
to address the policies, roles, and responsibilities for meeting the
liquidity needs of the SD.
The proposal further provides that the SD's senior management that
has responsibility for risk management would need to be informed if the
SD did not maintain a liquidity coverage ratio of at least 1.0. In
addition, the assumptions underlying the calculation of the liquidity
coverage ratio would need to be reviewed at least quarterly by senior
management that has responsibility to oversee risk management at the SD
and at least annually by senior management of the SD.\101\
---------------------------------------------------------------------------
\101\ See proposed Regulation 23.104(a)(2) and (3).
---------------------------------------------------------------------------
The Commission also is proposing to require an SD to obtain
Commission approval prior to transferring HQLAs to the SD's affiliates
or parent if, after the transfer of those liquid assets, the SD would
not be able to comply with the liquidity coverage ratio
requirement.\102\ Therefore, an SD may not transfer assets that would
qualify for the numerator of the liquidity coverage ratio to its
affiliates or parent if, after the transfer, the SD's HQLA would be
below 100 percent of its total projected net cash flows over a 30 day
period.
---------------------------------------------------------------------------
\102\ See proposed Regulation 23.104(a)(2).
---------------------------------------------------------------------------
ii. Swap Dealers Subject to the Net Liquid Assets Capital Approach
An SD that elects to be subject to a net liquid assets capital
approach would need to comply with liquidity risk management
requirements set forth in proposed Regulation 23.104(b). The Commission
understands that many financial institutions have traditionally used
liquidity funding stress tests as a means to measure liquidity risk.
These tests would generally estimate cash and collateral needs over a
period of time and assume that sources to meet those needs (e.g.,
obtaining secured funding lines and lines of credit) will become
impaired or be unavailable. Therefore, to raise funds during a
liquidity stress event, a firm would generally keep a pool of
unencumbered liquid assets that can be used to meet its current
liabilities or other funding needs. The size of the pool of
unencumbered liquid assets would be based on a firm's estimation of how
much of a diminution of value in those liquid assets and the amount of
funding that would be lost from external sources during a stress event
and the duration of the event.
Under proposed Regulation 23.104(b), an SD would need to perform a
liquidity stress test at least monthly that takes into account certain
assumed conditions lasting for 30 consecutive days. The results of the
liquidity stress test would need to be provided within 10 business days
of the month end to senior management responsible for overseeing risk
management at the SD. In addition, the assumptions underlying the
liquidity stress test would need to be reviewed at least quarterly by
senior management responsible for overseeing risk management at the SD
and at least annually by senior management of the SD.\103\
---------------------------------------------------------------------------
\103\ The assumptions would include (1) a decline in
creditworthiness of the SD severe enough to trigger contractual
credit related commitment provisions of counterparty agreements; the
loss of all existing unsecured funding at the earlier of its
maturity and an inability to acquire a material amount of new
unsecured funding; and, the potential for a material loss of secured
funding.
---------------------------------------------------------------------------
As noted above, the Commission's proposed liquidity requirements
for SDs that are subject to a net liquid assets capital approach are
consistent with the SEC's proposed liquidity requirements for SBSDs,
and are intended to address the types of liquidity outflows experienced
by ANC Firms in times of stress. Consistent with the SEC approach, the
Commission's liquidity stress test proposal is designed to ensure that
SDs are using a stress test that is severe enough to produce an
estimate of a potential funding loss of a magnitude that might be
expected in a severely stressed market. Proposed Regulation
23.104(b)(3) would require an SD to maintain at all times liquidity
reserves based on the results of the liquidity stress test in the form
of unencumbered cash or U.S. government securities. The Commission is
proposing this requirement to ensure that only the most liquid
instrument are held in reserves, given that the market for less liquid
instruments may not be available during a time of market stress.
As noted above, the results of stress tests play a key role in
shaping an SD's liquidity risk contingency planning. Therefore, similar
to the requirement for an SD that elects to be subject to a bank-based
capital approach, an SD that elects to be subject to a net liquid
assets capital approach would be required by proposed Regulation
23.104(b)(4) to establish a contingency funding plan. The plan would
need to clearly set out the strategies and funding sources for
addressing liquidity shortfalls in emergency situations and would need
to address the policies, roles, and responsibilities for meeting the
liquidity needs of the SD.
Request for Comment
The Commission requests comment on all aspects of the proposed
capital rule and liquidity requirements, including empirical data in
support of
[[Page 91275]]
comments. In addition, the Commission requests comment in response to
the following questions:
1. Should the Commission phase-in the implementation of any final
capital rule? For example, the capital requirements would be
implemented first and the liquidity requirements would be implemented
second. Please provide recommendations and implementation time-periods.
2. Should the Commission consider alternative approaches to the
proposed liquidity requirements? If so, explain the alternatives and
the rationale for the alternatives. Please provide any quantitative
analysis in support of alternative approaches, if possible.
2. Swap Dealer Equity Withdrawal Restrictions
The Commission is proposing certain equity withdrawal restrictions
for SDs that elect either the bank-based capital approach or the net
liquid assets capital approach. Proposed Regulation 23.104(c) would
provide that the capital of an SD, or any subsidiary or affiliate of
the SD that has any of its liabilities or obligations guaranteed by the
SD, may not be withdrawn by action of an SD or equity holder of the SD,
or by redemption of shares of stock by the swap dealer or such
affiliates or subsidiaries, or through the payment of dividends or any
similar distribution, if such withdrawal or payment, and any other
similar transactions that are scheduled to occur within the succeeding
six months, results in the SD holding less than 120 percent of the
minimum regulatory capital that the SD is required to hold pursuant to
proposed Regulation 23.101. The proposal includes an exception for
paying required tax payments and for paying reasonable compensation to
equity holders of the SD. The proposal is consistent with existing
equity withdrawal restrictions imposed on FCMs and BDs, and is
consistent with equity withdrawal restrictions proposed by the SEC for
SBSDs.\104\
---------------------------------------------------------------------------
\104\ Equity withdrawal restrictions for FCMs are set forth in
Regulation 1.17(e), and for BDs is set forth in 17 CFR 240.15c3-
1(e)(2). SEC proposed equity withdrawal restrictions for SBSDs is
contained in proposed Rule 18a-1(e)(2). See 77 FR 226 (Nov. 23,
2012).
---------------------------------------------------------------------------
Proposed Regulation 23.104(d) would grant the Commission the
ability to issue an order temporarily restricting for up to 20 business
days the withdrawal of capital from an SD, or prohibiting the SD from
making an unsecured loan or advance to any stockholder, partner,
member, employee or affiliate of the SD. The Regulation would further
provide that the Commission may issue such an order if, based upon the
information available, the Commission concludes that such withdrawal,
loan or advance may be detrimental to the financial integrity of the
SD, or may unduly jeopardize the SD's ability to meet its financial
obligations to counterparties or to pay other liabilities which may
cause a significant impact on the markets or expose the counterparties
and creditors of the SD to loss. The proposal further provides that the
SD may request a hearing on the order, which must be held within two
business days of the date of the written request by the SD. The
proposed grant of authority to the Commission to issue an order
temporarily restricting certain unsecured loans or advances is
consistent with the existing Commission authority under Regulation
1.17(g)(1) for FCMs and with the SEC's authority over BDs.\105\ The
proposed Commission authority to temporarily restrict equity
withdrawals also is consistent with the SEC's proposal governing
SBSDs.\106\
---------------------------------------------------------------------------
\105\ See Rule 15c3-1(e)(3) (17 CFR 240.15c3-1(e)(3)).
\106\ See SEC proposed Rule 18a-1(e)(3) (77 FR 70214 (Nov. 23,
2012).
---------------------------------------------------------------------------
Both the limitation on the withdrawal of equity capital and the
authority of the Commission to temporarily restrict the withdrawal of
capital are intended to provide mechanisms for the Commission to assess
the financial and operational condition of SDs in times of financial
stress. In such situations, it is a priority for the Commission that
SDs maintain the financial strength and liquidity to meet their
financial obligations to counterparties and creditors.
C. Swap Dealer and Major Swap Participant Financial Recordkeeping,
Reporting and Notification Requirements
1. Swap Dealer and Major Swap Participant Financial Recordkeeping and
Financial Statement Reporting Requirements
Section 4s(f) of the CEA directs the Commission to adopt
regulations governing reporting and recordkeeping for SDs and MSPs,
including financial condition reporting and position reporting.
Consistent with section 4s(f), the Commission is proposing new
Regulation 23.105, which would require SDs and MSPs to satisfy current
books and records requirements, ``early warning'' and other
notification filing requirements, and periodic and annual financial
report filing requirements with the Commission and with any RFA of
which the SDs and MSPs are members.
As discussed below, however, the proposed notice and financial
reporting requirements differentiate between SDs and MSPs that are
subject to the Commission's capital requirements and SDs and MSPs that
are subject to the prudential regulators' capital requirements.\107\
The Commission is proposing not to impose the majority of the financial
reporting provisions contained in Regulation 23.105 on SDs and MSPs
that are subject to the capital rules of a prudential regulator from,
with the exception of certain financial and swaps position and margin
reporting requirements and notice filing requirements discussed below,
as the financial condition of these entities will be supervised by the
applicable prudential regulator and subject to its financial reporting
requirements. The Commission believes that the proposal is consistent
with section 4s of the CEA which grants the prudential regulators the
authority to establish capital requirements for SDs and MSPs subject to
their jurisdiction. Additionally, the Commission's proposed approach
avoids imposing potential duplicative, and potentially contradictory,
requirements on SDs and MSPs that are subject to both Commission and
prudential regulator oversight.
---------------------------------------------------------------------------
\107\ See proposed Regulation 23.105(a)(2).
---------------------------------------------------------------------------
Proposed Regulation 23.105(b) is based upon existing FCM and BD
financial recordkeeping and reporting requirements and would require an
SD or MSP to prepare current ledgers or other similar records showing
or summarizing each transaction affecting its asset, liability, income,
expense and capital accounts.\108\ The accounts must be classified in
accordance with U.S. generally accepted accounting principles (``U.S.
GAAP'') provided, however, that if the SD or MSP is organized under the
laws of a foreign jurisdiction and is not otherwise required to prepare
its records or financial statements in accordance with U.S. GAAP, the
SD or MSP may prepare the required records in accordance with
International Financial Reporting Standards (``IFRS'') issued by the
International Accounting Standards Board (``IASB'').\109\ Proposed
Regulation
[[Page 91276]]
23.105(b) also would require an SD or MSP to maintain its ledgers or
other similar records showing or summarizing each transaction affecting
its asset, liability, income, expense and capital accounts for a period
of five years pursuant to Regulation 1.31.
---------------------------------------------------------------------------
\108\ Commission Regulation 1.18 requires each FCM to prepare
and keep current ledgers or other similar records which show or
summarize, with appropriate references to supporting documents, each
transaction affecting its asset, liability, income, expense and
capital accounts. SEC Rule 17a-3 (17 CFR 240.17a-3) requires a BD to
make and maintain comparable ledgers and other similar records
reflecting its assets, liabilities, income and expenses.
\109\ FCMs are required to classify accounts only in accordance
with U.S. GAAP.
---------------------------------------------------------------------------
The Commission is proposing in Regulation 23.105(b) to permit an SD
or MSP organized and domiciled outside of the U.S. to maintain
financial books and records in accordance with IFRS in recognition that
U.S. GAAP may not be the native accounting principles for a non-U.S.
firm and that these firms may be subject to existing non-U.S. GAAP
financial reporting requirements in their home country jurisdictions.
These SDs and MSPs would be subject to substantial expense and burden
if they were required to maintain two separate accounting records and
systems to satisfy two separate financial reporting requirements. The
Commission, however, is proposing that if the SD or MSP is otherwise
required to maintain books and records in accordance with U.S. GAAP,
the SD or MSP must maintain its records pursuant to U.S. GAAP in order
to comply with Regulation 23.105(b).
The Commission is also proposing to require SDs and MSPs to file
periodic financial reports with the Commission and with the SDs' or
MSPs' RFA. Consistent with the recordkeeping requirements, the proposed
financial reporting requirements are consistent with existing
Commission requirements for FCMs and SEC requirements for BDs.\110\
---------------------------------------------------------------------------
\110\ Regulation 1.10 requires FCMs to submit unaudited monthly
and audited annual financial reports to the Commission and to the
FCMs' respective designated self-regulatory organization. SEC Rule
17a-5 (17 CFR 240.17a-5) directs BDs to file unaudited monthly
reports and annual audited reports with the SEC.
---------------------------------------------------------------------------
Proposed Regulation 23.105(d)(1) would require an SD or MSP to file
a monthly unaudited financial report within 17 business days of the
close of business each month, and proposed Regulation 23.105(e)(1)
would require an SD or MSP to file an annual audited financial report
within 60 days of the close of the SD's or MSP's fiscal year-end
date.\111\ The monthly unaudited and the annual audited financial
reports must be prepared in the English language and denominated in
U.S. dollars.\112\ The monthly unaudited and annual audited financial
reports also must include: (1) A statement of financial condition; (2)
a statement of income or loss; (3) a statement of cash flows; (4) a
statement of changes in ownership equity; (5) a statement of the
applicable capital computation; and (6) any further materials that are
necessary to make the required statements not misleading.\113\ Proposed
Regulation 23.105(e)(4)(iii) would further require that the annual
audited financial statements also include any necessary footnote
disclosures. Proposed Regulation 23.105(e)(2) would require the annual
financial statements to be audited by a public accountant that is in
good standing in the accountant's home country jurisdiction.\114\
---------------------------------------------------------------------------
\111\ The Commission also is proposing certain technical,
administrative provisions for SD and MSP financial statements.
Proposed paragraph (g) to Regulation 23.105 would prohibit an SD or
MSP from changing its fiscal year end date unless the SD or MSP has
requested and received written approval for the change from the RFA
of which it is a member. Proposed paragraph (j) would provide that
an SD or MSP may request an extension of time to file its unaudited
monthly or audited annual report from the RFA, which may be granted
on a conditional or unconditional basis, or disapproved by the RFA.
Proposed paragraphs (g) and (j) of Regulation 23.105 are consistent
with current provisions governing FCMs under Regulation 1.10.
\112\ See proposed Regulations 23.105(d)(2) and (e)(3).
\113\ See proposed Regulations 23.105(d)(2) and (e)(4).
\114\ FCMs currently are required to file unaudited financial
reports and an annual financial report with the Commission within 17
and 60 days, respectively, of the end of the reporting period. See
Regulation 1.10(b).
---------------------------------------------------------------------------
The monthly unaudited and annual audited financial statements must
be prepared in accordance with U.S. GAAP, provided, however, that the
Commission is proposing to permit SDs or MSPs that are organized and
domiciled outside of the U.S., and otherwise are not required to
prepare financial statements in accordance with U.S. GAAP, to prepare
the financial statements in accordance with IFRS or another local
accounting standard, after requesting approval by the Commission, which
is discussed below, in lieu of U.S. GAAP.\115\ The use of IFRS in lieu
of U.S. GAAP is consistent with the proposed treatment in Regulation
23.105(b) discussed above that would allow a these SDs and MSP to
maintain their financial books and records in accordance with IFRS.
---------------------------------------------------------------------------
\115\ See proposed Regulations 23.105(d)(2) and (e)(3).
Regulation 1.10 provides that FCMs must present its unaudited
monthly reports and audited annual reports in accordance with U.S
GAAP.
---------------------------------------------------------------------------
The Commission, however, is proposing that if the non-U.S. SD or
non-U.S. MSP is otherwise required to prepare financial statements in
accordance with U.S. GAAP, the SD or MSP must submit financial
statements prepared in accordance with U.S. GAAP to the Commission and
to the firm's RFA in order to comply with the regulations. This
requirement reflects the fact that certain foreign-based SDs or MSPs
that consolidate into a U.S. parent organization may prepare U.S. GAAP
financial statements as part of the consolidation. Under the proposed
regulations, if the foreign-based SD or MSP prepares U.S. GAAP
financial statements as part of the consolidation, it would be required
to submit such U.S. GAAP statements to the Commission and to the firm's
RFA to comply with Regulation 23.105(d)(2) and (e)(3).
While the Commission has proposed to permit SDs or MSPs organized
and domiciled outside the U.S. to use IFRS in lieu of U.S. GAAP in the
preparation and presentation of the monthly unaudited and annual
audited financial reports, the Commission recognizes that not all non-
U.S. jurisdictions have adopted IFRS. In addition, the Commission
understands that even in certain foreign jurisdictions that have
adopted IFRS, SDs and MSPs may be permitted to prepare and present
their financial statements in accordance with local accounting
standards. To address this issue, the Commission is proposing in
Regulation 23.105(o) to permit an SD or MSP organized and domiciled
outside of the U.S. to petition the Commission to use local accounting
standards in lieu of U.S. GAAP or IFRS in monthly unaudited and annual
audited financial reports filed with the Commission.
The process for seeking Commission approval to use local accounting
standards is set forth in proposed Regulation 23.106 and is discussed
in more detail in section II.D below. The Commission would review each
request on a case-by-case basis and determine what, if any, additional
information would be necessary in order to accept financial reports
prepared in accordance with local accounting standards, including
possible reconciliations of the financial information to U.S. GAAP. The
Commission notes further that notwithstanding the proposed substituted
compliance provisions, financial statements from all SDs and MSPs must
be prepared in the English language and denominated in U.S. dollars, as
proposed in Regulation 23.105(d)(2) and 23.105(e)(3).
The Commission is also proposing in Regulation 23.105(d)(3), (4)
and (e)(5) to permit an SD or MSP that is registered with the
Commission as an FCM or registered with the SEC as a BD to satisfy the
Commission's SD or MSP financial statement reporting requirements by
submitting a CFTC Form 1-FR-FCM or its applicable SEC Financial and
Operational Combined Uniform Single ('' FOCUS'') Report in lieu of the
specific financial statements required under proposed Regulation
[[Page 91277]]
23.105.\116\ The financial information that would be required under
proposed Regulation 23.105(d) for SDs and MSPs is consistent with the
Commission's current requirements for Form 1-FR-FCM and the SEC's
requirements for FOCUS Reports for BDs. The proposal also is consistent
with the Commission's long history of permitting SEC registrants to
meet their financial statement filing obligations with the Commission
by submitting a FOCUS Report in lieu of CFTC Form 1-FR-FCM and reduces
the burden on dually-registered firms by not requiring two separate
financial reporting requirements.\117\
---------------------------------------------------------------------------
\116\ FCMs are required to file monthly unaudited and annual
audited Forms 1-FR-FCM with the Commission and with their designated
self-regulatory organization. The Forms 1-FR-FCM include, among
other information, a statement of financial condition, a statement
of income or loss, a statement of changes in ownership equity, a
statement of liabilities subordinated to the claims of general
creditors, a statement of the computation of regulatory minimum
capital, and any further information as may be necessary to make the
required statements not misleading. See Regulation 1.10(d).
SEC FOCUS Reports are required to contain, among other
statements and information, a statement of financial condition, a
statement of income or loss, a statement of changes in ownership
equity, a statement of liabilities subordinated to the claims of
general creditors, and a statement of the computation of regulatory
minimum capital. See SEC Rule 17a-5 (17 CFR 240.17a-5).
\117\ See Regulation 1.10(h), which permits an FCM that is also
registered as a BD to file its SEC FOCUS Report in lieu of the
Commission's Form 1-FR-FCM.
---------------------------------------------------------------------------
In addition to the specific financial reporting requirements
discussed above, the Commission is also proposing in Regulation
23.105(h) to require any SD or MSP to file additional financial or
operational information as the Commission may deem necessary in order
to adequately assess the SD's or MSP's financial condition or
operational status. This additional financial and operational
information may be necessary at times when an SD or MSP is experiencing
a financial or operational crisis, and the additional information is
necessary for the Commission to assess whether the SD or MSP will be
able to continue to meet its obligations to counterparties and other
creditors. The authorization to request additional information from a
registrant also is consistent with existing Regulation 1.10 which
provides the Commission with the authority to request financial
information from FCMs and IBs, and it is consistent with existing
authority that the SEC has with respect to BDs and with the proposed
authority that the SEC would have over SBSDs and MSBSPs.\118\
---------------------------------------------------------------------------
\118\ See CFTC Regulation 1.10(b)(4).
---------------------------------------------------------------------------
The Commission also is proposing limited financial reporting for
SDs and MSPs that are subject to the capital requirements of a
prudential regulator as such regulators have existing financial
reporting requirements in place for these SDs and MSPs. The financial
reporting requirements for such SDs and MSPs are described in section
II.C.6 below.
The Commission, however, is proposing that SDs and MSPs that are
subject to capital rules of a prudential regulator file financial
reports and specific position and margin information with the
Commission and with the RFA of which the SDs and MSPs are members
within 17 business days of the end of each calendar quarter and not on
a monthly basis. The financial reports and specific position
information that would be required is set forth in Appendix B to
proposed Regulation 23.105.
SDs and MSPs that are dually registered as FCMs will continue to be
subject to the capital requirements in Regulation 1.17, and along with
proposed conforming amendments in Regulation 1.17 applicable to dually
registered SDs and MSPs discussed above, will be permitted to comply
with the applicable financial recordkeeping, notification and reporting
under Regulation 23.105 by following applicable FCM requirements in
Regulations 1.10, 1.12, and 1.16.\119\ Similarly, SDs and MSPs dually
registered with the SEC as either SBSDs or MSBSPs will be permitted to
comply with the Commission's financial reporting and notification
requirements under Regulation 23.105 by filing simultaneously with the
Commission all applicable notices or reports required under the SEC's
rules.\120\
---------------------------------------------------------------------------
\119\ See Regulation 23.105(d)(4) and (e)(6), wherein SDs and
MSPs dually registered as FCMs will be permitted to comply with the
monthly and annual financial reporting requirements by filing form
1-FR-FCM in lieu of the financial reports required under proposed
Regulation 23.105.
\120\ See Regulation 23.105(c)(5) referencing proposed 17 CFR
240-18a-8 for notification requirements for SBSDs and MSBSPs. See
Sec. 23.105(d)(3) and Sec. 23.105(e)(5) referencing proposed 17
CFR 240-18a-7, for monthly and annual financial reporting
requirements for SBSDs and MSBSPs.
---------------------------------------------------------------------------
The Commission is further proposing to require that SDs and MSPs
provide public disclosure on their Web site of some of the proposed
required financial reporting, including a statement of financial
condition and of the amount of minimum regulatory capital required and
the amount of regulatory capital of the SD or MSP no less than
quarterly, with the same information provided from an audited financial
statement no less than annually. The proposal for public disclosure is
consistent with financial reporting information the Commission has
previously determined should not qualify as exempt from the Freedom of
Information Act for FCMs. The proposal to require quarterly reporting
is intended to make the frequency of such public disclosure consistent
with publicly available information provided by bank entities in call
reports.
2. Swap Dealer and Major Swap Participant Notice Requirements
The Commission is proposing to require SDs and MSPs to file certain
regulatory notices with the Commission and with the RFA of which the
SDs or MSPs are members if certain defined triggering events occur.
Proposed Regulation 23.105(c) would require an SD or MSP that is not
subject to the capital rules of a prudential regulator to provide the
Commission and RFA with immediate written notice when the firm is: (1)
Undercapitalized; (2) fails to maintain capital at a level that is in
excess of 120 percent of its minimum capital requirement; or (3) fails
to maintain current books and records.
Proposed Regulation 23.105(c) would further require an SD or MSP,
as applicable, to provide notice to the Commission and to the RFA
within 24 hours of: (1) Failing to comply with the liquidity
requirements under proposed Regulation 23.104, (2) experiencing a 30
percent reduction in capital as compared to the last reported capital
in a financial report filed with the Commission, or (3) failing to post
or collect initial margin for uncleared swap transactions or exchange
uncleared swap variation margin as required under the Commission's
uncleared swaps margin rules and the initial margin that would be
required for uncleared security-based swaps as required under 17 CFR
240.18a-3(c)(1)(i)(B), if the total amount that has not been either
collected by and exchanged with or posted by and exchanged with the SD
is equal to or greater than: (1) 25 percent of the SD's required
capital under the Commission's proposal calculated for a single
counterparty or group of counterparties that are under common ownership
or control; or (2) 50 percent of the SD's required capital under the
Commission's proposal calculated for all of the SD's
counterparties.\121\
---------------------------------------------------------------------------
\121\ See CFTC Regulations 23.152 and 23.153.
---------------------------------------------------------------------------
Proposed Regulation 23.105(c) also would require an SD to provide
the Commission and the RFA with two business day's advance notice of a
withdrawal that would exceed 30
[[Page 91278]]
percent of the SD's excess regulatory capital.\122\ Finally, the
proposal would also require an SD or MSP that is dually-registered with
the SEC as an SBSD or MSBSP to file with the Commission and with its
RFA a copy of any notice that the SBSD or MSBSP is required to file
with the SEC under SEC Rule 18a-8 (17 CFR 240.18a-8). SEC proposed Rule
18a-8 requires SBSDs and MSBSPs to provide written notice to the SEC
for comparable reporting events as proposed by the Commission in
Regulation 23.105(c), including if a SBSD or MSBSP is undercapitalized
or fails to maintain current books and records. The Commission is
proposing to require SDs and MSPs that are dually-registered with the
SEC to file copies with the Commission of notices filed with the SEC
under Rule 18-8 to allow the Commission to be aware of any events that
may indicate that the SD or MSP is unable to meet its operational or
financial obligations on an ongoing basis.
---------------------------------------------------------------------------
\122\ The term ``regulatory capital'' is defined in proposed
Regulation 23.100 and means the relevant capital approach applicable
to the SD under proposed Regulation 23.101.
---------------------------------------------------------------------------
The proposed notice provisions are intended to provide the
Commission and the appropriate RFA with timely notice of potentially
adverse financial or operational issues that may warrant immediate
attention and ongoing surveillance. The proposed notice requirements
are comparable to the notice requirements concerning capital currently
required for FCMs under Regulation 1.12 of the Commission's regulations
and with the SEC's notice requirements for BDs.\123\
---------------------------------------------------------------------------
\123\ See SEC Rule 17a-11 (17 CFR 240.17a-11).
---------------------------------------------------------------------------
3. Electronic Filing Requirements for Financial Reports and Regulatory
Notices
Proposed Regulation 23.105(m) would require all notifications and
financial statement filings submitted to the Commission pursuant to
Regulation 23.105 to be filed in an electronic manner using a user
authentication process approved by the Commission. The Commission notes
that the many SDs and MSPs are already familiar with the Commission
approved WinJammer filing system maintained jointly by NFA and Chicago
Mercantile Exchange. WinJammer currently allows Commission registrants
that are authorized to use the electronic system to file financial
reports and notices with the Commission and NFA simultaneously. The
Commission views this system, as well as other future Commission
approved systems, as the most effective way to ensure that the filings
required under proposed Regulation 23.105 would be submitted promptly
and directly to the Commission.
4. Swap Dealer and Major Swap Participant Reporting of Position
Information
Proposed Regulation 23.105(l) would require each SD or MSP that was
not subject to the capital rules of a prudential regulator to file
monthly swap and security-based swap position information with the
Commission and with the RFA of which the SD or MSP is a member. The
information required to be submitted would be included in proposed
Appendix A to Regulation 23.105, and is based upon the information that
the SEC is proposing be filed with the SEC by SBSDs.\124\ Accordingly,
SDs or MSPs that are dually-registered as SBSDs would be subject to
file the same position information with both regulators.
---------------------------------------------------------------------------
\124\ See SEC proposed Form SBS part 4.
---------------------------------------------------------------------------
The position information that would be required by proposed
Regulation 23.105(l) would include an SD's or MSP's: Current net
exposure by the top 15 counterparties, and all other counterparties
combined; total exposure by the top 15 counterparties, and all others
combined; the internal credit rating, gross replacement value, net
replacement value, current net exposure, total exposure, and margin
collected for the top 36 counterparties. The SD or MSP would also have
to provide current exposure and net exposure by country for the top 10
countries. The Commission would use this information as part of its
financial surveillance program to monitor the financial condition and
positions of SDs and MSPs.
5. Reporting Requirements for Swap Dealers Approved To Use Internal
Capital Models
The Commission is proposing reporting requirements for SDs that
have received approval from the Commission or from an RFA under
proposed Regulation 23.102(d) to use internal models to compute market
risk capital charges or credit risk capital charges. The Commission's
proposed requirements for the collection of model information are
largely based on existing requirements for ANC Firms under Regulation
1.17 and the rules of the SEC, and on SEC proposed Rules for SBSDs and
BDs.
Regulation 23.105(k) would require an SD to file, on a monthly
basis, a listing of each product category for which the SD does not use
an internal model to compute market, and the amount of the market risk
deduction; a graph reflecting, for each business line, the daily intra-
month VaR; the aggregate VaR for the SD; for each product for which the
SD uses scenario analysis, the product category and the deduction for
market risk; and, credit risk information on swap, mixed swap, and
security-based swap exposures, including: (A) Overall current exposure,
(B) current exposure listed by counterparty; (C) the 10 largest
commitments listed by counterparty, (D) the SD's maximum potential
exposure listed by counterparty for the 15 largest exposures; (E) the
SD's aggregate maximum potential exposure, (F) a summary report
reflecting the SD's current and maximum potential exposures by credit
rating category, and (G) a summary report reflecting the SD's current
exposure for each of the top 10 countries to which the SD is exposed.
Regulation 23.105(k) would also require an SD to report the results
of the liquidity stress tests required by proposed Regulation 23.104.
Regulation 23.104 also would require each SD approved to use internal
capital models to submit a report identifying the number of business
days for which the actual daily net trading loss exceeded the
corresponding daily VaR and the results of backtesting of all internal
models used to compute allowable capital, including VaR, and credit
risk models, indicating the number of backtesting exceptions. All of
the information required to be submitted to the Commission or RFA under
proposed Regulation 23.105(k) would be required to be filed within 17
days of the close of each month, with the exception of the report
identifying the number of business days for which the actual daily net
trading loss exceeded the corresponding daily VaR, which would be
required on a quarterly basis.
6. Financial Reporting Requirements for Swap Dealers and Major Swap
Participants Subject to the Capital Rules of a Prudential Regulator
The Commission is proposing not to require an SD or MSP that is
subject to the capital rules of a prudential regulator to file monthly
unaudited or annual audited financial statements with the Commission or
with the RFA of which the SD or MSP is a member. The Commission also is
proposing to not to require such SDs or MSPs to file notifications
contained in Regulation 23.105(c) with the Commission or with an RFA.
The Commission is, however, proposing to require SDs and MSPs that
are subject to capital rules of a
[[Page 91279]]
prudential regulator to file quarterly unaudited financial reports and
certain regulatory notices with the Commission and with an RFA.
Proposed Regulation 23.105(p) would require SDs and MSPs that are
subject to the capital requirements of a prudential regulator to file
quarterly unaudited financial reports with the Commission that are
largely based on existing ``call reports'' that the SDs and MSPs are
required to file with their respective prudential regulator.\125\ The
proposed financial reporting requirement is consistent with the SEC
proposed filing requirement for SBSDs that are subject to the capital
rule of a prudential regulator.\126\ Specifically, the Commission is
proposing that the SDs and MSPs submit to the Commission Appendix B of
proposed Regulation 23.105, which is largely based on the SEC's
proposed Form SBS part 2 and part 5.
---------------------------------------------------------------------------
\125\ See proposed Sec. 23.105(p) and Appendix B. See also
Consolidated Reports of Condition and Income for a Bank with
Domestic and Foreign Offices (``call reports''); 12 U.S.C. 324; 12
U.S.C. 1817; 12 U.S.C. 161; and 12 U.S.C. 1464.
\126\ See proposed SEC Rule 17 CFR 240.18a-8.
---------------------------------------------------------------------------
The financial information required by Regulation 23.105(p) would
include the SD's or MSP's balance sheet and details of the SD's or
MSP's capital composition and capital ratios. The financial information
would further focus on the SD's or MSP's swap and security-based swap
activities, including requiring aggregate security-based swaps, mixed
swaps, swaps, and other derivatives information. The information would
include both cleared and uncleared positions and would further
differentiate between long and short positions. The Commission is
requiring this information in order to provide the Commission and the
SD's or MSP's RFA with swap and security-based swap trading data, which
may be monitored as part of their respective financial and market
surveillance monitoring programs.
Proposed Regulation 23.105(p) would also require SDs and MSPs that
are subject to the capital rules of a prudential regulator to file
regulatory notices with the Commission and with an RFA. Proposed
Regulation 23.105(p)(3)(i) would require an SD or MSP to file a notice
with the Commission and with an RFA if the SD or MSP filed a notice of
change of its reported capital category with the Federal Reserve Board,
the OCC, or the FDIC. Prudential regulators have established five
capital categories that are used to describe a bank's capital strength:
(1) Well capitalized; (2) adequately capitalized; (3) undercapitalized;
(4) significantly undercapitalized; and (5) critically
undercapitalized.\127\ The definition of each capital category is based
on capital measures under the bank capital standard and other
factors.\128\
---------------------------------------------------------------------------
\127\ See 12 CFR 325.103; 12 CFR 6.4; 12 CFR 208.43.
\128\ See id.
---------------------------------------------------------------------------
A bank is required to notify its appropriate prudential regulator
of adjustments to the bank's capital category that may have occurred
that would put the bank into a lower capital category from the category
previously assigned to it. Following the notice, the prudential
regulator determines whether the bank needs to adjust its capital
category.\129\ Because these notices may indicate that a bank is in or
approaching financial difficulty, the Commission is proposing to
include a notification requirement in proposed regulation
23.105(p)(3)(i) that would require a bank SD or a bank MSP to give
notice to the Commission when it files an adjustment of reported
capital category with its prudential regulator by transmitting a copy
of the notice to the Commission.
---------------------------------------------------------------------------
\129\ See 12 CFR 6.3(c); 12 CFR 208.42(c); 12 CFR 325.102(c).
---------------------------------------------------------------------------
The rules of the Federal Reserve Board, OCC and FDIC also establish
minimum capital requirements in the form of capital ratios that banks
and bank holding companies are required to meet in order to comply with
the respective Agencies capital requirements.\130\ The Commission is
proposing to require a bank SD or bank MSP to file notice with the
Commission if the SD's or MSP's regulatory capital is less than the
applicable minimum capital requirements set forth in the prudential
regulators' rules.
---------------------------------------------------------------------------
\130\ See 12 CFR 3.10; 12 CFR 217.10; 12 CFR 324.10.
---------------------------------------------------------------------------
The Commission also is proposing in Regulation 23.105(p)(3) to
require an SD that is a foreign bank to notify the Commission if the
SD's files a notice of a change in its capital category or a notice of
falling below its minimum capital requirement with a prudential
regulator or with it home country supervisors. This notice requirement
is intended to provide the Commission with information that a
registered SD may be experiencing financial issues, and provides the
Commission with the opportunity to consult with the appropriate
prudential regulator.
The Commission also is proposing to require a bank SD or a bank MSP
to file a notice in the event the SD or MSP fails to post or collect
initial margin for uncleared swap transactions or post or collect
uncleared swap variation margin as required under the respective
prudential regulators' rules, if the total amount that has not been
either collected or posted by and exchanged with the SD or MSP is equal
to or greater than: (1) 25 percent of the SD's or MSP's minimum capital
requirement; or (2) 50 percent of the SD's or MSP's minimum capital
requirement.
Consistent with section 4s(e) of the CEA, bank SDs and bank MSPs
are subject to the capital rules of the prudential regulators. The
proposed bank SD and MSP notice requirements contained in Regulation
23.105(p) are intended to provide the Commission with sufficient
information to effectively monitor these entities as market
participants in the swap markets subject to Commission oversight. For
example, bank SDs and bank MSPs may be swap counterparties to non-bank
SDs and non-bank MSPs subject to the Commission's capital and margin
rules. The proposed notice provisions will assist Commission staff with
monitoring these bank SDs and bank MSPs for compliance with other
statutory and regulatory requirements, such as the existing business
conduct rules applicable on all SDs, and the potential impacts these
bank SDs and bank MSPs may have on other Commission registrants and on
the market as a whole. The Commission anticipates that its staff, as
appropriate, would engage with staff of the relevant prudential
regulator in assessing the potential market impacts upon receiving a
regulatory notice.
Proposed paragraph (p) of Regulation 23.105 would also include
identical oath and affirmation provisions and electronic filing
requirements for SDs and MSPs that are subject to the capital rules of
a prudential regulator as the Commission is proposing under paragraphs
(f) and (n) of Regulation 23.105 for SDs and MSPs that are subject to
the Commission's capital rules.
7. Weekly Position and Margin Reporting
The Commission is proposing weekly reporting of position and margin
information for the purposes of conducting risk surveillance of SDs and
MSPs. This requirement would apply to SDs and MSPs subject to the
capital and margin rules of either the Commission or a prudential
regulator. Similar reporting is currently provided on a daily basis by
DCOs for cleared swaps.\131\
---------------------------------------------------------------------------
\131\ 17 CFR 39.19(c)(1).
---------------------------------------------------------------------------
Proposed Regulation 23.105(q)(1) would require SDs and MSPs to
report position information, in a format specified by the Commission,
(i) by
[[Page 91280]]
counterparty, and (ii) for each counterparty, by the following asset
classes--commodity, credit, equity, and foreign exchange or interest
rate. Under the uncleared margin rules, these are asset classes within
which margin offsets may be taken.\132\
---------------------------------------------------------------------------
\132\ 17 CFR 23.154(b)(2)(v).
---------------------------------------------------------------------------
Proposed Regulation 23.105(q)(2) would require SDs and MSPs to
report margin information, in a format specified by the Commission,
showing (i) the total initial margin posted by the SD or MSP with each
counterparty; (ii) the total initial margin collected by the SD or MSP
from each counterparty; and (iii) the net variation margin paid or
collected over the previous week with each counterparty.
The Commission currently uses the position and margin information
filed by DCOs to identify and to take steps to mitigate the risks posed
to the financial system by participants in cleared markets including
DCOs, clearing members, and large traders. The Commission would
incorporate the additional data file by SDs and MSPs into that program.
The Commission would analyze positions and margin across cleared and
uncleared markets in order to obtain a picture of the risks posed by
large market participants to one another and to the financial system.
Request for Comment
The Commission requests comment on all aspects of the proposed
financial reporting, recordkeeping and notification requirements. In
addition, the Commission requests comment, including empirical data in
support of comments, in response to the following questions:
1. For SDs or MSPs organized and domiciled outside the U.S., is
IFRS issued by the IASB an appropriate accounting standard that would
allow the Commission and RFA to properly assess the financial condition
of SDs and MSPs? If not, explain why not, and suggest what
modifications the Commission should make to the proposed regulation.
2. Should the Commission accept financial statements prepared in
accordance with local accounting standards from SDs or MSPs located in
foreign jurisdictions and are not required to prepare financial
statements in accordance with U.S. GAAP or IFRS? If not, explain why
not. Should such firms be required to submit a reconciliation of the
local accounting to U.S. GAAP? Would such a reconciliation provide the
necessary information for the Commission and RFA to fully understand
the financial position of the SD or MSP? What costs would be incurred
by the SD or MSP in preparing the reconciliation?
3. Should SDs or MSPs that file non-U.S. GAAP financial statements
also file a reconciliation of the non-U.S. GAAP financial statements to
U.S. GAAP? Would such a reconciliation provide the Commission with
necessary information to understand the non-U.S. GAAP financial
statements? What costs would be incurred by the SD or MSP in preparing
the reconciliation?
4. Are there competitive advantages to SDs and MSPs that would be
permitted to prepare financial statements in accordance with IFRS or
another non-U.S. GAAP reporting standard? If so, is it necessary for
the Commission to address such advantages? How should the Commission
address those advantages?
5. The Commission is proposing to require SDs and MSPs that are
subject to the capital rules of a prudential regulator to file notices
with the Commission and with the SDs' or MSPs' RFA. Such notices
include if the SD's or MSP's regulatory capital is less than the
applicable minimum requirements set forth in the prudential regulators'
rules or an adjustment in the SD's or MSP's reported capital category.
The proposal would also require SDs that are foreign banks to file
notice with the Commission and with their RFA if they experience an
adjustment in their regulatory capital category under the rules of a
prudential regulator or a similar provision of the regulations of its
home country supervisors, and to file notice with the Commission and
with their RFA if their regulator capital is below the minimum required
by the prudential regulators or their home country supervisors. Should
the Commission require SDs that are subject to the capital rules of a
prudential regulator to file notices with the Commission regarding
changes to their capital status? If not, explain why not? Are SDs that
are banks subject to an legal restrictions on disclosing such capital
information to the Commission? If so, cite such legal restrictions.
Should the Commission differentiate between SDs that are U.S. banks
from SDs that are non-U.S. banks? If so, explain how and why the
Commission should differentiate between such SDs. Are there other
notices that the Commission should consider receiving from SDs or MSPs
that are subject to the capital and margin rules of a prudential
regulator? Do these rules adequately address SDs and MSPs that are
foreign domiciled entities subject to prudential regulation by foreign
banking authorities? Are there alternative provisions that the
Commission should consider for both domestic and foreign SDs and MSPs
that are subject to prudential regulation?
6. Are the reporting elements to Appendix A adequately defined to
capture the relevant information? If not, what specific changes should
the Commission consider?
7. Are the reporting elements to Appendix B adequately defined to
capture the relevant information? If not, what specific changes should
the Commission consider?
8. Should the Commission make public any other monthly unaudited or
annual audited financial information filed by an SD or MSP under
Regulation 23.105? If so, how would the public disclosure of such
information be consistent with the FOIA and Sunshine Act exemptions?
9. What SD or MSP financial information should the Commission make
publicly available?
10. Is it appropriate to have different disclosure rules for SDs
and MSPs? If so, explain why disclosure rules should be different for
SDs and MSPs?
11. Would disclosure of certain financial information provide SD
and MSP counterparties with necessary information concerning some SDs
or MSPs without adversely impacting that particular SD's or MSP's
ability to maintain a trading book?
12. Should the Commission post SD and MSP financial data on the
Commission's Web site?
D. Comparability Determinations for Eligible Swap Dealers and Major
Swap Participants
The Commission is proposing to permit eligible SDs and MSPs to rely
on substituted compliance to meet certain components of the
Commission's capital and financial reporting requirements to the extent
that the Commission determines that the relevant foreign jurisdiction's
capital and financial reporting requirements are comparable to the
Commission's corresponding capital and financial reporting requirements
(i.e., ``Comparability Determination''). Proposed Regulation 23.106
outlines a framework for the Commission's Comparability Determinations,
including establishing a standard of review for determining whether
some or all of the relevant foreign jurisdiction's capital and
financial reporting requirements are comparable to the Commission's
corresponding capital and financial reporting requirements. This
framework is generally consistent with the framework set forth in
Regulation 23.160 for assessing substituted compliance for applying
margin to
[[Page 91281]]
uncleared cross border swap transactions.
Proposed Regulation 23.106 identifies persons eligible to request a
Comparability Determination with respect to the Commission's capital
and financial reporting requirements, including any SD or MSP that is
eligible for substituted compliance under Regulation 23.101 and any
foreign regulatory authority that has direct supervisory authority over
one or more SDs or MSPs that are eligible for substituted compliance
under Regulation 23.101 and that is responsible for administering the
relevant foreign jurisdiction's capital adequacy and financial
reporting requirements over the SD or MSP. The proposal would permit
eligible persons to request a Comparability Determination individually
or collectively with respect to the Commission's capital and financial
reporting requirements. Eligible SDs and MSPs may wish to coordinate
with their home regulators and other SDs or MSPs in order to simplify
and streamline the process. The Commission would make Comparability
Determinations on a jurisdiction-by-jurisdiction basis.
Persons requesting Comparability Determinations would need to
provide the Commission with certain documents and information in
support of their request. Notably, the proposal would require
requesters to provide copies of the relevant foreign jurisdiction's
capital and financial reporting requirements (including English
translations of any foreign language documents), descriptions of their
objectives and how they are comparable to or differ from the
Commission's capital and financial reporting requirements (e.g., the
net liquid assets approach and bank-based approach), international
standards such as Basel bank capital requirements, if applicable, and
how they address the elements of the Commission's capital requirements.
The requestors would need to identify the regulatory provisions that
correspond to the Commission's capital requirements (and, if necessary,
whether the foreign jurisdiction's capital requirements do not address
a particular element). Requesters would also need to provide a
description of the ability of the relevant foreign regulatory authority
or authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's capital requirements and any other information
and documentation the Commission deems appropriate.
The proposal identifies certain key factors that the Commission
would consider in making a Comparability Determination. Specifically,
the Commission would consider the scope and objectives of the relevant
foreign jurisdiction's capital requirements; how and whether the
relevant foreign jurisdiction's capital adequacy requirements compare
to international Basel capital standards for banking institutions or to
other standards such as those use for securities brokers or dealers;
whether the relevant foreign jurisdiction's capital requirements
achieve comparable outcomes to the Commission's corresponding capital
requirements; the ability of the relevant regulatory authority or
authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's capital adequacy and financial reporting
requirements; as well as any other facts or circumstances the
Commission deems relevant. In making a comparability determination, it
is possible that a foreign capital regime may be comparable in some,
but not all, elements of the Commission's capital requirements.
Proposed Regulation 23.106 would provide that any SD or MSP that,
in accordance with a Comparability Determination, complies with a
foreign jurisdiction's capital requirements would be deemed in
compliance with the Commission's corresponding capital adequacy and
financial reporting requirements. Accordingly, the failure of such an
SD or MSP to comply with the relevant foreign capital and financial
reporting requirements may constitute a violation of the Commission's
capital adequacy and financial reporting requirements. In addition, all
SDs and MSPs remain subject to the Commission's examination and
enforcement authority regardless of whether they rely on a
Comparability Determination. The proposal would further provide that
the Commission retains the authority to impose any terms and conditions
it deems appropriate in issuing a Comparability Determination and to
further condition, modify, suspend, terminate or otherwise restrict any
Comparability Determination it has issued in its discretion. This could
result, for example, from a situation where, after the Commission
issues a comparability determination, the basis of that determination
ceases to be true.
In this regard, Comparability Determinations issued by the
Commission would require that the Commission be notified of any
material changes to information submitted in support of a Comparability
Determination, including, but not limited to, changes in the relevant
foreign jurisdiction's supervisory or regulatory regime. The Commission
expects that the comparability determination process would require
close consultation, cooperation, and coordination with other
appropriate U.S. regulators and relevant foreign regulators. The
Commission would also expect that the relevant foreign regulator will
enter into, or will have entered into, an appropriate memorandum of
understanding or similar arrangement with the Commission in connection
with a Comparability Determination.
E. Technical Amendments
1. Amendments to the Financial Reporting Requirements in Regulation
1.10 and 1.16
Regulation 1.10 currently requires each FCM to file within 17
business days of the close of each month an unaudited financial with
the Commission and with the firm's designated self-regulatory
organization.\133\ Regulation 1.10 also requires each FCM to file
within 60 days of the end of the firm's fiscal year end an audited
annual financial report. An FCM's monthly financial reports must be
submitted on CFTC Form 1-FR-FCM, while the annual financial report may
be submitted on Form 1-FR-FCM or, subject to certain conditions,
presented in a manner consistent with U.S. GAAP.\134\
---------------------------------------------------------------------------
\133\ The term ``self-regulatory organization'' (``SRO'') is
defined in Regulation 1.3(ee) as a contract market (as defined in
Regulation 1.3(h)), a swap execution facility (as defined in
Regulation 1.3(rrrr)), or a registered futures association under
section 17 of the Act. The term ``designated self-regulatory
organization'' is defined in Regulation 1.3(ff) and generally means
the SRO that has primary financial surveillance responsibilities
over a registrant.
\134\ See Regulation 1.10(d)(3).
---------------------------------------------------------------------------
Regulation 1.10 requires each IB to file an unaudited financial
report with NFA on a semi-annual basis, and an audited annual financial
report with the NFA. The IB unaudited reports must be submitted on Form
1-FR-IB and the audited annual report may be filed on Form 1-FR-IB or,
subject to certain conditions, presented in a manner consistent with
U.S. GAAP.
Regulation 1.10(h) currently provides relief from the Form 1-FR
filing requirements to FCMs or IBs that are dually-registered as BDs.
Such dual-registrants are permitted to file the SEC's Financial and
Operational Combined Uniform Single Report under the Securities
Exchange Act of 1934, Part II, Part IIA, or Part II CSE (FOCUS Report),
in lieu of a Form 1-FR-FCM or Form 1-FR-IB.
The Commission is proposing to amend Regulation 1.10(h) to permit
an
[[Page 91282]]
FCM or IB that is dually-registered as SBSD or MSBSP to file its SEC
FOCUS Report in lieu of a CFTC Form 1-FR-FCM or CFTC Form 1-FR-IB. The
proposed amendment would be consistent, as noted above, with the
current relief provided to entities that are dually-registered as an
FCM and a BD. Furthermore, the Commission's experience with Regulation
1.10(h) indicates that the FOCUS Reports include information that is
substantially comparable to the Form 1-FR and adequate for the
Commission to conduct financial surveillance of the registrant.
Regulations 1.10(f) and 1.16(f) currently provide that a dually-
registered FCM/BD or IB/BD may automatically obtain an extension of
time to file its unaudited and audited financial reports required under
Regulation 1.10 by submitting a copy of the written approval for the
extension issued by the BD's securities designated examining authority
(``DEA''). The Commission is proposing to amend Regulations 1.10(f) and
1.16 to provide that an FCM or IB that is also registered with the SEC
as a SBSD or MSBSP may obtain the automatic extension of time to file
its unaudited or audited FOCUS Report or Form SBS with the Commission
and with the firm's DSRO, as applicable, by submitting a copy of the
SEC's or the DEA's approval of the extension request. This proposed
amendment maintains the intent of the current regulations by retaining
a consistent approach to the granting to dual registrants extensions of
time to file financial reports. The Commission also is proposing a
technical amendment to Regulation 1.16 to correct a cross reference to
SEC Rule 17a-5 (17 CFR 240.17a-5) for extensions of time to file
audited financial statements.
2. Amendments to the Notice Provisions in Regulation 1.12
Regulation 1.12 requires an FCM or IB to file a notice with the
Commission and with the firm's DSRO when certain prescribed events
occur that trigger a notice filing requirement. Such events include the
firm: (1) Failing to maintain compliance with the Commission's capital
requirements or the capital rules of a SRO; (2) failing to hold
sufficient funds in segregated or secured amount accounts to meet its
regulatory requirements; (3) failing to maintain current books and
records; and (4) experiencing a significant reduction in capital from
the previous month-end.
The Commission is proposing several amendments to Regulation 1.12.
The proposed amendments to Regulation 1.12(a) would revise the
obligation of an FCM or IB to file a notice when it fails to meet the
capital requirement of the Commission or of an SRO to include if the
firm fails to meet the SEC's capital requirements when the firm is a
dual-registrant. Such notice is appropriate as it would provide
Commission staff with the opportunity to assess the potential impact on
its CFTC regulated activities, and to initiate discussions with the SEC
regarding the capital deficiency.
Commission Regulation 1.12(b) requires an FCM or IB to file notice
with the Commission and with the firm's DSRO if the firm's adjusted net
capital falls below the applicable ``early warning level'' set forth in
the regulation.\135\ The Commission is proposing amendments to
Regulation 1.12(b) to require an FCM or IB that is also registered with
the SEC as a SBSD or a MSBSP to file a notice if the SBSD or MSBSP
falls below the ``early warning level'' established in the rules of the
SEC. The proposal is intended to provide additional information to the
Commission in its efforts to monitor the financial condition of its
registrants.
---------------------------------------------------------------------------
\135\ If an FCM's or IB's adjusted net capital falls below a
certain threshold, such as 120 percent of its minimum adjusted net
capital requirement, the firm is deemed to be maintaining adjusted
net capital at a level below its ``early warning level.''
---------------------------------------------------------------------------
3. Commissions Receivable for Certain Swap Transactions in Regulation
1.17
The Commission is proposing to amend Regulation 1.17(c)(2)(ii)(B)
to codify several staff no-action letters that permit IBs to reflect
certain commissions receivable balances from swap transactions that are
aged not more than 60 days from the month-end accrual date as a current
asset in computing the IB's adjusted net capital, provided that the
commissions are promptly billed. The proposed amendments would extend
the current asset treatment to commission receivables from both cleared
swaps and uncleared swaps.
4. Changes to Notice and Disclosure Requirements for Bulk Transfers in
Regulation 1.65
Regulation 1.65 describes the notice and disclosure requirements to
customers and to the Commission, which must be given prior to the
transfer of customer accounts other than at the request of the
customer, to another futures commission merchant or introducing broker.
Regulation 1.65(b) requires that notice of such a transfer be filed
with the Commission at least five business days in advance of the
transfer if the transfer meets certain enumerated conditions. Further,
Regulation 1.65(d) requires, among other things, that such notice to
the Commission must be filed by mail, addressed to the Deputy Director,
Compliance and Registration Section, Division of Swap Dealer and
Intermediary Oversight and does not provide for electronic filing.
Finally, Regulation 1.65(e) provides that in the event notice cannot be
filed with the Commission within five days, then it must be filed as
soon as practicable and no later than the day of the transfer along
with a brief statement explaining the circumstances necessitating the
delay in filing.
The Commission has found that five days' notice, when given, is
often not a sufficient amount of time to allow the Commission to
oversee the bulk transfer of customer accounts. Accordingly, the
Commission is proposing to amend Regulation 1.65(b) to require that the
notice of a bulk transfer of customer accounts be filed with the
Commission at least ten business days in advance of a transfer. The
Commission notes that bulk transfers of customer accounts are generally
planned well in advance such that the FCM should be able to provide the
Commission ten days advance notice of such a transfer. The Commission
is also proposing to amend Regulation 1.65(d) to require the notice to
be filed electronically. This is consistent with the filing
requirements of other notices and financial forms with the Commission,
which are already required to be filed electronically. The Commission
notes that the electronic system to file such notices already exists
and is in use by registrants, therefore, this change should not result
in any additional costs either to the Commission or to registrants.
Finally, the Commission is proposing to amend Regulation 1.65(e) to
delegate to the Director of the Division of Swap Dealer and
Intermediary Oversight the authority to accept a lesser time period for
the notification provided for in Regulation 1.65(b). However, the
notice must be filed as soon as practicable and in no event later than
the day of the transfer.
5. Conforming Amendments to Delegated Authority Provisions in
Regulation 140.91
Commission Regulations 1.10, 1.12, and 1.17 reserve certain
functions to the Commission, the greater part of which the Commission
has delegated to the Director of the Division of Swap Dealer and
Intermediary Oversight through the provisions of Regulation 140.91. The
Commission proposes to amend Regulation 140.91 to provide similar
delegations with respect to functions reserved to the Commission in
part 23.
Proposed Regulation 23.101(c) would require an SD or MSP to be in
[[Page 91283]]
compliance with the minimum regulatory capital requirements at all
times and to be able to demonstrate such compliance to the Commission
at any time. Proposed Regulation 23.103(d) would require an SD or MSP,
upon the request of the Commission, to provide the Commission with
additional information regarding its internal models used to compute
its market risk exposure requirement and OTC derivatives credit risk
requirement. Proposed Regulation 23.105(a)(2) would require an SD or
MSP to provide the Commission with immediate notification if the SD or
MSP failed to maintain compliance with the minimum regulatory capital
requirements, and further authorizes the Commission to request
financial condition reporting and other financial information from the
SD or MSP. Proposed Regulation 23.105(d) authorizes the Commission to
direct an SD or MSP that is subject to capital rules established by a
prudential regulator, or has been designated a systemically important
financial institution by the Financial Stability Oversight Council and
is subject to capital requirements imposed by the Board of Governors of
the Federal Reserve System to file with the Commission copies of its
capital computations for any periods of time specified by the
Commission.
The Commission is proposing to amend Regulation 140.91 to delegate
to the Director of the Division of Swap Dealer and Intermediary
Oversight, or the Director's designee, the authority reserved to the
Commission under proposed Regulations 23.101(c), 23.103(d), and
23.105(a)(2) and (d). The delegation of such functions to staff of the
Division of Swap Dealer and Intermediary Oversight is necessary for the
effective oversight of SDs and MSPs compliance with minimum financial
and related reporting requirements. The delegation of authority also is
comparable to the authorities currently delegated to staff under
Regulation 140.91 regarding the supervision of FCMs compliance with
minimum financial requirements.
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.\136\ This
proposed rulemaking would affect the obligations of SDs, MSPs, FCMs,
and IBs. The Commission has previously determined that SDs, MSPs, and
FCMs are not small entities for purposes of the RFA.\137\ Therefore,
the requirements of the RFA do not apply to those entities. The
Commission has found it appropriate to consider whether IBs should be
deemed small entities for purposes of the RFA on a case-by-case basis,
in the context of the particular Commission regulation at issue.\138\
As certain IBs may be small entities for purposes of the RFA, the
Commission considered whether this proposed rulemaking would have a
significant economic impact on such registrants. Only a few of the
regulations included in this proposed rulemaking, the amendment of
Commission regulations 1.10, 1.12, 1.16 and 1.17, will impact the
obligations of IBs. As discussed above, these amendments will permit
the filing and harmonization of financial reporting and notification
rules as adopted by the SEC for dual registered SBSD and MSBSPs and
accommodate common billing practices in the swap industry surrounding
the collection of commission receivables. Because these amendments
benefits IBs, they are not expected to impose any new burdens or costs
on them. The Commission does not, therefore, expect small entities to
incur any additional costs as a result of this proposed rulemaking.
---------------------------------------------------------------------------
\136\ 5 U.S.C. 601 et seq.
\137\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982) (FCMs) and Registration of Swap Dealers
and Major Swap Participants, 77 FR 2613, 2620 (Jan. 19, 2012) (SDs
and MSPs).
\138\ See Introducing Brokers and Associated Persons of
Introducing Brokers, Commodity Trading Advisors and Commodity Pool
Operators; Registration and Other Regulatory Requirements, 48 FR
35248, 35276 (Aug. 3, 1983).
---------------------------------------------------------------------------
Accordingly, for the reasons stated above, the Commission believes
that this proposed rulemaking will not have a significant economic
impact on a substantial number of small entities. Therefore, the
Chairman, on behalf of the Commission, hereby certifies, pursuant to 5
U.S.C. 605(b), that the proposed regulations being published today by
this Federal Register release will not have a significant economic
impact on a substantial number of small entities. The Commission
invites comment on the impact of this proposal on small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \139\ 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 an amendment to existing collection of information
``Regulations and Forms Pertaining to Financial Integrity of the Market
Place; Margin Requirements for SDs/MSPs'' \140\ as discussed below. The
Commission, therefore, is submitting this proposed rulemaking to the
Office of Management and Budget (``OMB'') for its review and approval
in accordance with 44 U.S.C. 3507(d) and 5 CFR Regulation 1320.11.
---------------------------------------------------------------------------
\139\ 44 U.S.C. 3501 et seq.
\140\ See OMB Control No. 3038-0024, http://www.reginfo.gov/public/do/PRAOMBHistory?ombControlNumber=3038-0024 (last visited
Apr. 7, 2016). This collection is being retitled ``Regulations and
Forms Pertaining to Financial Integrity of the Market Place.''
---------------------------------------------------------------------------
The responses to this collection of information are mandatory. An
agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a currently
valid control number issued by OMB.
1. New Information Collection Requirements and Related Burden Estimates
\141\
---------------------------------------------------------------------------
\141\ This discussion does not include information collection
requirements that are included under other Commission regulations
and related OMB control numbers. For example, Proposed Commission
Regulation 1.17(c)(5)(iii)(E)(4) would require that appropriate
documentation of qualifying master netting agreements be maintained
by dual-registered FCM-SDs for purposes of certain margin deductions
from net capital. As noted in the Margin rulemaking, this collection
is already covered under OMB Control Number 3038-0088 pertaining to
swap trading relationship documentation. See 81 FR 636, 680 (Jan. 6,
2016).
---------------------------------------------------------------------------
Currently, there are approximately 104 SDs and no MSPs
provisionally registered with the Commission that may be impacted by
this proposed rulemaking and, in particular, the collections of
information contained herein and discussed below.\142\
---------------------------------------------------------------------------
\142\ The number of impacted SDs and MSPs is significantly
smaller than the 300 expected in the Commission's previous proposed
rulemaking, and the Commission has reduced its burden estimates
accordingly herein. See, Capital Requirements of Swap Dealers and
Major Swap Participants, 76 FR 27802 (May 12, 2011).
---------------------------------------------------------------------------
i. Form SBS
The proposed amendments to Commission regulation 1.10(h) would
allow an FCM or IB that is also a securities broker or dealer to file,
subject to certain conditions, its Form SBS in lieu of its Form 1-FR.
Because these amendments would provide an alternative to filing Form 1-
FR, the Commission believes that the amendments would not cause FCMs or
IBs to incur any additional burden. Rather, to the extent that the
proposed rule provides an alternative to filing a Form 1-FR and is
elected by FCMs or
[[Page 91284]]
IBs, it is reasonable for the Commission to infer that the alternative
is less burdensome to such FCMs and IBs.
The proposed amendments to Commission regulation 1.10(f) would
allow an FCM or IB that is dually-registered with the SEC as either a
SBSD or MSBSP to request an extension of time to file its uncertified
Form SBS. The Commission is unable to estimate with precision how many
requests it would receive from registrants under proposed Sec. 1.10(f)
in relation to Form SBS annually. The Commission anticipates that it
would receive one such request in the aggregate annually, and that
preparing such a request would consume five burden hours, resulting in
an annual increase in burden of five hours in the aggregate.
ii. Notice of Failure To Maintain Minimum Financial Requirements
Commission regulations 1.12(a) and (b) currently require FCMs and
IBs, to file notices if they know or should have known that certain
specified minimum financial thresholds have been exceeded. The
amendments to Commission regulation 1.12(a) and (b) would add as an
additional threshold for such notices certain financial requirements of
the SEC if the applicant or registrant is registered with the SEC as an
SBSD or MSBSD. The Commission is unable to estimate with precision how
many additional notices it would receive from such entities as a result
of the additional minimum threshold. In an attempt to provide
conservative estimates, the Commission anticipates that it would
receive 10 such notices in the aggregate annually, and that preparing
such a notice would consume five burden hours, resulting in an annual
increase in burden of 50 hours in the aggregate.
iii. Requests for Extensions of Time To File Financial Statements
The proposed amendments to Commission regulation 1.16(f) would
allow an FCM or IB that is registered with the SEC as an SBSD or MSBSP
to request an extension of time to file its audited annual financial
statements.\143\ The Commission is unable to estimate with precision
how many of such requests it would receive from such entities. The
Commission anticipates that it would receive one of such requests in
the aggregate annually, and that preparing such a request would consume
five burden hours, resulting in an annual increase in burden of five
hours in the aggregate.
---------------------------------------------------------------------------
\143\ The registrant would also be required to promptly file
with the DSRO designated self-regulatory organization and the
Commission copies of any notice it receives from its designated
examining authority to approve or deny the requested extension of
time.
---------------------------------------------------------------------------
iv. Capital Requirement Elections
Proposed Commission regulation 23.101(a)(7) would require that
certain SDs that wish to change their capital election submit a written
request to the Commission and provide any additional information and
documentation requested by the Commission. The Commission is unable to
estimate with precision how many of such requests it would receive from
such entities. The Commission anticipates that it would receive one
such request in the aggregate annually, and that preparing such a
request would consume five burden hours, resulting in an annual
increase in burden of five hours in the aggregate.
v. Application for Use of Models
Commission regulation 23.102(a) would allow an SD to apply to the
Commission or an RFA of which it is a member for approval to use
internal models when calculating its market risk exposure and credit
risk exposure under Sec. Sec. 23.101(a)(1)(i)(B), 23.101(a)(1)(ii)(A),
or 23.101(a)(2)(ii)(A), by sending to the Commission and such RFA an
application, including the information set forth in Appendix A to
Commission regulation 23.102 and meeting certain other requirements.
Proposed Commission regulation 1.17(c)(6)(v) relatedly would allow an
FCM that is also an SD to apply in writing to the Commission or an RFA
of which it is a member for approval to compute deductions for market
risk and credit risk using internal models in lieu of the standardized
deductions otherwise required under Commission regulation 1.17.\144\
---------------------------------------------------------------------------
\144\ Note that the changes to proposed 1.17(c)(6)(i), which
permit any dual registered FCM Broker-Dealer who has received
approval by the SEC under Sec. 240.15c3-1(a)(7) to use models to
calculate its market and credit risk charges, do not add an
additional collection of information and therefore are not
considered in this analysis.
---------------------------------------------------------------------------
Appendices A and B to Commission regulation 23.102 contain further
related information collection requirements, including that the SD: (i)
Provide notice to the Commission and RFA and/or update its application
and related materials for certain inaccuracies and amendments; (ii)
notify the Commission or RFA before it ceases to use such internal
models to compute deductions; (iii) if a VaR model is used, have an
annual review of such model conducted by a qualified third party
service, (iv) conduct stress-testing, retain and make available to the
Commission and the RFA records of the results and all assumptions and
parameters thereof, and notify the Commission and RFA promptly of
instances where such tests indicate any material deficiencies in the
comprehensive risk model; (v) demonstrate to the Commission or the RFA
that certain additional conditions have been satisfied and retain and
make available to the Commission or the RFA records related thereto;
and (vi) comply with additional conditions that may be imposed on the
SD by the Commission or the RFA.
As discussed above, there are currently 104 SDs and 0 MSPs
provisionally registered with the Commission. Of these, the Commission
estimates that approximately 53 SDs and no MSPs would be subject to the
Commission's capital rules as they are not subject to the capital rules
of a prudential regulator. The Commission further estimates
conservatively that 32 of these SDs would seek to obtain Commission
approval to use models for computing their market and credit risk
capital charges.
The Commission staff estimates that an SD approved to use internal
models would spend approximately 5,600 hours per year to review and
update the models and approximately 640 hours per year to back-test the
models for the aggregate of 6240 annual burden hours for each SD.\145\
Consequently, Commission staff estimates that reviewing and back-
testing the models for the 32 SDs would result in an aggregate annual
hour burden of approximately 199,680 hours.\146\
---------------------------------------------------------------------------
\145\ Id. at 70294.
\146\ 343,200 is the product of 55 and the sum of 5,600 and 640.
---------------------------------------------------------------------------
vi. Liquidity Requirements
Commission regulation 23.104 proposes additional liquidity
requirements and equity withdrawal restrictions on certain SDs.
Commission regulation 23.104(a)(2) would provide that certain SDs may
not dispose of, or transfer to an affiliate, a high quality liquid
asset without prior notice to and approval by the Commission. Section
23.104(a)(3) would require certain SDs to have a written contingency
funding plan that addresses the SD's policies and the roles and
responsibilities of relevant personnel for meeting the liquidity needs
of the SD and communicating with the public and other market
participants during a liquidity stress event.
Commission regulations 23.104(a)(2) and 23.104(a)(3) apply only to
SDs that have elected to be subject to the requirements of
23.101(a)(1)(i) as if the
[[Page 91285]]
SD were regulated by the Federal Reserve Board. Out of the 104
provisionally registered SDs, the Commission currently estimates that
16 SDs will elect to be subject to the requirements of 23.101(a)(1)(i).
Accordingly, the Commission estimates these proposed regulations will
add 50 burden hours per month, or 600 burden hours per year, for each
of the 16 electing SDs, resulting in a an aggregate annual burden of
9,600.
Commission regulation 23.104(b)(1) would require that certain SDs
perform a monthly liquidity stress test, provide the results of that
test to senior management, and perform a quarterly and annual reviews
with appropriate levels of management. Commission regulation
23.104(b)(2) would require that an SD document any differences with
those of the liquidity stress test of the consolidated parent and
regulation 23.104(b)(4) would require that an SD have a written
contingency funding plan. Regulation 23.104(b) applies only to SDs that
have elected to be subject to the requirements of regulation
23.101(a)(1)(ii). The Commission estimates that 11 SDs out of the 104
provisionally registered will fall into this category and that all 11
will be part of a consolidated entity that performs a liquidity stress
test. As such, the Commission estimates that the proposed regulations
will add 50 burden hours per month, or 600 burden hours per year,
resulting in an aggregate annual burden of 6,600 hours.
Commission regulation 23.104(c) would allow an SD to apply in
writing for relief from restrictions on certain equity withdrawals.
Regulation 23.104(c) applies to SDs that have elected to comply under
regulation 23.101(a)(1)(i) and 23.101(a)(1)(ii). Commission staff
estimates that 28 of the 104 currently provisionally registered SDs
would be subject to this regulation. Commission staff estimates that
each of these 28 SDs would file approximately two notices annually with
the Commission and that it would take approximately 30 minutes to file
each of these notices. This results in an aggregate annual hour burden
estimate of approximately 28 hours.
vii. Financial Recordkeeping, Reporting and Notification Requirements
for SDs and MSPs
Commission regulation 23.105 would require generally that each SD
and MSP maintain certain specified records, report certain financial
information and notify or request permission from the Commission under
certain specified circumstances, in each case, as provided in the
proposed regulation. For example, the regulation requires generally
that SDs and MSPs maintain current books and records, provide notice to
the Commission of regulatory capital deficiencies and related
documentation, provide notice of certain other events specified in the
proposed rule, and file financial reports and related materials with
the Commission (including the information in Appendix A and B to the
proposed regulation, as applicable). Regulation 23.105 also requires
the SD or MSP to furnish information about its custodians that hold
margin for uncleared swap transactions and the amounts of margin so
held, and for SDs approved to use models (as discussed above), provide
additional information regarding such models, as further described in
regulation 23.105(k).
The Commission estimates that there are 28 SD firms which will be
required to fulfill their financial reporting, recordkeeping and
notification obligations under Regulation 23.105(a)-23.105(n) because
they are not subject to a prudential regulator, not already registered
as an FCM, and not dually registered as a SBSD. The Commission expects
these 28 firms will apply to use models. Commission staff estimates
that the preparation of monthly and annual financial reports for these
SDs, including the recordkeeping, related notification and preparation
of the specific information required in proposed Appendix A to
regulation 23.105, would impose an on-going burden of 250 hour per firm
annually. The Commission further estimates it would cost each SD
$300,000 to retain an independent public accountant to audit its
financial statements each year. Thus, the total burden hours estimated
for compliance with 23.105(a)-23.105(n) for these 28 SD firms would be
7,000 hours annually.
Regulation 23.105(p) and its accompanying Appendix B propose a
quarterly financial reporting and notification obligations on SDs which
are subject to a prudential regulator. The Commission expects that
approximately 51 of the 104 currently provisionally registered SDs are
subject to a prudential regulator. The Commission estimates that this
proposed reporting and notification requirements will impose a burden
of 33 hours on-going annually. This results in a total aggregate burden
of 1,683 hours annually.
Regulation 23.105(q) requires all SDs and MSPs to report to the
Commission weekly summary position and margin data. The Commission
expects that all 104 SDs and no MSPs will be subject to this
requirement. The Commission estimates that it would impose 520 burden
hours per firm annually. This results in total aggregate burden of
54,080 hours annually.
viii. Capital Comparability Determinations
Commission regulation 23.106 would allow certain SDs, MSPs, and
foreign regulatory authorities to request a Capital Comparability
Determination with respect to capital adequacy and financial reporting
requirements for SDs or MSPs, as discussed above. As part of this
request, persons are required to submit to the Commission certain
specified supporting information and further information, as requested
by the Commission. Further, if such a determination was made by the
Commission, an SD or MSP would be required to file a notice with the
RFA of which it is a member of its intent to comply with the capital
adequacy and financial reporting requirements of the foreign
jurisdiction. Moreover, in issuing a Capital Comparability
Determination, the Commission would be able to impose any terms and
conditions it deems appropriate, including additional capital and
financial reporting requirements.
The Commission expects that 17 firms out of the 104 currently
provisionally registered SDs would seek Capital Comparability
Determinations. These 17 firms are located in five different
jurisdictions, all of which appear to have adopted some level of Basel
compliant capital rule or another capital rule that would apply to SDs.
As such, Commission staff estimates that it will take approximately ten
hours per firm annually to prepare and submit requests for Capital
Comparability Determinations and otherwise comply with the requirements
of proposed Regulation 23.106, resulting in aggregate annual burden of
170 hours.
2. Information Collection Comments
The Commission invites the public and other Federal agencies to
comment on any aspect of the proposed information collection
requirements discussed above. Pursuant to 44 U.S.C.3506(c)(2)(B), the
Commission will consider public comments on such proposed requirements
in:
Evaluating whether the proposed collections of information
are necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
Evaluating the accuracy of the estimated burden of the
proposed information collection requirements, including the degree to
which the
[[Page 91286]]
methodology and the assumptions that the Commission employed were
valid;
Enhancing the quality, utility, and clarity of the
information proposed to be collected; and
Minimizing the burden of the proposed information
collection requirements on respondents, including through the use of
appropriate automated, electronic, mechanical, or other technological
information collection techniques, e.g., permitting electronic
submission of responses.
Copies of the submission from the Commission to OMB are available
from the CFTC Clearance Officer, 1155 21st Street NW., Washington, DC
20581, (202) 418-5160 or from http://RegInfo.gov. Organizations and
individuals desiring to submit comments on the proposed information
collection requirements should send those comments to the OMB Office of
Information and Regulatory Affairs at:
The Office of Information and Regulatory Affairs, Office
of Management and Budget, Room 10235, New Executive Office Building,
Washington, DC 20503, Attn: Desk Officer of the Commodity Futures
Trading Commission;
(202) 395-6566 (fax); or
[email protected] (email).
Please provide the Commission with a copy of submitted comments so
that all comments can be summarized and addressed in the final rule
preamble. Please refer to the ADDRESSES section of this rulemaking and
the margin rulemaking for instructions on submitting comments to the
Commission. OMB is required to make a decision concerning the proposed
information collection requirements between thirty (30) and sixty (60)
days after publication of the NPRM in the Federal Register. Therefore,
a comment to OMB is best assured of receiving full consideration if OMB
(as well as the Commission) receives it within thirty (30) days of
publication of this NPRM.
IV. Cost Benefit Considerations
A. Background
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its discretionary actions before promulgating a
regulation under the CEA or issuing certain orders.\147\ Section 15(a)
further specifies that the costs and benefits shall be evaluated in
light of five broad areas of market and public concern: (1) Protection
of market participants and the public; (2) efficiency, competitiveness,
and financial integrity of futures markets; (3) price discovery; (4)
sound risk management practices; and (5) other public interest
considerations. In this cost benefit section, the Commission discusses
the costs and benefits resulting from its discretionary determinations
with respect to the section 15(a) factors.\148\ In addition, in
Appendix A to this section, the Commission, using available data,
estimates the cost of the proposal to each type of SD or MSP and the
overall market.
---------------------------------------------------------------------------
\147\ U.S.C. 19(a).
\148\ The Commission notes that the costs and benefits
considered in this proposal, and highlighted below, have informed
the policy choices described throughout this release.
---------------------------------------------------------------------------
This proposed rulemaking implements the new statutory framework of
Section 4s(e) of the CEA, added by Section 731 of the Dodd-Frank Act,
which requires the Commission to adopt capital requirements for SDs and
MSPs that do not have a prudential regulator (i.e., ``covered swap
entities'' or ``CSEs'') and amends Commission Regulation 1.17 to impose
specific market risk and credit risk capital charges for uncleared swap
and security-based swap positions held by an FCM.\149\ Section 4s(e) of
the CEA requires the Commission to adopt minimum capital requirements
for CSEs that are designed to help ensure the CSE's safety and
soundness and be appropriate for the risk associated with the uncleared
swaps held by a CSE. In addition, section 4s(e)(2)(C) of the CEA,
requires the Commission to set capital requirements for CSEs that
account for the risks associated with the CSE's entire swaps portfolio
and all other activities conducted by the CSE. Lastly, section
4s(e)(3)(D) of the CEA provides that the Commission, the prudential
regulators, and the SEC, must ``to the maximum extent practicable''
establish and maintain comparable capital rules. The proposal also
includes certain financial reporting requirements related to an SDs and
MSPs financial condition and capital requirements.
---------------------------------------------------------------------------
\149\ See Section 4s(e)(2)(B).
---------------------------------------------------------------------------
In the following cost-benefit considerations, the Commission will
discuss the costs and benefits of this proposal and some critical
decisions it made in developing this proposal. The Commission will: (i)
Discuss the general benefits and costs of regulatory capital; (ii)
summarize the proposal; (iii) set the baseline for which the cost and
benefits of this proposal will be compared; (iv) provide an overview of
the different capital approaches set out in this proposal and the
rationale for proposing each approach; (v) set out the costs and
benefits to each type of SD and MSP under their corresponding capital
approaches; (vi) discuss the proposal's liquidity and funding
requirements; (vii) discuss the proposal's reporting requirements; and
(viii) an analyze the proposal as it relates to each of the 15(a)
factors.
B. Regulatory Capital
Regulatory capital is designed to ensure that a firm will have
enough capital, in times of financial stress, to cover the risk
inherent of the activities in the firm. Regulatory capital's framework
can be designed differently, but its primary purpose remains the same--
to meet this objective. Although a firm may mitigate its risks through
other methods, including risk management techniques (e.g., netting,
credit limits, margin), capital is viewed as the last line of defense
of an entity, ensuring its viability in times of financial stress. In
designing this proposal, the Commission was cognizant of the purpose of
capital and the potential trade-off between the costs of requiring
additional capital and the Commission's statutory mandate of helping to
ensure the safety and soundness of SDs and MSPs thereby promoting the
stability of the U.S. financial system.
C. General Summary of Proposal
The Commission designed this proposal on well-established existing
capital regimes. The proposal's framework, which draws upon the
principles and structures of bank-based capital, broker-dealer capital,
and FCM capital, provides CSEs, operating under a current capital
regime, with the ability to continue to comply with that regime, with
minor adjustments to account for the inherent risk of swap dealing and
to mitigate regulatory arbitrage. The Commission, in developing its
capital framework, provides CSEs with the flexibility to continue
operating under a similar capital framework, which should result in
minor disruptions to the markets and mitigate the possibility of
duplicative or even conflicting rules, while helping to ensure the
safety and soundness of the CSE and the stability of the U.S. financial
system.
The proposal details minimum capital requirements for different
``types'' or ``categories'' of CSEs and further defines the capital
computations, including various market risk and credit risk charges,
whether using models or a standardized rules-based or table-based
approach, to determine whether a CSE satisfies the minimum capital
requirements. The Commission is proposing to permit SDs that are
neither
[[Page 91287]]
registered as FCMs nor subject to the capital rules of a prudential
regulator to elect a capital requirement that is based on existing bank
holding company (``BHC'') capital rules adopted by the Federal Reserve
Board (the ``bank-based capital approach'') or a capital requirement
that is based on the existing FCM/BD net capital rules (the ``net
liquid assets capital approach''). The Commission is also proposing to
permit certain SDs that meet defined conditions designed to ensure that
they are ``predominantly engaged in non-financial activities'' to
compute their minimum regulatory capital based upon the firms' tangible
net worth (the ``tangible net worth capital approach''). Further, the
Commission is proposing to allow SDs to obtain approval from the
Commission, or from an RFA of which the SDs are members, to use
internal models to compute certain market risk and credit risk capital
charges when calculating their capital.\150\
---------------------------------------------------------------------------
\150\ Section 17 of the CEA sets forth the registration
requirements for RFAs. RFAs are defined as self-regulatory
organizations under Regulation 1.3(ee). The Commission recognizes
that SDs that seek model approval from the Commission or from an RFA
will be required to submit documentation addressing several capital
models including value at risk, stressed value at risk, specific
risk, comprehensive risk and incremental risk. To the extent that
models are reviewed and approved by an RFA, additional costs may be
incurred by the RFA which may be passed on to the SDs.
---------------------------------------------------------------------------
The Commission is proposing to require SDs that elect to use the
bank-based capital approach or the net liquid assets capital approach
to perform prescribed liquidity stress testing and to maintain liquid
assets above defined levels. The Commission is further proposing to
impose certain restrictions on the withdrawal of capital from SDs if
certain defined triggers are breached.
The proposal also establishes a program of ``substituted
compliance'' that would allow a CSE that is organized and domiciled in
a non-U.S. jurisdiction (``non-U.S. CSE'') (or an appropriate
regulatory authority in the non-U.S. CSE's home country jurisdiction)
to petition the Commission for a determination that the home country
jurisdiction's capital and financial reporting requirements are
comparable to the CFTC's capital and financial reporting requirements
for such CSE, such that the CSE may satisfy its home country
jurisdiction's capital and financial reporting requirements (subject to
any conditions imposed by the Commission) in lieu of the Commission's
capital and financial reporting requirements (i.e., ``Comparability
Determination'').
Consistent with section 4s(f), the Commission is proposing to
require SDs and MSPs to satisfy current books and records requirements,
``early warning'' and other notification filing requirements, and
periodic and annual financial report filing requirements with the
Commission and with any RFA of which the SDs and MSPs are members.
D. Baseline
In determining the costs and benefits of this proposal, the
Commission's benchmark from which this proposal is compared against is
the market's status quo, i.e., the swap market as it exists today. As
the proposal will implement capital and financial reporting on CSEs and
recordkeeping requirements on SDs and MSPs, the Commission will discuss
the incremental costs and benefits to each type or category of SD and
MSP, as to their current capital and financial reporting and
recordkeeping requirements. As each CSE or its parent holding company
may be complying with current capital requirements, based on capital
requirements that are a result of the entity or its parent entity
registering with a financial agency, as a result of it being a
financial intermediary (e.g., as an BD, FCM or BHC), the Commission has
set different baselines for each type or category of entity. In the
case that a CSE does not have current capital requirements, the
Commission considered the full cost and benefit of its proposal on the
entity. The following is a list of types or categories of registered
entities and their corresponding capital regimes that the CSE currently
complies with, if there is any, and their corresponding financial
reporting and capital requirements. Therefore, the Commission is using
the status quo or baseline for this proposal for the following types or
categories of CSEs:
(1) SDs That Are Bank Subsidiaries
(a) Capital. Currently U.S. CSEs that are bank subsidiaries and are
not a BD or an FCM are not subject to capital requirements; however, as
part of a BHC or a subsidiary of a bank, the CSE's parent entity must
comply with the prudential regulators' capital requirements. In
addition, certain non-U.S. CSEs that are subsidiaries within a bank
holding company and are not BDs or FCMs are currently complying with a
foreign jurisdiction's capital, liquidity and financial reporting
requirements and these CSEs are covered below, in the Substituted
Compliance section.
(b) Liquidity. Although the U.S. CSE entities do not have liquidity
or funding requirements, their BHC must comply with the Federal Reserve
Board's liquidity requirements.\151\
---------------------------------------------------------------------------
\151\ The Federal Reserve Board has proposed funding
requirements for certain large bank holding companies. See Net
Stable Funding Ratio: Liquidity Risk Measurement Standards and
Disclosure Requirements, 81 FR 35123 (Jun. 1, 2016).
---------------------------------------------------------------------------
(c) Reporting. These SDs do have reporting requirements, but not
for the information that is requested in this proposal; however, a BHC
must report the requested information to the Federal Reserve Board,
which includes certain swap and security-based swap positions held at
its SD subsidiary.
(2) SDs That Are BDs (Including, OTC Derivatives Dealers) (With and
Without Models)
(a) Capital. If a CSE is also registered as a BD with the SEC, the
CSE is already meeting the SEC's BD capital requirements.
(b) The SEC currently imposes the net liquid assets capital
approach on BDs. However, the SEC has modified certain parts of this
approach to address certain types of BDs (i.e., ANC Firms and OTC
derivatives dealers). As discussed below, an ANC Firm is currently
using SEC-approved capital models to calculate certain market and
credit risk charges. In addition, OTC derivatives dealers that are
registered as BDs may use SEC-approved capital models provided that
they maintain a minimum of $100 million in tentative net capital and at
least $20 million in net capital. Certain non-U.S. SDs are already
complying with capital, liquidity and reporting requirements in other
jurisdictions. Therefore, the Commission will cover these SDs in the
Substituted Compliance section.
(c) Liquidity. These SDs do not have any existing regulatory
liquidity requirements.
(d) Reporting. As a BD, these SDs must comply with the SEC's BD
reporting requirements (the Commission's proposed reporting
requirements are based on the SEC reporting requirements).
(3) SDs That Are FCMs and Not BDs (With and Without Models)
(a) Capital. For CSEs that are also registered with the Commission
as FCMs, the Commission is proposing a net liquid asset capital
approach that is similar to the capital requirements of a registered
BD.
(b) Liquidity. These SDs do not have existing regulatory liquidity
requirements.
(c) Reporting. As an FCM, these SDs must comply with the
Commission's FCM reporting requirements (the
[[Page 91288]]
Commission's proposed reporting requirements are based on these).
(4) SDs That Are BDs and/or FCMs (ANC Firms With Models and One Other
SD)
(a) Capital. For CSEs that are also registered as BDs/FCMs (using
approved models), a significant percentage of these SDs are currently
using the ANC capital approach, as discussed below. There is currently
one other SD that is not an ANC Firm, but meets the requirements set
out above for SD/BDs and SD/FCMs.
(b) Liquidity. These SDs must comply with the SEC's and the CFTC's
reporting requirements.
(c) Reporting. As an ANC firm, these SDs must comply with the SEC's
and the CFTC's ANC firm reporting requirements.
(5) Stand-Alone SDs and Commercial SDs (With and Without Models)
(a) Capital. Currently a CSE that is a stand-alone SD has no
capital requirements; however, certain non-US Stand-alone SDs are
complying with a foreign jurisdiction's capital, liquidity and
reporting requirements and therefore, will be included in the
Substituted Compliance benchmark below.
(b) Liquidity. These CSEs do not have existing liquidity
requirements.
(c) Reporting. As CSEs, these entities have reporting requirements,
but not for the information requested in this proposal.
(6) MSPs
(a) Capital. Although there are no MSPs at this time, it is
possible that an MSP in the future may have existing capital
requirements. For example, if a bank is determined to be an MSP or an
insurance company, these entities may have existing capital
requirements.
(b) Liquidity. These MSPs do not have existing regulatory liquidity
requirements.
(c) Reporting. As MSPs, these entities have reporting requirements,
but not for the information requested in this proposal.
(7) Substituted Compliance \152\
---------------------------------------------------------------------------
\152\ The Commission estimates that there are 17 SDs that may be
eligible for substituted compliance under this proposal.
---------------------------------------------------------------------------
(a) Capital. As discussed above, there are certain non-U.S. CSEs
that comply with a foreign jurisdiction's capital and financial
reporting requirements. Commission staff understands that generally
these foreign capital requirements are either a bank-based capital
regime or a dealer-based regime, which, as the Commission has been
informed by these foreign regulators, are similar to the net liquid
assets capital approach.
(b) Liquidity. The Commission is aware that there are certain
liquidity requirements that some of these non-U.S. CSEs are currently
complying with. The Commission understands that some of these non-U.S.
CSEs or their parent entities are complying with a bank-based liquidity
requirement.
(c) Reporting. The Commission understands that some of these non-
U.S. CSEs are currently complying with a foreign jurisdiction's
financial reporting requirements; however, these financial reporting
requirements may not be the same as the Commission is requiring in this
proposal.
(8) Prudentially Regulated SDs \153\
---------------------------------------------------------------------------
\153\ The Commission notes that under Section 4s(e) of the CEA,
these SDs must comply with the prudential regulators' capital
requirements, but must comply with the Commission's reporting and
recordkeeping requirements.
---------------------------------------------------------------------------
(a) Reporting. These SDs comply with their applicable prudential
regulator's reporting requirements.
E. Overview of Approaches
In developing the proposed capital approaches in this proposal, the
Commission selected from well-established frameworks. As a result of
the financial crisis and over the years after the crisis, each of the
approaches has undergone significant analysis and changes. After
conducting its analysis, BCBS and the prudential regulators
acknowledged that capital alone was not enough to prevent certain
financial entities from failing and, therefore, adopted requirements
for banks and bank holding companies to meet defined liquidity
requirements. As the financial crisis has shown, a firm can be
adequately capitalized, but due to a lack of liquidity or funding in
the firm, it may be unable to meet its current obligations.
Accordingly, the Commission is proposing to include in its capital
frameworks liquidity and funding requirements for SDs that are based
upon the liquidity and funding requirements adopted by the prudential
regulators and proposed by the SEC for SBSDs. As detailed above, the
Commission is not including BCBS's leverage ratio, as the Commission
believes that this ratio is designed to cover a consolidated entity
(i.e., the BHC), however, as noted above, the Commission may in the
future include a similar leverage requirement. In addition, the
Commission is not including a leverage ratio under the net liquid
assets approach, but may consider leverage requirements in the future.
Under the proposal, the Commission is providing certain CSEs with
an option to choose between a bank-based capital approach (similar to
the prudential regulators' capital approach) and a net liquid assets
capital approach (similar to the SEC's and CFTC's capital approach). As
detailed below, the bank-based capital approach is designed to require
an SD to have enough common equity tier 1 capital (as defined above) to
absorb losses in a time of stress, while the net liquid assets method
is designed to require an SD to hold at all times more than one dollar
of highly liquid assets for each dollar of unsubordinated liabilities.
The following table summarizes the Commission capital proposal
followed by a summary of each approach:
----------------------------------------------------------------------------------------------------------------
The greatest of the
Approaches SD entities Equity type following:
----------------------------------------------------------------------------------------------------------------
Bank-Based Capital................... Non-Bank Subsidiaries Common Tier 1 Equity... $20 million.
of BHC. 8% of RWA (Basel Model
Stand-Alone SDs........ or Regulation 1.17
BDs (including, OTC table) plus current
Derivatives Dealers counterparty credit
and ANC Firms).. risk.
8% of the total amount
of a swap dealer's
margin.
RFA.
[[Page 91289]]
Net Liquid Assets Capital............ Non-Bank Subsidiaries Net Discounted Assets $20 million or $100
Regulation 1.17...................... of BHC. (Assets - Liabilities million if approved to
FCMs (SDs)............. = Net Capital, which use capital models.
Stand-Alone SDs........ is discounted 8% of the total amount
(according to of a swap dealer's
Regulation 1.17)). margin.
RFA.
Net Liquid Assets Capital............ BDs (SDs).............. Net Discounted Assets $20 million.
SEC Rule 15c3-1...................... BDs (OTC Derivatives (Assets-Liabilities = 8% of the total amount
Dealers).. Net Capital, which is of a swap dealer's
discounted (according margin.
to SEA 15c3-1 or VaR RFA.
based models).
ANC.................................. ANC Firms.............. Net Discounted Assets $5 billion tentative
(Assets-Liabilities = net capital (not
Net Capital, which is discounted).\154\
discounted (VaR based $6 billion early
model). warning net capital
(not discounted).
$1 billion Net
Discounted Assets.
RFA.
Non-Financial Swap Dealers........... Non-financial Entities Equity................. $20 million plus market
(15% test). and credit risk
charges.
8% of the total amount
of a swap dealer's
margin.
RFA.
MSPs................................. MSP.................... Equity................. >=$1.
RFA.
----------------------------------------------------------------------------------------------------------------
1. Bank-Based Capital
Under the bank-based capital approach a CSE would need to maintain
common equity tier 1 capital equal to the greatest of the following:
---------------------------------------------------------------------------
\154\ The SEC is proposing to increase the minimum capital
requirements for ANC Firms to require the firms to maintain a
minimum of $1 billion of net capital and $5 billion of tentative net
capital. Under the SEC proposal, ANC Firms also must file a
regulatory notice (i.e., ``early warning notice'') with the SEC if
its tentative net is below $6 billion.
---------------------------------------------------------------------------
$20 million;
Eight percent of the sum of the following: (i) The amount
of its risk-weighted-assets (``RWA''), which is the market risk capital
charge under a VaR computation or a standardized formula table (Reg.
1.17); (ii) the amount of current counterparty credit risk (``CCR''),
which is the sum of the default risk capital charge and a credit value
adjustment (``CVA'') risk capital charge, which is under either a
standardized formula table or a VaR method;
Eight percent of the total amount of a swap dealer's
uncleared swap margin, uncleared security-based swap margin and initial
margin required for its cleared positions; or
The amount required by its RFA.
As noted above, the Commission is proposing a $20 million fixed-
dollar floor, as this is the minimum amount of required capital under
all proposed approaches. The Commission is proposing this minimum level
as it believes that this is the minimum amount of capital that should
be required for a CSE, without regard to the volume of swaps the CSE
engages in, to conduct its dealing activity. As noted above, this
amount is based on the Commission's experience with other registered
entities that are currently subject to capital requirements. The
Commission is also proposing, however, an eight percent of margin
requirement, as through its experience in supervising FCMs, it
recognizes that this capital computation is a determinative condition
in computing their required capital and requires an SD to maintain a
higher level of capital as the risks associated with its dealing
activities increases, as measured by the initial margin requirements on
the swaps positions. Moreover, under the net liquid assets approach,
the Commission is including the same eight percent margin requirement.
In calculating the eight percent of the total uncleared margin, the
Commission is including all uncollateralized exposures from uncleared
swaps (e.g., inter-affiliate swaps, swaps with commercial end users,
and legacy swaps), as these are exposures where no initial margin is
collected and, therefore, are part of the SD's counterparty credit
risk, which the Commission believes must be part of the SD's required
capital. The Commission believes that not requiring capital on these
uncollateralized amounts would leave a significant gap in determining a
level of capital that adequately reflects the overall risk of the SD
and would not help to ensure that safety and soundness of the SD.
In addition, the Commission is also requiring the inclusion of an
SD's required initial margin from clearing organizations for all its
cleared positions. The Commission's eight percent of margin requirement
is intended to serve as a proxy for the level of risk associated with
the SD's swap activities and proprietary trading. The Commission
believes it is appropriate to include the margin for both cleared and
uncleared products in this calculation as it provides a measure of the
potential risks posed by the cleared and uncleared positions.
In addition, the Commission has proposed to include a standardized
table for market risk that is currently not part of the BCBS or
prudential regulator capital framework. The Commission included the
standardized table in calculating an SD's market risk charges to
address SDs that do not use approved models in computing market risk
charges. The Commission included the Regulation 1.17 standard market
risk charges, as it believes these charges result in adequate capital
computations for the level of market risk inherent in these financial
instruments. In addition, the Commission is currently using these
standardized charges in computing an FCM's market risk charges on the
same financial instruments for an FCM's required capital.
2. Net Liquid Assets
Under this proposed approach, an SD would be required to maintain
minimum net capital equal to or exceeding the greatest of:
$20 million; or
Eight percent of the total amount of a swap dealer's
uncleared swap margin,
[[Page 91290]]
uncleared security-based swap margin and initial margin required for
its cleared positions.
Net capital is generally defined as an SD's current and liquid
assets minus its liabilities (excluding certain qualifying subordinated
debt), with the remainder discounted according to either a CFTC-
approved VaR-based model or a standardized rules-based approach set out
in Regulation 1.17.
As noted and discussed above, under this approach, the Commission
is proposing a $20 million fixed-dollar floor. In addition, the
Commission is proposing, under this approach, a net liquid assets test
that is designed to allow an SD to engage in activities that are part
of its swaps business (e.g., holding risk inherent in swaps into its
dealing inventory), but in a manner that places the SD in the position
of holding at all times more than one dollar of highly liquid assets
for each dollar of unsubordinated liabilities (e.g., money owed to
customers, counterparties, and creditors). Further, the Commission is
requiring a liquidity ratio and a funding plan under this approach. The
Commission believes that the net liquid assets approach, although
structurally different than the bank-based approach, helps to ensure
the safety and soundness of the SD, while providing the same
protections to the financial system.
As discussed above and for the same reasons, the Commission is
requiring an SD to include in its eight percent of the total uncleared
margin calculation all uncollateralized exposures from uncleared swaps
(e.g., inter-affiliate swaps, swaps with commercial end users, and
legacy swaps) and with clearing organizations.
3. Alternative Net Capital (``ANC'')
Under the ANC approach, an SD would need to maintain its net
capital in accordance with the following requirements:
$1 billion net capital; \155\
---------------------------------------------------------------------------
\155\ See proposed 17 CFR 240.15c3-1(a)(7) in Capital, Margin,
and Segregation Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and Capital Requirements for
Broker-Dealers; Proposed Rule, 77 FR 70214, at 70228 (Nov. 23,
1012).
---------------------------------------------------------------------------
$5 billion tentative net capital; \156\ and
---------------------------------------------------------------------------
\156\ See Id.
---------------------------------------------------------------------------
$6 billion early warning net capital.\157\
---------------------------------------------------------------------------
\157\ See Id.
---------------------------------------------------------------------------
Under the proposal, an SD that is registered with the SEC as a BD
and is approved by the SEC to use internal models to compute certain
market risk and credit risk capital charges (an ``ANC Firm'') will be
able to continue to use the ANC approach in calculating its SD capital;
however, with enhancements to the minimum capital requirements as
proposed by the SEC.
Under the proposal, an ANC Firm must maintain, at all times,
tentative net capital, which is the net capital of an ANC Firm before
deductions for market and credit risk, of $5 billion. In addition, an
ANC Firm must maintain, at all times, early warning net capital, which
is the net capital of an ANC Firm before deductions for market and
credit risk, of $6 billion. Lastly, an ANC Firm must maintain, at all
times, $1 billion of net capital, which is net discounted assets
(discounted by VaR models for market and credit risk).
In proposing to adopt this approach, but with some amendments to
the requirements, the Commission recognizes that ANC Firms are dual
registrants with the Commission and SEC that offer a wide-range of
financial services and act as different types of intermediaries (e.g.,
BD, FCM, SD). As a result of the additional complexity and risk
inherent in these entities, and the Commission's experience with these
ANC Firms, the Commission is proposing to increase their minimum
capital requirements in this proposal consistent with the SEC. In
addition, as with the other approaches, the Commission is proposing to
require ANC Firms to meet liquidity and funding requirements consistent
with the SEC.
The Commission expects that SDs that are ANC Firms will elect to
use this capital approach for its swaps transactions. The Commission
believes that since this approach has been in effect for more than 10
years and it properly accounts for the inherent risk and complexity of
these firms, including their swap dealing activities, that it is
appropriate to propose to permit ANC Firms to continue using this
approach, but with some enhancements based on the Commission's
experience. As discussed above, the Commission is proposing to increase
the minimum capital requirements for ANC Firms in a manner consistent
with the SEC's proposed increases for ANC Firms. The Commission
believes that the increases are appropriate to reflect the potential
increase in swaps activities that ANC Firms may engage in, particularly
if affiliates move their swaps activities into the ANC Firms to
effectively use the capital held by the ANC Firms.
4. Tangible Net Worth
The Commission is proposing a tangible net worth approach for both
SDs and MSPs. With respect to SDs, the proposal would require an SD to
maintain minimum net capital equal to or in excess of the greater of:
$20 million plus market and credit risk charges;
8 percent of the total amount of a swap dealer's uncleared
swap margin, uncleared security-based swap margin and initial margin
required for its cleared positions; or
The amount required by its RFA.
The term tangible net worth is proposed to be defined to mean an
SD's net worth as determined in accordance with generally accepted
accounting principles in the United States, excluding goodwill and
other intangible assets.
As noted above, the Commission is proposing this approach as it
recognizes that certain SD's that are primarily engaged in non-
financial activities may engage in a diverse range of business
activities different from, and broader than, the dealing activities
conducted by a financial entity. Under the proposal, an SD, availing
itself of this approach, must meet the Commission's 15% revenue test
and 15% asset test as discussed in section II.A.2.iii of this proposal
to demonstrate that entity is primarily engaged in non-financial
activities.
As discussed below, the Commission believes that the tangible net
worth capital approach meets statutory mandate, as it is designed to
help ensure the safety and soundness of the SD, while calibrated to the
inherent risk of the uncleared swaps held by the SD and the overall
activity of the SD. In addition, the Commission is not requiring these
SDs to meet its liquidity and funding requirements. As discussed below,
the Commission believes that the imposition of such requirements would
result in an over-inclusive requirement, as it would include all non-
financial funding requirements; likewise, if it narrowed the scope of
the liquidity requirement to just swap dealing activity, the
requirement would be under-inclusive as the required liquid assets
would be comingled with the SD's other liquid assets, which could be
used for all the entity's liabilities and not just for its swap dealing
related liabilities. As the proposed tangible net worth capital
approach would only be available to SDs that are primarily engaged in
non-financial activities, the Commission believes that this approach
has proper controls to ensure that it is not exploited by financial
entities seeking a regulatory advantage.
With respect to MSPs, the Commission is proposing to require an MSP
to maintain net tangible net worth in the amount equal to or in excess
of
[[Page 91291]]
the greater of the MSP's positive net worth or the amount of capital
required by an RFA of which the MSP is a member. There are currently no
MSPs and the only previously registered MSP were required to register
as a result of their legacy swaps and not any current swap activity.
The Commission believes that the proposed capital requirements for MSPs
are appropriate given that no entities are currently registered and the
Commission is uncertain of the types of entities that may register in
the future. As noted above, the Commission has taken this uncertainty
into consideration by proposing to allow an RFA to establish an MSP's
minimum capital requirements. Such RFA's are required under section 17
of the CEA to establish capital requirements for all members that are
subject to a Commission minimum capital requirement. Accordingly, RFAs
may adjust their rules going forward depending on the nature of any
entities that may seek to register as MSPs, and adopt minimum capital
requirements as appropriate. Such RFA rules must be submitted to the
Commission for review prior to the rules becoming effective.
5. Substituted Compliance
As described above, the Commission is providing certain non-U.S.
CSEs with the ability to petition the Commission for approval to comply
with comparable foreign capital and financial reporting requirements in
lieu of some or all of the Commission's requirements. In proposing this
approach, the Commission recognizes that this may provide these CSEs
with cost advantages by avoiding the costs of potentially duplicative
or conflicting regulation.
In limiting the scope of substituted compliance, the Commission
does not believe it should make available substituted compliance to all
CSEs. The Commission is proposing substituted compliance only to non-
U.S. CSEs, as it believes that it is necessary that its capital
requirements apply to U.S. CSEs, as they are integral to the U.S. swaps
market and critical in ensuring the stability of the U.S. financial
system.
Additionally, the Commission recognizes that substituted
compliance, to the extent that it puts conditions on its comparability
determination, may result in additional costs to these CSEs; however,
the Commission believes that providing a substituted compliance regime
that allows for conditions instead of an all-or-nothing approach will
benefit these CSEs and provide for a more competitive swaps market.
Moreover, to the extent that a non-U.S. CSE must comply with a foreign
regime and the Commission does not find that regime comparable, the
Commission recognizes that these non-U.S. CSE may be burdened with
additional costs and subject to conflicting and/or duplicative costs.
F. Entities
The following section discusses the related incremental costs and
benefits of the proposal's capital approaches and reporting
requirements on each type or category of SDs and MSPs. The Commission
understands that certain SDs and MSP organized and domiciled outside of
the U.S. would be included in these types or categories of entities.
These non-U.S. SDs and MSPs are discussed in the Substituted Compliance
section below.
1. Bank Subsidiaries
All U.S. CSEs that are subsidiaries in a BHC and are not a BD or
FCM currently are not subject to capital requirements; \158\ however,
their parent BHC currently complies with the Federal Reserve's capital
requirements. Under the Federal Reserve Board's capital requirements,
which are based on Basel III requirements, a BHC must maintain adequate
capital for the entire consolidated entity.\159\ That is, all the
assets and liabilities of the BHC's consolidated subsidiaries are
consolidated into the holding company. The Federal Reserve Board's
capital requirements are then imposed on the BHC, requiring the BHC to
maintain capital levels according to those requirements.
---------------------------------------------------------------------------
\158\ The Commission acknowledges that some subsidiaries in a
BHC may be an insurance company and, therefore, may have capital
requirements set by its insurance regulator. Such entities are
outside the scope of the Commission's proposed rulemaking, as these
entities are currently not registered with the CFTC as an SD or MSP.
The Commission further acknowledges that there are some non-U.S.
subsidiaries that are part of a bank and those subsidiaries and/or
their parent may be subject to the capital regime of a foreign
regulator. The Commission believes that in such a case, the capital
regime that is likely to be applicable would be either the Basel
III-based approach or a version of the net liquid assets approach.
\159\ See Regulatory Capital Rules: Regulatory Capital,
Implementation of Basel III, Capital Adequacy, Transition
Provisions, Prompt Corrective Action, Standardized Approach for
Risk-weighted Assets, Market Discipline and Disclosure Requirements,
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital
Rule; Final Rule, 78 FR 62018 (Oct. 11, 2013).
---------------------------------------------------------------------------
As these CSEs are not currently required to be capitalized, the
Commission understands that this may add incremental cost to the
consolidated entity and/or the CSE as it will have to retain earnings
or further capitalize the CSE to the required capital levels. However,
the Commission recognizes that a consolidated entity may capitalize one
of its subsidiaries in many different ways, including retaining
earnings from the CSE or from within the consolidated group. Even with
this proposed requirement imposing capital on the subsidiaries, as
noted above, the BHC must maintain capital levels in accordance with
the Federal Reserve Board's capital requirements, which are calculated
on a consolidated basis; therefore, incremental costs may be mitigated,
as it may be possible for the consolidated entity to keep the same
level of capital within the BHC, but reallocated among its
subsidiaries.\160\ In addition, the Commission recognizes that earnings
may now have to be retained in the CSE and may no longer be available
to be reallocated to fund other more profitable activities within the
consolidated group or to be returned to shareholders; however, the
Commission believes that by providing these CSEs with the option of
differing capital approaches, these CSEs will select the capital
approach most optimal for its operations, financial structure and which
will reduce duplicative or conflicting rules and the administrative
costs of calculating and maintaining additional sets of books and
records.
---------------------------------------------------------------------------
\160\ The Commission notes that the bank or an insurance company
in a BHC must maintain certain capital and as such, may not be able
available to capitalize the CSE.
---------------------------------------------------------------------------
The Commission believes that although the proposed capital
approaches maybe structurally different, they require a CSE to maintain
adequate capital levels for its activities, which should help ensure
the safety and soundness of the CSE and the stability of the U.S.
financial system.
In requiring capital for a bank subsidiary that is an SD, as
discussed above, the SD may incur additional costs. As a result of the
additional costs, some SDs may be put at a competitive disadvantage,
when compared to those dealers with lesser capital requirements or with
no capital requirements. As a result of this additional cost, some swap
dealing activity may become too costly--becoming a low margin
activity--and, therefore, some SDs may limit their dealing activity or
exit the swaps market. Additional costs may also be passed on to
customers in the form of higher prices; however, if these SDs are to
remain competitive in the swaps market, they must compete with
competitors by matching or beating prices. In addition, as most of the
largest swap dealers are part of a BHC, these SDs are already incurring
capital charges at the consolidated level, and, therefore, the
incremental cost and the effect on competition and pricing of
[[Page 91292]]
swaps may be mitigated. Because these SDs have the option to select the
most optimal capital approach for them, they can control some of the
burdens placed on them by the proposal and thereby, mitigate the
proposal's effect on pricing.
2. SD/BD (Without Models)
Under the proposal, an SD that is also a BD that does not use SEC/
CFTC-approved models to calculate its market and credit risk charges
has the option to use either the bank-based approach or the net liquid
assets approach, but with a standardized capital charges for market
risk and credit risk. The Commission recognizes that although it is
giving an option to these SDs to comply with either approach, these SDs
must still meet the SEC's BD capital requirement.
The standardized capital charges impose significant capital
requirements for uncleared swaps primarily in the form of rules-based
market risk charges and credit risk charges. Therefore, these firms
currently engage in limited swaps activity in the BD, and the
Commission does not anticipate that SD/BDs engaging in significant
swaps activity in the future absent SEC rule amendments.
3. SD/BD/OTC Derivatives Dealers (Without Models)
Under the proposal, an SD that is registered with the SEC as an OTC
derivatives dealer will have the option to comply with either the bank-
based capital approach or the net liquid assets capital approach. As
OTC derivatives dealers, these SDs already comply with the SEC's net
liquid assets capital requirements. OTC derivative dealers also may be
approved by the SEC to use internal models to calculate market and
credit risk charges in lieu of standardized, rules and table-based
capital charges for swaps, security-based swaps and other financial
instruments.
The Commission believes that since SDs that are registered OTC
derivatives dealers are already complying with the SEC's net liquid
assets approach, they will select this approach in meeting with the
Commission SD's proposed capital requirements. The Commission believes
that allowing these entities to continue using current capital
requirements will reduce the possibility of duplicative or conflicting
rules and administrative costs of calculating and maintaining
additional sets of books and records. The Commission believes that its
proposal will result in only a small incremental cost to OTC derivative
dealers.
The Commission recognizes that OTC derivatives dealers already have
SEC-approved models in computing their current capital requirements
and, therefore, will not incur any additional costs in developing and
implementing this model-based approach in computing capital charges.
4. SD/FCM (Without Models)
Under the proposal, an SD that is also registered with the
Commission as an FCM that does not use Var models to calculate market
and credit risk charges, must compute its capital in accordance with
the rules-based approach set forth in Regulation 1.17. In the proposal,
the Commission is amending certain provisions of Regulation 1.17 to
reduce the burden on an FCM engaging in swaps. The amendments align the
FCM capital requirements with that of new net liquid assets capital
approach set out in proposed Regulation 23.101. In amending the
requirements, the Commission believes that it is reducing the burden
placed on SDs/FCMs, as the amount of capital on uncleared swaps would
have been significantly higher under the current requirements and would
have placed SD/FCMs at a competitive disadvantage. Specifically,
Regulation 1.17 currently does not allow an FCM to recognize collateral
held at a third-party custodian as capital. Therefore, under Regulation
1.17 an SD/FCM would have to take a 100 percent capital charge for
margin posted with third-party custodians even though the Commission's
uncleared margin rules require initial margin to be held at a third-
party custodian. This is true even though the custodian has no ability
to rehypothecate the initial margin and the SD has the ability to
retrieve the initial margin back from the custodian with no
encumbrance. Therefore, the Commission believes that its proposed
amendments to Regulation 1.17 to allow an SD/FCM to recognize margin
posted with third-party custodians in accordance with the Commission's
margin rules will make it easier for an SD/FCM to meet its minimum
level of required capital while also requiring an SD/FCM to maintain
adequate capital levels, when considering the amount of initial margin
that the SD has at its disposal in the event of a counterparty default.
As a result of the proposal's amendments, these SD/FCMs should
benefit from lower capital charges and should allow these SD/FCMs to
continue to comply with one capital rule, which should mitigate some of
the administrative costs and reduce the possibility of duplicative or
conflicting rules. The Commission is not providing these SDs with an
option to use the bank-based capital approach, as the Commission
believes that this option is unnecessary and costly, and the current
FCM capital approach reflects that the firm acts as an intermediary for
customers on futures markets. The Commission has made amendments to
account for SD/FCMs' swap activities and in allowing these FCMs to
change their current capital method, the Commission believes that this
would add an additional layer of complexity and costs to the FCMs, as
the FCMs would have to change, modify or migrate all of their current
systems to a new capital regime. In addition, the Commission believes
that requiring the same capital regime, with beneficial amendments, is
more appropriate in transitioning the Commission's capital requirements
to these entities, as it should result in fewer burdens and a simple
transition in implementing the Commission's proposed capital
requirements. In addition, the Commission believes that this would
simplify the Commission's ability to supervise these entities, as the
Commission will be able to seamlessly transition from its current
capital regime to these new requirements; however, the Commission
recognizes that by not providing these SDs with the option to use the
bank-based capital approach it may be foreclosing the ability of these
SDs to use a capital approach that may be more cost effective than the
one proposed.
As a result of this proposal, the Commission recognizes that by
amending Regulation 1.17 capital charges it is reducing the burden
currently placed on SD/FCMs' swaps activities, which may result in
greater liquidity in the swaps market, as this activity will be less
costly and may incentivize these entities to engage in more swap
dealing activity.
As a result of the amendments to Regulation 1.17, these SD/FCMs may
be able to realize some of the cost saving of the amendments when
competing with other dealers for counterparties. This cost savings may
also result in more efficient pricing for their counterparties.
However, the Commission notes, as stated above, that as a result of the
Commission's margin requirements for uncleared swaps these benefits may
be limited.
5. ANC Firms (SD/BDs and/or FCMs That Use Models)
Under the proposal, an SD that is an ANC Firm (i.e., also a BD and/
or FCM, with approval by the SEC/CFTC to use models in computing market
risk and credit risk charges), will incur minimal additional capital
charges, as a result of this proposal. The Commission is retaining this
approach for these firms,
[[Page 91293]]
but with an increase in the capital thresholds, as noted above. The
Commission is proposing these amendments based on market experience in
supervising ANC Firms, and in recognition that the proposal is
consistent with the SEC's proposed capital increases for ANC Firms. The
Commission notes that the current ANC Firms are already maintaining
more than the amended thresholds; however, by increasing these capital
requirements the Commission recognizes that this may have an additional
cost, as ANC Firms will now be required to maintain these capital
levels, as under the current capital thresholds, these were held at
their discretion.
The Commission recognizes that ANC firms already have SEC-approved
models in computing their current capital requirements and, therefore,
they will not incur any additional costs in developing and implementing
this model-based approach in computing capital charges.
6. Stand-Alone SD (With and Without Models)
Under the proposal, a stand-alone SD is provided with an option to
comply with either the bank-based capital approach or the net liquid
assets capital approach. In providing this option, the Commission, as
discussed above, believes that both options provide adequate capital
requirements and account for the financial activities of an SD.
Therefore, under the proposal, the Commission believes that these SDs
will benefit, as these SDs will have the ability to select the most
optimal approach, based on their organizational and operational
structure and the composition of their assets. In addition, this option
will also reduce the possibility of duplicative or conflicting rules
and administrative costs of calculating and maintaining additional sets
of books and records.
Under the proposal, a stand-alone SD that does not use models must
compute their market risk and credit risk charges in accordance with
rules-based requirements and a standardized table. The Commission
recognizes that under the bank-based capital approach, market risk
charges are calculated with a prudential regulator's approved model;
however, to allow stand-alone SDs to use the bank-based capital
approach without a model, the Commission is proposing to incorporate
Regulation 1.17 market risk charges into the framework. In providing
this alternative, the Commission is providing an option to those stand-
alone SDs that do not have Commission-approved models. In doing so, the
Commission is providing these SDs with a benefit, as they are still
able to choose the most efficient capital approach. The Commission
incorporated Regulation 1.17 market risk charges, with proposed
amendments, as it believes that this is a well-established method that
properly accounts for market risk charges.
However, the Commission recognizes that many of these entities are
not currently subject to minimum capital requirements, and as such,
will incur additional costs on all of their financial activities,
including their swap activities, which may result in possible increases
in costs and pricing. In addition, a stand-alone SD selecting to use
models in computing its market and credit risk charges may incur
additional costs in developing and implementing these models.
As a result of this proposal, the Commission recognizes that by
requiring capital for SDs this may put these SDs at a competitive
disadvantage, when compared to those entities with a lesser capital
requirement or with no capital requirements. As a result of this
additional cost, some swap activities may become too costly and,
therefore, some SDs may limit their activity or exit the swaps market.
This additional cost may in turn be passed on to customers in the form
of higher prices; however, if these SDs are to remain competitive in
the swaps market, they must compete by matching or beating prices of
their competitors. If an SD decides to limit its activity or withdraw
from the swaps market, this may result in a reduced level of liquidity
in the swaps market.
In requiring minimum capital requirements, the Commission believes
that it is complying with its statutory mandate, as these standards are
calibrated to the level of risk in an SD and are designed to help
ensure safety and soundness of the SD and the stability of the U.S.
financial system. In addition, the Commission's proposal is modeled
after two well-established capital regimes, which should help ensure
safety and soundness of the SD and competition among all registered
SDs.
7. Non-Financial SD (With and Without Models)
Under the proposal, an SD that is predominantly engaged in non-
financial activities, as defined in proposed Regulation 23.100 (85%
non-financial threshold), may use the tangible net worth capital
approach. This approach is designed after GAAP's tangible net worth
computation and excludes intangibles and goodwill.\161\ The Commission
is also requiring that the non-financial SD include in its capital
requirement its market risk and credit risk charges.
---------------------------------------------------------------------------
\161\ Under GAAP, tangible net equity is determined by
subtracting a firm's liabilities from its tangible assets.
---------------------------------------------------------------------------
The Commission believes that this approach, which is tailored to
non-financial entities that are SDs, provides these entities with the
flexibility to meet an appropriate capital requirement, without
requiring the firms to engage in costly restructuring of their
operations and business. The Commission recognizes that these SDs deal
in swaps, but the Commission also recognizes that these entities are
primarily engaged in commercial activities and counteract with
primarily with commercial clients. BCBS, the Commission and the SEC did
not fully consider this type of business model when developing the
bank-based capital approach and the net liquid assets capital approach
set out in this proposal. In allowing these entities to maintain their
current structure, the Commission believes that its proposed approach
will allow for less disruption to these SDs and in the markets, as
these SDs may serve smaller clients that would not otherwise be able to
participate in the swaps market without these SDs. However, the
Commission, in helping to ensure the safety and soundness of these SDs,
is requiring that these entities maintain a level of tangible net worth
equal to or greater than the greatest of (i) $20 million plus the SD's
market and credit risk charges, (ii) eight percent of its margin amount
(i.e., eight percent of all of the SD's uncleared swap margin,
uncleared security-based swap margin and initial margin required for
its cleared positions), or (iii) the amount of capital required by an
RFA, as this would account for the SD's exposure (market and credit
risk) to the swaps markets, without penalizes the SD's commercial
activities.
In developing this approach, the Commission also recognizes that
the commercial activities of a commercial SD could affect the overall
financial health of the SD. That is, in the event of a substantial loss
emanating from its commercial activities, this loss may have a
substantial negative affect on the SD, which may find itself in
financial distress. As the Commission is not accounting for the risk in
the commercial activities, it is possible that the amount and type of
capital that a commercial SD is required to maintain may not be
adequate to prevent the failure of the SD, which then will affect
[[Page 91294]]
all of its swap counterparties. However, in tailoring this method to
these commercial SDs, the Commission is taking a position that is
consistent with the Commission's prior positions on commercial
entities, as it believes these commercial entities and their
corresponding activities are less risky than a financial entity.\162\
In addition, and as discussed above, an RFA will have the ability to
assess capital levels at all SDs and may adopt rules to impose capital
requirements that are more stringent than the Commission's capital
requirements on SDs as their experience with these firms develops.
---------------------------------------------------------------------------
\162\ See e.g., 17 CFR 39.6.
---------------------------------------------------------------------------
The Commission recognizes that these entities are not currently
subject to minimum capital requirements, and as such, will incur
additional costs on all of their swap activities, which may result in
possible increases in pricing; however, as the Commission has developed
its capital requirements to better target these commercial SDs, it
believes that the additional cost should be mitigated by this approach.
In addition, as the Commission expects that these SDs will use
models in computing its market and credit risk charges, this may also
result in additional costs in developing and implementing these models;
however, this cost should be mitigated by the savings that may be
realized by using such models.
8. MSP
Under the proposal, an MSP must maintain capital (i.e., tangible
net worth) of the greater of positive tangible net worth or the amount
of capital required by a registered futures association of which the
MSP is a member. This approach is designed after GAAP's tangible net
worth computation and excludes intangible assets and goodwill.
Currently there are no MSPs. The Commission cannot determine if other
entities will register in the future as MSPs, however, the Commission
is required to propose a capital requirement to address potential
future registrants.
In proposing the tangible net worth approach for MSPs, the
Commission is allowing these entities to continue their operations if
they become registered as MSPs with little to no changes to the
entities' structures. In providing for this, the Commission believes
that these entities if they become registered as MSPs will incur
minimal additional costs to comply with the proposed requirements.
The Commission believes that the proposed capital requirements will
help ensure the safety and soundness of MSPs, as these entities will
typically be posting and collect margin on all of their new uncleared
swaps and, therefore, as these MSPs are registered only as a result of
being an end-user of swaps and not a swap dealer, the margin
requirements are better tailored to cover that same risk, which is on a
$1 for $1 basis, than through its capital requirements. Therefore, the
Commission is only proposing to require MSPs to be solvent, while
nothing that the entity may be subject to other capital requirements
and hence required to comply with those capital requirements.
As the Commission's capital requirements will result in minimal
additional costs to these MSPs, there should be little to no effect on
competition, as they are end-users (i.e., price takers) and little to
no incremental effect on pricing.
9. Substituted Compliance
Under the proposal, a non-U.S. CSE that is already complying with a
comparable foreign jurisdiction's capital or financial reporting regime
is provided with the ability to meet the Commission's capital
requirements by meeting the foreign jurisdiction's capital
requirements. In providing these CSEs with the ability to continue to
comply with their current capital and financial reporting regimes the
Commission believes that it is limiting the potential for conflicting
and duplicate capital requirements. In addition, as each foreign
jurisdiction must be determined to be comparable, the possible negative
effect on the U.S. financial system is mitigated.
The Commission further recognizes that non-U.S. CSEs that use
conditional substituted compliance may incur additional costs; however,
the Commission believes that conditional substituted compliance
provides an offsetting benefit to these CSEs as it allows for a
conditional substituted compliance determination instead of an all-or-
nothing approach, which may result in the Commission not recognizing a
foreign jurisdictions capital requirements, resulting in additional
cost, including possible conflicting and/or duplicative requirements.
G. Liquidity and Funding Requirements
Under the proposal, the Commission is requiring that SDs, excluding
SDs that are predominantly engaged in non-financial activities, be
required to comply with a liquidity requirement and to adopt a funding
plan. Depending on the capital approach that the SD is complying with,
the SD must comply with the corresponding liquidity requirement. Any SD
that complies with the bank-based capital approach must comply with
liquidity coverage ratio (``bank-based liquidity''). Alternatively, any
SD that complies with the net liquid assets capital approach must
comply with the liquidity stress test requirement (``liquidity stress
test'').
As discussed above, in recognizing the limitations that were
highlighted by the financial crisis and acknowledged by BCBS, the
Commission is adopting a liquidity requirement to enhance protection
provided by its capital requirements. During the financial crisis, it
was evident that although many firms had adequate capital levels they
did not have enough liquidity or funding sources to cover their current
obligations, which resulted in firms being adequately capitalized under
the applicable regulations, but nonetheless in default on their
obligations. Therefore, the Commission believes that in proposing this
requirement it is enhancing the safety and soundness of SDs and
thereby, helping to ensure stability of the U.S. financial system.
The Commission selected these two approaches from the prudential
regulators' liquidity model and the SEC's proposed capital
requirements, which contains a liquidity requirement. Each approach is
designed to ensure that an SD has enough liquid assets over a stressed
30-day period to meet its obligations, over that same period. As the
bank-based liquidity ratio is required under the prudential regulators'
capital rules, the Commission believes that it would be consistent in
tying these two requirements, as it was developed to complement its
corresponding capital requirements. Alternatively, the Commission is
requiring the liquidity stress test approach for those SDs that comply
with the net liquid assets capital approach, as the Commission believes
these two approaches complement each other, as these both focus on net
liquid assets of a SD. The Commission believes that matching these two
requirements will benefit SDs, as they will not have to comply with
possible duplicative and/or conflicting requirements.
The Commission is also requiring these SDs to maintain a funding
plan. The Commission believes that these costs are marginal and are
accounted for in the proposal's PRA. As discussed above in regard to
the proposal's liquidity requirements and for the same reasons, under
the proposal the Commission is requiring a funding plan, as it believes
that this requirement is necessary to further enhance the
[[Page 91295]]
Commission's capital requirements and to help ensure the safety and
soundness of the CSEs.
As noted above, SDs are not required by the Commission to comply
with any liquidity or funding requirements. In requiring these SDs to
comply with its liquidity requirements, the Commission recognizes that
these SDs may have to hold more liquid assets; however, the Commission
believes that this requirement increases the possibility that an SD
will be able to withstand another financial crisis. As the Commission
is mandated to set capital requirements to help ensure the safety and
soundness of the SD, and in learning from the events of the financial
crisis, the Commission believes that this requirement is necessary to
ensure the viability of SDs. In addition, non-bank subsidiaries of a
BHC, although not required to retain a certain level of liquid assets,
are constrained on the amount of illiquid assets that they can hold on
their balance sheet indirectly, as their BHC parent must meet the
Federal Reserve's liquidity requirements. This will mitigate some of
the costs incurred by certain SDs that select the bank-based capital
requirements. Moreover, the Commission recognizes that these costs will
also be mitigated to some degree, as liquidity can be moved around an
organization, provided there are no legal restrictions or
constraints.\163\
---------------------------------------------------------------------------
\163\ The Commission notes that Section 23A and 23B may
constrain the ability of moving liquidity in a BHC. In addition, if
an entity must current comply with liquidity provisions, this may
also limit the ability to move liquidity among consolidated
entities.
---------------------------------------------------------------------------
The Commission believes that to the extent that all of its
financial SDs must comply with one of the two liquidity requirements,
the competitive effects should be mitigated. In addition, as a result
of a liquidity requirement being an internationally accepted
requirement under BCBS, this should mitigate some of the competitive
advantages that non-CFTC registered dealers may have over financial
SDs. In addition, to the extent that SDs maintain liquid assets to
cover their initial margin requirements and variation margin
requirements (under the Commission's variation margin requirements,
swaps between two CSEs require the exchange of cash or U.S.
treasuries), this may also mitigate the cost of this proposed liquidity
requirement.
In proposing a liquidity requirement, the Commission understands
that this may have a negative effect on liquidity of the swaps market.
This proposed requirement will require financial SDs to hold more
liquid assets than prior to this proposal. Therefore, this may cause
some of these financial SDs, to limit or withdraw from swap dealing
activity, as the proposal may make swaps activity more costly, which
may result in a reduction in market liquidity.
Under the proposal, the Commission is not requiring Commercial SDs
to comply with its proposed liquidity and funding requirements. The
Commission believes that if it were to impose liquidity and funding
requirements on Commercial SDs it would result in an over-inclusive
requirement, as it would include all non-financial liquidity and
funding requirements. Alternatively, if the Commission narrowed the
scope of the liquidity and funding requirements to just swap dealing
activity, the Commission believes that it would be under-inclusive, as
the required liquid assets will be comingled with the SD's other liquid
assets, which could be used for all the entity's liabilities and not
just for its swap dealing related liabilities. In addition, the
Commission understands that if the Commercial SD defaults on any
obligation, including commercial, this may have a negative impact on
the entity's SD. With these two conflicting views, the Commission
believes it is not appropriate at this time to propose liquidity or
funding requirements on Commercial SDs.
As noted in the section F.9., the Commission is providing
substituted compliance to certain non-U.S. CSEs. As discussed above and
for the same reasons, the Commission believes that, in regards to its
liquidity and funding requirements, providing substitute compliance to
these non-U.S. CSEs should reduce the possibility of additional costs
and duplicative or conflicting requirements.
H. Reporting and Recordkeeping Requirements
The recordkeeping, reporting and notification requirements set out
in this proposal are intended to facilitate effective oversight and
improve internal risk management, via requiring robust internal
procedures for creating and retaining records central to the conduct of
business as an SD or MSP. Requiring registered SDs and MSPs to comply
with recordkeeping and reporting rules should help ensure more
effective regulatory oversight. The proposal would help the Commission
determine whether an SD or MSP is operating in compliance with the
Commission's capital requirements and allow the Commission to assess
the risks and exposures that these entities are managing.
As detailed above in Section II.C of this proposal, the Commission
is requiring all SDs to file certain financial information pertaining
to their capital requirements. Those SDs that are prudentially
regulated are provided with the option to submit their financial
information that is reported to their prudential regulator to the
Commission. In addition, those SDs that are also FCMs may file their
financial information pertaining to their capital requirements under
this proposal with the Commission, including notices, in the same
manner as they currently report. For those SDs that are also registered
with the SEC as a BD or a SBSD, these SDs may file the same financial
information to the Commission, as they file with the SEC. In filing the
proposed required financial information with the Commission, these
entities must file through the Winjammer electronic filing system.
Alternatively, these same SDs have the option to report their financial
information like stand-alone SDs, commercial SDs and MSPs report their
financial information to the Commission. The Commission is providing
this option, as the information reported to the Commission under this
proposal and that is filed with the Commission or other financial
regulatory agencies are similar, as the information provides the
Commission with the ability to assess and monitor an SD's financial
condition and whether the SD is currently meeting the Commission's
capital requirements. In permitting these SDs to use their current
required information, the Commission believes that this should mitigate
some additional costs to prepare and report this information to the
Commission. In addition, these SDs should already have developed
policies, procedures and systems to aggregate, monitor, and track their
swap dealing activities and risks. As such, this should also mitigate
some of the costs incurred under the proposal.
Under the proposal, those SDs and MSPs that are not subject to
current capital requirements will have to develop and establish
policies, procedures and systems to monitor, track, calculate and
report the required information. In developing these policies,
procedures and systems, these SDs will incur costs; however, as these
entities are registered with the Commission as SDs, the Commission
believes that they should already have developed policies, procedures
and systems to aggregate, monitor, and track their swap activities and
risks, as is required under the Commission's swap dealer framework.
This should mitigate some of the burdens of the proposed reporting and
recordkeeping
[[Page 91296]]
requirements. In addition, as the information that the Commission is
proposing to require is based on GAAP or another accounting method,
this information is already being prepared for other purposes and
therefore, should again mitigate the costs in meeting these proposed
requirements.
The Commission also believes that as a result of the proposed
reporting and recordkeeping requirements, SDs should be able to more
effectively track their trading and risk exposure in swaps and other
financial activities. To the extent that these SDs can better monitor
and track their risks, this should help them better manage risk.
As noted in the section F.9., the Commission is providing
substituted compliance to certain non-U.S. CSEs. As discussed above and
for the same reasons, the Commission believes that, in regards its
reporting requirements, providing substitute compliance to these non-
U.S. CSEs it should reduce the possibility of additional costs and
duplicative or conflicting requirements
I. Section 15(a) Factors
The following is a discussion of the cost and benefit
considerations of the proposal, as it relates to the five broad areas
of market and public concern: (1) Protection of market participants and
the public; (2) efficiency, competitiveness, and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations.
1. Protection of Market Participants and the Public
The proposed rules are intended to strengthen the swaps market by
requiring all CSEs to maintain a minimum level of capital and
liquidity. These minimum capital requirements should enhance the loss
absorbing capacity of CSEs and reduce the probability of financial
contagion in the event of a counterparty default or a financial crisis.
In addition, capital functions as a risk management tool by limiting
the amount of leverage that a CSE can incur. Moreover, the proposal's
liquidity and funding requirements should provide CSEs with the
ability, in times of financial stress, to meet their current and other
obligations as they come due, which should lower the probability of a
CSE defaulting. This should help mitigate the overall risk in the
financial system and ultimately reduce systemic risk. Financial
reporting requirements for CSEs set out in this proposal should help
the Commission and investors monitor and assess the financial condition
of these CSEs. As this proposal is designed to protect financial
entities from default, this should have a direct benefit to the public,
as the failure of these CSEs could result in a financial contagion,
which could negatively impact the general public. On the other hand,
the proposed capital rules may require additional capital to be raised
and may increase the cost of swaps, as described above.
Request for Comment
Do proposed capital, liquidity, and financial reporting
requirements properly protect market participants and the public?
Please explain.
2. Efficiency, Competitiveness, and Financial Integrity of Swaps
Markets
In this proposal, the Commission sought to promote efficiency and
financial integrity of the swaps market, and where possible, mitigate
undue competitive disparities. Most notably, the Commission aligned the
proposed regulations with that of the prudential regulators', SEC's and
the Commission's current capital frameworks to the greatest extent
possible. Doing so should promote greater operational efficiencies for
those SDs that are part of a BHC or are also registered with the SEC as
a BD or the Commission as an FCM, as they may be able to avoid creating
duplicative compliance and operational infrastructures and instead,
rely on the infrastructure supporting the other registered entities. In
addition, this approach should also enhance efficiency and limit
conflicting rules, as these entities can continue to operate under
their current regimes. Moreover, the proposal permits CSEs to calculate
credit and market risk charges under a standardized or model-based
approach, which allows them to choose the methodology that is the most
suitable for their asset composition.
The Commission notes that the proposed capital rule, like other
requirements under the Dodd-Frank Act, could have a substantial impact
on competition in the swaps market. As the Commission's proposal will
result in additional costs to certain CSEs that do not have current
capital requirements, these CSEs may either limit their swap activities
or withdraw from the swaps market. In this event, it is possible that
this may result in less competition and increases in prices of swaps.
Depending on the relative cost of the Commission's capital and
liquidity requirements compared with corresponding requirements under
prudential regulators' regime, SEC's regime or in other jurisdictions,
certain CSEs may have a competitive advantage or disadvantage; however,
the Commission, in developing the proposal, harmonized the proposal
with those of the prudential regulators and the SEC to the maximum
extent practicable.
As noted above, the Commission, recognizing that SDs are critical
to the financial integrity of the financial markets, designed their
capital requirements to help ensure the safety and soundness of these
SDs. In doing so, this should protect an SD in the event of a default
by its counterparty or a financial crisis, which should reduce the
probability of financial contagion.
Request for Comment
Is market integrity adversely affected by the proposed rules? If
so, how might the Commission mitigate any harmful impact?
3. Price Discovery
As noted above, the proposal may have a negative effect on
competition, as a result of increasing costs, which may result in some
SDs limiting or withdrawing from the swaps markets. In that event, this
negative effect on competition could result in a less liquid swaps
market, which will have a negative effect on price discovery. However,
as discussed above, most of the larger SDs or their parent entities are
already subject to capital requirements that impose capital charges for
their swap activities and, therefore, the proposal's effect on
competition, liquidity and price discovery should be limited.
Request for Comment
How might this proposal affect price discovery? Please explain.
4. Sound Risk Management Practices
A well-designed risk management system helps to identify, evaluate,
address, and monitor the risks associated with a firm's business. As
discussed above, capital plays an important risk management function
and limits the amount of leverage an entity can incur. In addition,
capital serves as the last line of defensive in the event of a
counterparty default or severe losses at a firm. The Commission's
proposal is developed from two well-established capital regimes. In
addition, the Commission is requiring certain liquidity standards and a
funding requirement. Therefore, the Commission's proposal should
promote increase risk management practices within a CSE. Moreover, the
Commission believes that as a result of the proposed reporting and
recordkeeping requirements, SDs may
[[Page 91297]]
more effectively track their trading and risk exposure in swaps and
other financial activities. To the extent that these SDs can better
monitor and track their risks, this should help them better manage risk
within the entity.
Request for Comment
How might this proposal affect sound risk management practices?
Please explain.
5. Other Public Interest Considerations
The Commission has not identified any additional public interest
considerations related to the costs and benefits of the proposed rule.
Request for Comment
Are there other public interest considerations that the Commission
should consider? Please explain.
Appendix to Cost Benefit Considerations
The Commission generally requests comments about its analysis of
the general costs and benefits of the proposed rule. The Commission
requests data to quantify and estimate the costs and the value of the
benefits of the proposals. Are there additional costs and benefits that
the Commission should consider? Has the Commission misidentified any
costs or benefits? Commenters are encouraged to include both
quantitative and qualitative assessments of benefits as well as data,
or other information of support for such assessments.
i. Minimum Capital Requirement
The Commission focuses its analysis on cost arising from minimum
capital requirement, due to data availability. As discussed above, this
proposal would prescribe capital requirements for SDs and MSPs, and
proposed amendments to existing capital rules for FCMs would prescribe
capital requirement for FCMs that are also registered as SDs and
increase capital requirement for FCMs to account for risk arising from
their swaps and security-based swaps. The Commission first discusses
cost at the entity level, and then quantifies cost at the industry
level using SDR data.
As of Nov. 9, 2016, there are approximately 104 SDs and no MSPs
provisionally registered with the Commission. The Commission estimates
that out of the 104 provisionally registered SDs, 15 U.S. Prudential
Regulated Registrants SDs are exempt from the Commission's capital
requirement; 36 SDs which are Non-U.S. Registrants Overseen by the FRB
are also exempt from the Commission's capital requirement. For the rest
53 provisionally registered SDs, eight SDs are currently also
registered with the Commission as FCMs, while the other 45 SDs
currently are not FCMs.\164\
---------------------------------------------------------------------------
\164\ CAs of Nov. 9, 2016, one SD has filed a request with the
Commission to withdraw its SD registration.
---------------------------------------------------------------------------
Discussing Capital Requirement Cost at Entity Level
The Commission collects monthly financial and capital information
from FCMs. There are currently eight SDs which are also registered as
FCMs. The Commission proposed following amendments to existing FCM
capital rule to increase capital requirement to account for risk
arising from swaps.
Table 1--Minimum Capital Requirement for SDs That Are Also FCMs
----------------------------------------------------------------------------------------------------------------
Tentative net Adjusted net capital
capital ----------------------------------------------------
----------------
Fixed dollar Fixed dollar Financial ratio
(million) (million)
----------------------------------------------------------------------------------------------------------------
FCM SD (not using models).................. N/A $20 8% of risk margin plus ``uncleared
swap margin''.
FCM SD (using models)...................... $100 $20 8% of risk margin plus ``uncleared
swap margin''.
----------------------------------------------------------------------------------------------------------------
The Commission expects most if not all entities would use models.
For the purpose of discussing cost of complying with these proposed
minimum capital requirements, the Commission further separates these
SDs that are also FCMs into two categories: SDs that are also SEC
registered ANC firms, and FCMs that are not ANC firms registered with
the SEC.
1. SDs That Are FCMs and ANC Firms With the SEC
Table 2--Capital for SDs That Are Also FCMs and ANC Firms as of April 30, 2016
----------------------------------------------------------------------------------------------------------------
Adjusted net Net capital Excess net
Name of swap dealers Registered as capital requirement capital
----------------------------------------------------------------------------------------------------------------
CITIGROUP GLOBAL MARKETS INC... FCM BD SD 7,378,708,335 1,449,570,569 5,929,137,766
GOLDMAN SACHS & CO............. FCM BD SD 16,978,669,484 2,553,867,535 14,424,801,949
JP MORGAN SECURITIES LLC....... FCM BD SD 13,539,160,236 2,542,050,203 10,997,110,033
MORGAN STANLEY & CO LLC........ FCM BD SD 10,906,187,328 1,818,426,660 9,087,760,668
----------------------------------------------------------------------------------------------------------------
Source: FCM financial data as of April 30, 2016.
The Commission estimates that four SDs are already registered as
ANC broker-dealers with SEC. ANC firms registered with the SEC are
currently required to maintain a minimum of five billion dollars of
tentative net capital and a minimum of one billion dollars of net
capital. In addition, all ANC firms use models for risk charge
computations. These required minimum capital for ANC firms by the SEC
are much higher than the proposed minimum capital requirement by the
Commission, thus are more likely the binding constraints for these
firms. Based on financial information reported by these SDs in their
monthly reports filed with the Commission, these four SDs maintain a
significant amount of net capital in excess of SEC's requirement and
the Commission's proposal. Therefore, the Commission expects that
incremental costs from this
[[Page 91298]]
proposed capital requirement may not be significant for these firms.
2. SDs That Are FCMs but Currently Are Not ANC Firms Registered With
SEC
The Commission estimates that there are four SDs in this category
with one SD withdrawn pending. Based on the FCM Financial data provided
to the Commission, three SDs currently have excess net capital ranging
from $26.4 million to $312 million.\165\ The Commission expects that
smaller SDs with less than 100 million adjusted net capital might need
to raise additional capital and might incur significant cost to comply
with this proposal. The Commission would like to request comments on
(1) how much capital these SDs might need to raise? (2) Is it feasible
for these SDs to raise capital? (3) If these SDs would raise capital
through retained earnings, what would be the estimated ratio of
required capital as percent of their current retained earnings?
---------------------------------------------------------------------------
\165\ Selected FCM Financial Data as of April 30, 2016. http://www.cftc.gov/idc/groups/public/@financialdataforfcms/documents/file/fcmdata0416.pdf.
Table 3--Capital for SDs That Are FCMs but Not ANC Firms as of April 30, 2016
----------------------------------------------------------------------------------------------------------------
Adjusted net Net capital Excess net
Name of swap dealers Registered as capital requirement capital
----------------------------------------------------------------------------------------------------------------
FOREX CAPITAL MARKETS LLC...... FCMRFD SD 58,264,892 31,858,770 26,406,122
MIZUHO SECURITIES USA INC...... FCM BD SD 575,181,123 263,266,797 311,914,326
RJ OBRIEN ASSOCIATES LLC....... FCM SD 209,084,814 138,749,913 70,334,901
IBFX INC *..................... ...................... ................. ................. .................
----------------------------------------------------------------------------------------------------------------
IBFX INC * withdrawn pending.
Source: FCM financial data as of April 30, 2016.
For SDs that are not FCMs, the Commission prescribes following
minimum capital requirements depending whether SDs use models to
compute credit and market risk charges and whether SDs are financial
entities or commercial entities. In addition, the Commission proposes
positive tangible net worth requirement for MSPs. The Commission
expects that most, if not all, stand-alone SDs would use models. For
the purpose of discussing the cost of complying with minimum capital
requirement, the Commission separates stand-alone SDs into following
categories.
Table 4--Minimum Capital Requirement for Stand-Alone SDs/MSPs
--------------------------------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------------------------------
Type of registrant Net liquid asset approach
Bank-based capital approach
Tangible net worth
approach
--------------------------------------------------------------------------------------------------------------------------------------------------------
Tentative Adjusted net capital
net capital
Common equity tier 1
Tangible net worth
---------------------------------------------------------------------------------------------------------------------------
Fixed Fixed Financial ratio Fixed Financial ratios Fixed dollar... Financial ratio
dollar dollar dollar
(million) (million) (million)
--------------------------------------------------------------------------------------------------------------------------------------------------------
U.S. SD (Financial Entity N/A $20 8% of the total $20 8% of the total 8% of risk N/A............ N/A.
not using internal models). amount of amount of weighted asset.
margin. margin.
U.S. SD (Financial Entity $100 $20 8% of the total $20 8% of the total 8% of risk N/A............ N/A.
using internal models). amount of amount of weighted asset.
margin. margin.
U.S. SD (Not predominantly N/A N/A N/A............ N/A N/A............ N/A............ $20 million 8% of the total
engaged in financial plus credit amount of
activities). risk charge margin.
and market
risk charge.
U.S. MSP.................... N/A N/A N/A............ N/A N/A............ N/A............ Positive....... N/A.
---------------------------------------------------------------------------------------------------------------------------
Non-U.S. SDs................ Substituted Compliance Eligible, Capital Comparability Determination Required.
--------------------------------------------------------------------------------------------------------------------------------------------------------
3. Nonbank Subsidiaries of U.S. Bank Holding Companies (BHCs)
The Commission estimates that 12 SDs are nonbank subsidiaries of
U.S. BHC. These SDs currently do not have any capital requirement, and
the proposed capital requirement may increase cost to these SDs as it
may have to retain earnings to capitalize to the required level.
However, their parents are currently subject to Federal Reserve's
capital requirements on a consolidated basis, including U.S. Basel III
capital requirement and also are participants of the Comprehensive
Capital Analysis and Review (CCAR) and Dodd-Frank Act Stress Test
(DFAST). CCAR evaluates the capital planning process and capital
adequacy of the largest U.S.-based BHCs, including the firms' planned
capital actions. The Dodd-Frank Act stress tests are a forward-looking
component to help assess whether firms have sufficient capital to
absorb losses and have the ability to lend to households and businesses
even in times of financial and economic stress. The parent BHCs of
these nonbank SDs below are well capitalized due to these requirements,
as indicated by their common equity tier 1 capital ratio at
consolidated level is much higher than eight percent in the table
below. Therefore, the additional cost from the Commission's proposed
capital requirement may not be significant, as it may be possible for
the consolidated entity to keep the same level of capital within the
BHC, but just reallocate among its subsidiaries. In addition, the
Commission recognizes that earnings
[[Page 91299]]
will now have to retain in the SD and will no longer be available to be
reallocated to fund other more profitable activities within the
consolidated group or to be returned to shareholders. The Commission
understands that capital is not additive, i.e., the sum of capital at
individual subsidiary level may be more than the amount of capital
required at the parent level for all its subsidiaries, due to the loss
of netting benefits. The Commission requests comments on whether it is
reasonable to assume that SDs would be able to comply with the proposal
while consolidated group of these SDs would not be able to keep the
current level of capital. If not, please provide specific comments and
estimates the additional cost of complying with the proposal.
Table 5--SD's Parent BHC's Common Equity Tier 1 Capital Ratio as of
First Quarter 2016
------------------------------------------------------------------------
Common equity tier 1
Name of swap dealers capital ratio of SEC registered
parent BHC BD
------------------------------------------------------------------------
CITIGROUP ENERGY INC........... Citigroup Inc. 12.3% N
\166\.
GOLDMAN SACHS FINANCIAL MARKETS Goldman Sachs 13.4% Y
LP. \167\.
GOLDMAN SACHS MITSUI MARINE Goldman Sachs 13.4%... N
DERIVATIVE PRODUCTS LP.
J ARON & COMPANY............... Goldman Sachs 13.4%... N
JP MORGAN VENTURES ENERGY JP Morgan Chase & Co. N
CORPORATION. 11.7% \168\.
MERRILL LYNCH CAPITAL SERVICES Bank of America 11% N
INC. \169\.
MERRILL LYNCH COMMODITIES INC.. Bank of America 11%... N
MERRILL LYNCH FINANCIAL MARKETS Bank of America 11%... Y
INC.
MORGAN STANLEY CAPITAL GROUP Morgan Stanley 14.5% N
INC. \170\.
MORGAN STANLEY CAPITAL SERVICES Morgan Stanley 14.5%.. N
LLC.
MORGAN STANLEY DERIVATIVE Morgan Stanley 14.5%.. N
PRODUCTS INC.
MORGAN STANLEY CAPITAL PRODUCTS Morgan Stanley 14.5%.. N
LLC.
------------------------------------------------------------------------
As discussed above, the Commission expects all SDs would use models
to calculate market risk and credit risk charges. Their parents BHCs
most likely are already using their risk models to calculate capital
for the positions of these wholly owned subsidiaries (including
uncleared swaps) to measure the credit and market risk exposures of
these positions.
---------------------------------------------------------------------------
\166\ http://www.citigroup.com/citi/investor/data/qer116.pdf?ieNocache=23.
\167\ http://www.goldmansachs.com/investor-relations/creditor-information/creditor-Website-presentation.pdf
\168\ https://www.jpmorganchase.com/corporate/investor-relations/document/1Q16_Earnings_Presentation.pdf
\169\ http://investor.bankofamerica.com/phoenix.zhtml?c=71595&p=quarterlyearnings#fbid=ECX9ZgSZ-Oq.
\170\ https://www.morganstanley.com/about-us-ir/shareholder/1q2016.pdf.
---------------------------------------------------------------------------
4. U.S. SDs That Are Not Part of U.S. BHCs
The Commission estimates that there are 15 U.S. SDs not part of
U.S. BHCs. These SDs currently do not have any capital requirement.
However, out of these 15 SDs, six SDs are subsidiaries of foreign BHCs
or a foreign financial holding company (FHC) which already comply with
Basel III risk-based capital requirements and having common equity tier
1 capital ratio at consolidated level exceeding eight percent.
Specifically, two SDs are wholly-owned subsidiaries of Japanese BHCs,
two SDs are subsidiaries of a Japanese Financial Holding Company, one
SD is subsidiary of Netherlands BHC, and one SD is subsidiary of
Australian investment bank. For the 9 SDs that are not subsidiaries of
foreign holding companies that comply with Basel III, six SDs are part
of groups that are subject to the CFTC's or the SEC's net capital
requirements. Specifically, four SDs are subsidiaries of FCMs, and two
SDs are also SEC registered BDs. These SDs' consolidated group has
excess net capital ranging from $14.8 million to $1.2 billion.\171\ As
it is possible for the consolidated entity to keep the same level of
capital within the group, but just reallocate among its subsidiaries,
the additional cost of complying with the Commission's proposed capital
requirement may not be too burdensome. However, for those SDs or their
consolidated groups that currently have smaller amount of excess net
capital, they might need to raise additional capital and thus might
incur significant cost to comply with this proposal. The Commission
would like to request comments on (1) how much capital these SDs might
need to raise? (2) Is it feasible for these SDs to raise capital? (3)
If these SDs would raise capital through retained earnings, what would
be the estimated ratio of required capital as percent of their current
retained earnings?
---------------------------------------------------------------------------
\171\ Selected FCM Financial Data as of April 30, 2016. http://www.cftc.gov/idc/groups/public/@financialdataforfcms/documents/file/fcmdata0416.pdf.
---------------------------------------------------------------------------
The Commission estimates that three SDs do not belong to
consolidated entities that have excess capital (either common equity
tier 1 or net capital). The Commission, therefore, expects that these
three SDs may incur significant additional costs to comply with this
proposal and maintain their current business model. However, the
Commission does not have data to precisely estimate the possible
capital costs for these three SDs.
Table 6--Current Capital Requirement (Common Equity Tier 1 Capital Ratio or Excess Net Capital) at the SD or Its
Parent Level
----------------------------------------------------------------------------------------------------------------
Excess net
Common equity tier 1 capital capital at SEC registered
Name of swap dealers ratio at parent level entity or its BD
parent level
----------------------------------------------------------------------------------------------------------------
BTIG LLC.................................... .............................. \172\ 50,043,660 Y
GAIN GTX LLC................................ .............................. \173\ 14,821,951 N
[[Page 91300]]
ING CAPITAL MARKETS LLC \174\............... ING bank--11.6% \175\......... ................. N
INTL FCSTONE MARKETS LLC.................... .............................. 60,582,006 Y
JEFFERIES FINANCIAL PRODUCTS LLC............ .............................. \176\ N
1,204,270,344
MACQUARIE ENERGY LLC........................ Macquarie Bank--9.9% \177\.... ................. N
MIZUHO CAPITAL MARKETS CORPORATION.......... Mizuho Financial Group--10.5% ................. N
\178\.
NOMURA DERIVATIVE PRODUCTS INC.............. Nomura Holdings, Inc.--15.1%.. ................. N
NOMURA GLOBAL FINANCIAL PRODUCTS INC........ Nomura Holdings, Inc.--15.1%.. ................. Y
SMBC CAPITAL MARKETS INC.................... SMFG--11.81% \179\............ ................. N
JEFFERIES FINANCIAL SERVICES INC............ .............................. 1,204,270,344 N
CANTOR FITZGERALD SECURITIES................ .............................. \180\ 232,219,010 N
SHELL TRADING RISK MANAGEMENT LLC........... .............................. ................. N
BP ENERGY COMPANY........................... .............................. ................. N
CITADEL SECURITIES SWAP DEALER LLC.......... .............................. ................. N
----------------------------------------------------------------------------------------------------------------
5. Non-Financial/Commercial SDs
This proposal would require Non-Financial/Commercial SDs to
maintain tangible net worth in an amount equal to or in excess of the
minimum capital level ($20 million plus market risk charges and credit
risk charges). Currently there is no capital requirement for commercial
SDs. The Commission estimates that currently only one SD would be in
this category, and believes that its tangible net worth greatly exceeds
the Commission's proposed requirement.\181\ Therefore, the costs of
this proposal are not expected to be material because it is not
expected that this firm would have to alter its existing business
practice in any substantial way to comply with minimum tangible net
worth requirement.
---------------------------------------------------------------------------
\172\ https://www.sec.gov/Archives/edgar/vprr/1600/16001826.pdf.
\173\ GAIN GTX LLC is a wholly owned subsidiary of GAIN Capital
Holdings, Inc., a global provider of online trading services. GAIN
Capital Group LLC (a CFTC registered FCM and RFD) is also subsidiary
of GAIN Capital Holdings, Inc. and has excess net capital of
14,821,951.
\174\ ING Bank was designated by the Basel Committee and the FSB
as one of the global systemically important banks `G-SIBs' and by
the Dutch Central Bank and the Dutch Ministry of Finance as a
domestic SIFI. See ``ING Group Annual Report on Form 20-F 2015''.
\175\ http://www.ing.com/About-us/Profile-Fast-facts/Fast-facts.htm.
\176\ Excess net capital of Jefferies LLC, parent of Jefferies
Derivative Products LLC, Jefferies Financial Products LLC, and
Jefferies Financial Services LLC.
\177\ http://www.macquarie.com/us/about/newsroom/2015/agm-2015.
\178\ http://www.mizuho-fg.co.jp/english/faq/kessan.html.
\179\ http://www.smfg.co.jp/english/investor/financial/latest_statement/2016_3/h2803_e1_01.pdf.
\180\ Excess net capital at Cantor Fitzgerald & CO. (FCM and
Broker-Dealer), which is owned by Cantor Fitzgerald Securities (94%
ownership).
\181\ http://www.cargill.com/company/financial/five-year/index.jsp.
---------------------------------------------------------------------------
6. Non-U.S. SDs Not Subject to a Prudential Regulator
The Commission is proposing to allow a ``substituted compliance''
program for capital requirements for SDs that are: (1) Not organized
under the laws of the U.S., and (2) not domiciled in the U.S. The
Commission estimates that there are 17 non-U.S. provisionally
registered SDs not subject to U.S. prudential regulators that would be
eligible to apply for substituted compliance. Out of these 18 non-U.S.
SDs, approximately 10 SDs are domiciled in the U.K., three SDs are
domiciled in Japan, two SDs are domiciled in Mexico, one SD is
domiciled in Singapore, and one SD is domiciled in Australia. The
Commission would permit these non-U.S. SDs (or regulatory authorities
in the non-U.S. SD's home country jurisdictions) to petition the
Commission to satisfy the Commission's capital requirements through a
program of substituted compliance with the SD's home country capital
requirements. U.K., Japan, Mexico, Singapore, and Australia are members
of Basel Committee on Banking Supervision and have adopted Basel III
risk-based capital.\182\ Thus, the Commission does not expect
significant additional cost arising from this proposal for these
entities.
---------------------------------------------------------------------------
\182\ http://www.bis.org/bcbs/publ/d338.pdf.
---------------------------------------------------------------------------
Estimated Capital Requirement for IRS Positions of the SDs Subject to
the Commission's Capital Requirement
The Commission focuses its analysis on IRS as it covers the
majority of swaps' notional reported to SDRs. Table below shows that
IRS positons reported to SDR on June 24, 2016 account for about $312
trillion. Cleared IRS positions are roughly $165 trillion, accounting
for 53% of all IRS positions; while uncleared IRS positions are roughly
$147 trillion, accounting for the rest 47%. Of the $147 trillion
uncleared IRS positions, the Commission estimates that about 39% are
inter-affiliate swaps \183\ and 61% are outward-facing swaps.
---------------------------------------------------------------------------
\183\ An inter-affiliate swap is identified if the ultimate
parent of both counterparties is the same entity, using the
Commission's internal legal entity hierarchy database.
\184\ These numbers are roughly the same numbers of CFTC Weekly
Swap Report posted on http://www.cftc.gov/MarketReports/SwapsReports/L1GrossExpCS. The small discrepancies may be due to the
fact that the table above is generated using the new automated
weekly swaps report process.
Table 7--Gross Notional of IRS Billion $ Reported to SDR on Positions
[June 24, 2016]
----------------------------------------------------------------------------------------------------------------
Uncleared Cleared Total
----------------------------------------------------------------------------------------------------------------
Outward-facing \184\............................................ 90,117 164,646 254,763
[[Page 91301]]
Inter-affiliate................................................. 57,222 2 57,224
-----------------------------------------------
Total....................................................... 147,339 164,648 311,987
----------------------------------------------------------------------------------------------------------------
For the purpose of capital estimates, we double the notional
amounts listed above since both counterparties to a swap position may
be subject to the capital rules and therefore need to hold capital.
Table below shows that of roughly $295 trillion uncleared IRS position
on June 24, 2016 (double counting $147 trillion of uncleared notional),
the Commission estimates that about 46% of uncleared swaps are held by
SDs that are subject to the prudential regulators' capital requirement
and, therefore, are exempt from this proposal, 30% of uncleared swaps
are held by SDs that are subject to the Commission's capital
requirement, while the rest 24% are held by institutions not subject to
prudential regulators or the Commission's capital requirement.\185\
About 88 trillion of uncleared IRS positions (with double counting) are
held by SDs subject to the Commission's capital requirement. Of the 88
trillion uncleared IRS swap positions (double counting), 38% are
outward-facing swaps while 62% are inter-affiliate swaps. The
Commission assumes that these uncleared swaps will require margin of
about 0.2% to two percent of gross notional amount.\186\ The upper
bound two percent margin rate based on average of table-based approach
and is a conservative assumption because margin estimates from models
tend to be on a much lower side. The initial margin amount required for
these uncleared swaps (including inter-affiliate swaps) is 177 billion
to 1.77 trillion. Assuming capital required is eight percent of margin
amount, the capital required for the uncleared swaps held by SDs
subject to CFTC's capital requirement would range from $14 billion to
$140 billion. The Commission believes that most institutions, if not
all institutions, will use models to calculate initial margin amount.
If that is the case, the estimated capital required may be close to the
lower bound of $14 billion. This estimated capital required here
assumes that covered SDs currently do not hold capital for these swap
positions. This is also a conservative assumption, because many SDs or
their parent entities may already be holding capital against these
uncleared swap positions. The Commission estimates that SDs may have
significant amount of excess capital and in the case that SDs do not
hold capital themselves, their parents may hold significant amount of
excess capital. It may be possible for the consolidated entity (their
parents) to keep the same level of capital within the group, but just
reallocate among its subsidiaries and therefore, the additional cost of
complying with the Commission's proposed capital requirement may not be
too burdensome.
---------------------------------------------------------------------------
\185\ These estimates are based on SDs registered with
Commission on June 24, 2016. Since then, three SDs withdrew their
registration with the Commission.
\186\ The upper bound 2% is based on standardized approach,
while the lower bound 0.2% is based on surveys that show model-based
margin numbers could be as low as 10% of standardized margin
requirement.
Table 8--Gross Notional of Uncleared IRS Positions (Billion $) Reported to SDR on June 24, 2016
[Double counting as both Counterparties may need to hold capital]
----------------------------------------------------------------------------------------------------------------
Gross notional in billion $ for uncleared IRS position (double Outward- Inter-
counting) facing affiliate Total
----------------------------------------------------------------------------------------------------------------
Held by SDs subject to CFTC capital requirement................. 33,627 54,742 88,369
Held by SDs subject to Prudential Regulator (PR)'s capital 89,062 46,689 135,751
requirement....................................................
Held by institutions not subject to CFTC or PR capital 57,546 13,013 70,558
requirement....................................................
-----------------------------------------------
Total....................................................... 180,234 114,443 294,677
----------------------------------------------------------------------------------------------------------------
The table below shows that of $329 trillion cleared IRS position on
June 24, 2016 (double counting $216 trillion as both counterparties may
need to hold capital against the same position), the Commission
estimates that about 31% of cleared swaps are held by SDs that are
already subject to prudential regulators' capital requirement and
exempt from this proposal, nine percent of cleared swaps are held by
SDs that are subject to the Commission's capital requirement, while the
remaining 60% are held by institutions not subject to prudential
regulators or the Commission's capital requirement. Roughly $29
trillion of outward-facing cleared IRS positions (with double counting)
are held by SDs subject to the Commission's capital requirement. The
Commission assumes that cleared swaps requires margin of about 0.14%
(which is, 0.2%/[radic]2) to 1.4% (2%/[radic]2) of gross notional,
because margin period of risk is five days for cleared swaps compared
to ten days for uncleared swaps. The initial margin required for
cleared swaps held by SDs subject to CFTC requirement is about 40
billion to 400.6 billion. Assuming capital required is eight percent of
initial margin, the capital required for the cleared swaps held by SDs
subject to CFTC's proposed capital requirement is about $4.84 billion
to $48.4 billion. As discussed earlier, estimated capital required for
covered SDs is most likely to be close to the lower bound of $4.84
billion. Therefore, the total capital required for both cleared and
uncleared IRS positions held by SDs subject to the Commission's
proposed rule would range from $18.84 billion to $188.4 billion. As
discussed earlier, the estimated capital for IRS swaps held by SDs
subject to the Commission's requirement is most likely to be $18.84
billion. As discussed earlier, many SDs
[[Page 91302]]
already hold significant amount of excess capital. In the case that SDs
do not hold capital themselves, their parents hold significant amount
of excess capital. It may be possible for the consolidated entity to
keep the same level of capital within the group, but just reallocate
among its subsidiaries and therefore, the additional cost of complying
with the Commission's proposed capital requirement may not be too
burdensome.
Table 9--Gross Notional of Cleared IRS Positions (Billion $) Reported to SDR on June 24, 2016
[Double counting as both Counterparties may need to hold capital]
----------------------------------------------------------------------------------------------------------------
Gross notional in billion $ for uncleared IRS position (double Outward- Inter-
counting) facing affiliate Total
----------------------------------------------------------------------------------------------------------------
Held by SDs subject to CFTC capital requirement................. 28,612 0 28,612
Held by SDs subject to Prudential Regulator (PR)'s capital 102,221 0 102,221
requirement....................................................
Held by institutions not subject to CFTC or PR capital 198,458 5 198,463
requirement....................................................
-----------------------------------------------
Total....................................................... 329,291 5 329,296
----------------------------------------------------------------------------------------------------------------
Request for Comment
The Commission does not have sufficient financial information about
these SDs to estimate precise costs of these proposed requirements and
would welcome comments on how the proposed rule would impact the
capital structure and the cost of doing business.
1. Would the minimum capital requirements represent a barrier to
entry to firms that may otherwise seek to trade swaps as SDs? If so,
which types of firms would be foreclosed?
2. Is it correct to assume that firms part of U.S. BHCs that are
subject to Basel III and stress testing requirements would be readily
able to meet the proposed capital requirement?
3. Is it correct to assume that ANC firms would be readily able to
meet the proposed capital requirement?
4. Is it correct to assume that it would not be too costly for
firms or their parents already subject to SEC current BD and/or
proposed SBSD capital requirement or CFTC's current FCM capital
requirement to comply with the capital requirement?
5. Is it correct to assume that proposed capital requirements would
not be too burdensome for firms that are part of foreign BHCs subject
to Basel?
6. Would it be too costly for the smaller SDs and SDs that are not
subject to Basel or SEC or CFTC capital requirements to comply?
7. What restrictions would smaller firms be willing to accept for a
lower capital requirement?
8. What alternative capital requirements might achieve the same
policy goal?
ii. Margin vs. Capital
The Commission's proposal also would require an SD to include the
initial margin for all swaps that would otherwise fall below the $50
million initial margin threshold amount or the $500,000 minimum
transfer amount, as defined in Regulation 23.151, for purposes of
computing the uncleared swap margin amount. As such, the uncleared swap
margin amount would be the amount that an SD would have to collect from
a counterparty, assuming that the exclusions and exemptions for
collecting initial margin for uncleared swaps set forth in Regulations
23.150-161 would not apply, and also assuming that the thresholds under
which initial margin and/or variation margin would not need to be
exchanged would not apply. Accordingly, swaps that are not subject to
the margin requirement such as those executed prior to the compliance
date for margin requirements (``legacy swaps''), inter-affiliate swaps,
and swaps with counterparties that would qualify for the exception or
exemption under section 2(h)(7)(A) would have to be taken into account
in determining the capital requirement.
The Commission is proposing this approach as it believes that it
would be appropriate to require an SD to maintain capital for
uncollateralized swap exposures to counterparties to cover the
``residual'' risk of a counterparty's uncleared swaps positions. The
Commission's proposed approach regarding the inclusion of
uncollateralized swap exposures in the SD's capital requirements is
consistent with the approach adopted by the prudential regulators in
setting capital requirements for SDs subject to their jurisdiction and
is consistent with the approach proposed by the SEC for SBSDs.
The Commission provides certain exemptions from initial margin
requirements for uncleared trades between affiliates. However, for the
proposed capital rule inter-affiliate swaps would require capital to be
held against them. The Commission requests comments on how the proposed
capital rule would impact the competitiveness between different SDs
based on the legal entity structure of the firm. The Commission
understands that SDs may have different organizational structures due
to various reasons. These reasons include, among others, centralized
risk management for consolidation of balance-sheet, asset-liability and
liquidity risk management; taxation benefits; funds transfer pricing;
merger and acquisition; and subsidiaries in different jurisdictions. An
arms-length swap may be offset by swap transaction with an affiliated
SD because of any of the reasons listed above and possibly others.
Centralization of risk within different entities of a firm in the same
jurisdiction provides risk reduction benefits somewhat similar to the
CCP and is encouraged.
As per the proposed rule, both parties to a swap transaction may be
required to hold capital even if they both are part of the same parent
institution. In that sense, there may be double (or more) counting of
capital at the parent level for a given outward facing swap based on
the legal structure of the entity. This may lead to an uneven playing
field between SDs if for a given swap, different swap dealers are
required to hold different amount of capital based on the number of
inter-affiliate trades that they execute for the same client facing
trade.
iii. Model vs. Table
The proposal would allow an SD to apply to the Commission or an RFA
of which it is a member for approval to use internal models when
calculating its market risk exposure and credit risk exposure. The
proposal would also allow an FCM that is also an SD to apply in writing
to the Commission or an RFA of which it is a member for approval to
compute deductions for market risk and credit risk using internal
models in lieu of the standardized deductions otherwise required.
As discussed above, there are approximately 107 SDs and no MSPs
provisionally registered with the
[[Page 91303]]
Commission. Of these, the Commission estimates that approximately 55
SDs and no MSPs would be subject to the Commission's capital rules as
they are not subject to those of a prudential regulator. The Commission
further estimates conservatively that most of these SDs and MSPs would
seek to obtain Commission approval to use models for computing their
market and credit risk capital charges. These entities would incur cost
to develop, maintain, document, audit models, and seek model approval.
The possibility of using models to calculate credit risk and market
risk charges may allow SDs to more efficiently deploy capital in other
parts of its operations, because models could reduce capital charges
and thereby could make additional capital available. This reduced
capital requirement due to model use could improve returns of SDs and
make them more competitive.
Although the Commission expects that SDs would use models for
calculating market risk and credit risk charges, it is possible that
some entities, particularly potential new entrants, may not have the
risk management capabilities of which the models are an integral part,
and, therefore, have to rely on the standardized haircut approach. The
benefit of the standardized haircut approach for measuring market risk
is its inherent simplicity. Therefore, this approach may improve
customer protections and reduce systemic risk. In addition, a
standardized haircut approach may reduce costs for the SD related to
the risk of failing to observe or correct a problem with the use of
models that could adversely impact the firm's financial conditions,
because the use of models would require the allocation by the SD of
additional firm resources and personnel. Conversely, if the proposed
standardized haircuts are too conservative, they could make conducting
swap business too costly, preventing or impairing the ability of the
firms to engage in swaps, increasing transaction costs, reducing
liquidity, and reducing the availability of swaps for risk mitigation
by end users.
Request for Comment
Does the proposed capital requirement reflect the increased risk
associated with the use of models and trading in a portfolio of swaps?
iv. Liquidity Requirement and Equity Withdrawal Restrictions
The Commission proposes additional liquidity requirements and
equity withdrawal restrictions on certain eligible SDs. For SDs that
elect a bank-based capital approach, the Commission is proposing to
require the SD to maintain each day an amount of high quality liquid
assets (``HQLAs''), that is no less than 100 percent of the SDs total
net cash outflows over a prospective 30 calendar-day period. The HQLAs
could be converted quickly into cash without reasonably expecting to
incur losses in excess of the applicable haircuts during a stress
period. Total net cash outflow amount are calculated by applying
outflow and inflow rates, which reflect certain standardized stressed
assumptions, against the balances of an SD's funding sources,
obligations, transactions, and assets over a prospective 30 day period.
For SDs that elect a net liquid assets capital approach, the
Commission is proposing a liquidity stress test to be conducted by SDs
that elect a net liquid assets capital approach at least monthly that
takes into account certain assumed stressed conditions lasting for 30
consecutive days. The proposed minimum elements are designed to ensure
that SDs employ a stress test that is severe enough to produce an
estimate of a potential funding loss of a magnitude that might be
expected in a severely stressed market.
Table 10--Minimum Liquidity Requirement
----------------------------------------------------------------------------------------------------------------
Liquidity reserve Contingency Transferring
requirement funding plan Risk management approval
----------------------------------------------------------------------------------------------------------------
SDs that elect a bank-based Liquidity Coverage Strategies to Review LCR Approval prior to
capital approach. Ratio (LCR) >=1; address liquidity quarterly by transferring
HQLAs >= total net shortfalls in senior management HQLAs if, after
cash outflows emergency. overseeing risk transferring, LCR
over a management, <1.
prospective 30 annually by
calendar-day senior management.
period.
SDs that elect a net liquid Liquidity Stress Strategies to .................. ..................
asset capital approach. Test; address liquidity
Unencumbered cash shortfalls in
+ U.S. government emergency..
securities >= a
potential funding
loss of a
magnitude that
might be expected
in a severely
stressed market
for 30
consecutive days.
----------------------------------------
SDs that elect a tangible net None .................. ..................
worth approach.
----------------------------------------------------------------------------------------------------------------
The benefit of the proposed liquidity requirement is an additional
level of protection against disruptions in the ability to obtain
funding for a firm. This requirement intends to increase the likelihood
that a firm could withstand a general loss of confidence in the firm
itself, or the markets more generally and stay solvent for up to 30
days, during which time it could either regain the ability to obtain
funding in the ordinary course or else better position itself for
resolution, with less impact on other market participants and the
financial system. Therefore, this requirement may reduce the likelihood
and severity of a fire sale and thus mitigate spillover effects and
lower systemic risk. This, in turn, may increase confidence in swap
markets and may lead to an increase in the use of swaps.
However, this requirement would impose additional cost of capital
and other costs directly related to the amount of the required
liquidity reserve because an SD would be unable to deploy the assets
that are maintained for the liquidity reserve in other, potentially
more profitable ways. In addition, some firms may incur more
implementation costs, because, firms (or their parent holding
companies) that are
[[Page 91304]]
already complying with Basel III or SEC's liquidity requirements may
already run stress tests, maintain liquidity reserves based on those
tests, and/or have a written contingency funding plan.
Request for Comment
How much additional cost would SDs incur resulting from the
proposed liquidity requirements given their current practice? The
Commission requests that commenters quantify the extent of the
additional cost the proposed minimum liquidity requirement would incur
based on its portfolios and financials, and provide the Commission with
such data. The Commission also requests comments on alternative
approaches to liquidity requirements to achieve the same policy goal.
v. Other Considerations
The proposed requirements should reduce the risk of a failure of
any major market participant in the swap market, which in turn reduces
the possibility of a general market failure, and thus promotes
confidence for market participants to transact in swaps for investment
and hedging purposes. The proposed capital requirements are designed to
promote confidence in SDs among customers, counterparties, and the
entities that provide financing to SDs, thereby, lessen the potential
that these market participants may seek to rapidly withdraw assets and
financing from SDs during a time of market stress. This heightened
confidence is expected to increase swap transactions and promote
competition among dealers. A more competitive swap market may promote a
more efficient capital allocation.
However, to the extent that costs associated with the proposed
rules are high, they may negatively affect competition within the swap
markets. This may, for example, lead smaller dealers or entities for
whom dealing is not a core business to exit the market because
compliance with the proposed minimum capital, liquidity, and reporting
requirements is not feasible due to its cost. The same costs might also
deter the entry of new SDs into the market, and if sufficiently high,
increase concentration among SDs.
The proposals ultimately adopted could have a substantial impact on
domestic and international commerce and the relative competitive
position of SDs operating under different requirements of various
jurisdictions. Specifically, SDs subject to a particular regulatory
regime may be advantaged or disadvantaged if corresponding requirements
in other regimes are substantially more or less stringent. This could
affect the ability of U.S. SDs to compete in the domestic and global
markets, the ability of non-U.S. to compete in U.S. markets.
Substantial differences between the U.S. and foreign jurisdictions in
the costs of complying with these requirements for swaps between U.S.
and foreign jurisdictions could reduce cross-border capital flows and
hinder the ability of global firms to most efficiently allocate capital
among legal entities to meet the demands of their customers/
counterparties.
The willingness of end users to trade with an SD dealer will depend
on their evaluation of the counterparty credit risks of trading with
that particular SD compared to alternative SDs, and their ability to
negotiate favorable price and other terms. The proposed capital,
liquidity, and risk management requirements would in general reduce the
likelihood of SDs' defaulting or failing, and therefore may increase
the willingness of end users to trade with more SDs that have strong
capital and liquidity reserves. End users of covered swaps are mostly
made up of sophisticated participants such as hedge fund, asset
management, other financial firms, and large commercial corporations.
Many of these entities trade substantial volume of swaps and are
relatively well-positioned to negotiate price and other terms with
competing dealers. To the extent that the proposals result in increased
competition, participants should be able to take advantage of this
increased competition and negotiate improved terms. On the other hand,
SDs may pass on additional capital, liquidity, and operational costs
resulting from the proposal to end users in the form of higher fees or
wider spreads. Thus end users may experience increased cost of using
swaps for hedging and investing purposes.
In addition, benefits may arise when SDs consolidate with other
affiliated SDs, FCMs, and/or broker-dealers. This may yield
efficiencies for clients conducting business in swaps, including
netting benefits, reduced number of account relationships, and reduced
number of governing agreements. These potential benefits, however, may
be offset by reduced competition from a smaller number of competing
SDs. Further, the proposals would permit conducting swap business in an
entity jointly registered as an FCM, or SBSD, or broker-dealer, which
may offer the potential for these firms to offer portfolio margining
for a variety of positions. From a holding company's perspective,
aggregating swap business in a single entity, could help simplify and
streamline risk management, allow more efficient use of capital, as
well as operational efficiencies, and avoid the need for multiple
netting and other agreements.
The proposed rules may create the potential for regulatory
arbitrage to the extent that they differ from corresponding rules other
regulators adopt. Also, to the extent that the proposed requirements
are overly stringent, they may prevent or discourage new entrants into
swap markets and thereby may either increase spreads and trading costs
or even reduce the availability of swaps. In these cases, end users
would face higher cost or be forced to use less effective financial
instruments to meet their business needs.
List of Subjects
17 CFR Part 1
Brokers, Commodity futures, Reporting and recordkeeping
requirements.
17 CFR Part 23
Capital and margin requirements, Major swap participants, Swap
dealers, Swaps.
17 CFR Part 140
Authority delegations (Government agencies).
For the reasons discussed in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR chapter I as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 9a, 12, 12a,
16, 18, 19, 21, and 23.
0
2. In Sec. 1.10, revise paragraph (f)(1) introductory text; paragraphs
(f)(1)(i)(B), (f)(1)(ii)(B), and (g)(1); paragraph (g)(2) introductory
text; and paragraph (h) to read as follows:
Sec. 1.10 Financial reports of futures commission merchants and
introducing brokers.
* * * * *
(f) Extension of time for filing uncertified reports. (1) In the
event a registrant finds that it cannot file its Form 1-FR, or, in
accordance with paragraph (h) of this section, its Financial and
Operational Combined Uniform Single Report under the Securities
Exchange Act of 1934, part II,
[[Page 91305]]
part IIA, part II CSE (FOCUS report), or a Form SBS, for any period
within the time specified in paragraphs (b)(1)(i) or (b)(2)(i) of this
section without substantial undue hardship, it may request approval for
an extension of time, as follows:
(i) * * *
(B) A futures commission merchant that is registered with the
Securities and Exchange Commission as a securities broker or dealer may
file with its designated self-regulatory organization a copy of any
application that the registrant has filed with its designated examining
authority, pursuant to Sec. 240.17a-5(m) of this title, for an
extension of time to file its FOCUS report or Form SBS. The registrant
must also promptly file with the designated self-regulatory
organization and the Commission copies of any notice it receives from
its designated examining authority to approve or deny the requested
extension of time. Upon receipt by the designated self-regulatory
organization and the Commission of copies of any such notice of
approval, the requested extension of time referenced in the notice
shall be deemed approved under this paragraph (f)(1).
* * * * *
(ii) * * *
(B) An introducing broker that is registered with the Securities
and Exchange Commission as a securities broker or dealer may file with
the National Futures Association copies of any application that the
registrant has filed with its designated examining authority, pursuant
to Sec. 240.17a-5(m) of this title, for an extension of time to file
its FOCUS report or Form SBS. The registrant also must promptly file
with the National Futures Association copies of any notice it receives
from its designated examining authority to approve or deny the
requested extension of time. Upon the receipt by the National Futures
Association of a copy of any such notice of approval, the requested
extension of time referenced in the notice shall be deemed approved
under this paragraph (f)(1)(ii).
* * * * *
(g) Public availability of reports. (1) Forms 1-FR filed pursuant
to this section, and FOCUS reports or Forms SBS filed in lieu of Forms
1-FR pursuant to paragraph (h) of this section, will be treated as
exempt from mandatory public disclosure for purposes of the Freedom of
Information Act and the Government in the Sunshine Act and parts 145
and 147 of this chapter, except for the information described in
paragraph (g)(2) of this section.
(2) The following information in Forms 1-FR, and the same or
equivalent information in FOCUS reports or Forms SBS filed in lieu of
Forms 1-FR, will be publicly available:
* * * * *
(h) Filing option available to a futures commission merchant or an
introducing broker that is also a securities broker or dealer. Any
applicant or registrant which is registered with the Securities and
Exchange Commission as a securities broker or dealer, a security-based
swap dealer, or a major security-based market participant may comply
with the requirements of this section by filing (in accordance with
paragraphs (a), (b), (c), and (j) of this section) a copy, as
applicable, of its Financial and Operational Combined Uniform Single
Report under the Securities Exchange Act of 1934, Part II, Part IIA, or
Part II CSE (FOCUS Report), or Form SBS, in lieu of Form 1-FR;
Provided, however, That all information which is required to be
furnished on and submitted with Form 1-FR is provided with such FOCUS
Report or Form SBS; and Provided, further, That a certified FOCUS
Report or Form SBS filed by an introducing broker or applicant for
registration as an introducing broker in lieu of a certified Form 1-FR-
IB must be filed according to National Futures Association rules,
either in paper form or electronically, in accordance with procedures
established by the National Futures Association, and if filed
electronically, a paper copy of such filing with the original manually
signed certification must be maintained by such introducing broker or
applicant in accordance with Sec. 1.31.
* * * * *
0
3. Amend Sec. 1.12 as follows:
0
a. Revise paragraph (a) introductory text and paragraphs (a)(1),
(b)(3), and (b)(4); and
0
b. Add paragraph (b)(5).
The revisions and addition to read as follows:
Sec. 1.12 Maintenance of minimum financial requirements by futures
commission merchants and introducing brokers.
(a) Each person registered as a futures commission merchant or who
files an application for registration as a futures commission merchant,
and each person registered as an introducing broker or who files an
application for registration as an introducing broker (except for an
introducing broker or applicant for registration as an introducing
broker operating pursuant to, or who has filed concurrently with its
application for registration, a guarantee agreement and who is not also
a securities broker or dealer), who knows or should have known that its
adjusted net capital at any time is less than the minimum required by
Sec. 1.17 or by the capital rule of any self-regulatory organization
to which such person is subject, or the minimum net capital
requirements of the Securities and Exchange Commission if the applicant
or registrant is registered with the Securities and Exchange
Commission, must:
(1) Give notice, as set forth in paragraph (n) of this section that
the applicant's or registrant's capital is below the applicable minimum
requirement. Such notice must be given immediately after the applicant
or registrant knows or should have known that its adjusted net capital
or net capital, as applicable, is less than minimum required amount;
and
* * * * *
(b) * * *
(3) 150 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member, unless such
amount has been determined by a margin-based capital computation set
forth in the rules of the registered futures association, and such
amount meets or exceeds the amount of adjusted net capital required
under the margin-based capital computation set forth in Sec.
1.17(a)(1)(i)(B), in which case the required percentage is 110 percent;
(4) For securities brokers or dealers, the amount of net capital
specified in Rule 17a-11(b) of the Securities and Exchange Commission
(Sec. 240.17a-11(b) of this title); or
(5) For security-based swap dealers or major security-based swap
participants, the amount of net capital specified in Rule 18a-8(b) of
the Securities and Exchange Commission (Sec. 240.18a-8(b) of this
title), must file notice to that effect, as soon as possible and no
later than twenty-four (24) hours of such event.
* * * * *
0
4. In Sec. 1.16, revise paragraphs (f)(1)(i)(B) and (f)(1)(ii)(B) to
read as follows:
Sec. 1.16 Qualifications and reports of accountants.
* * * * *
(f)(1) * * *
(i) * * *
(B) A futures commission merchant that is registered with the
Securities and Exchange Commission as a securities broker or dealer, a
security-based swap dealer, or a major security-based swap participant,
may file with its designated self-regulatory organization a copy of any
application that the registrant has filed with its designated examining
[[Page 91306]]
authority, pursuant to Sec. 240.17a-5(m) of this title, for an
extension of time to file audited annual financial statements. The
registrant must also promptly file with the designated self-regulatory
organization and the Commission copies of any notice it receives from
its designated examining authority to approve or deny the requested
extension of time. Upon receipt by the designated self-regulatory
organization and the Commission of copies of any such notice of
approval, the requested extension of time referenced in the notice
shall be deemed approved under this paragraph (f)(1)(i).
* * * * *
(ii) * * *
(B) An introducing broker that is registered with the Securities
and Exchange Commission as a securities broker or dealer, a security-
based swap dealer, or a major security-based swap participant may file
with the National Futures Association copies of any application that
the registrant has filed with its designated examining authority,
pursuant to Sec. 240.17a-5(m) of this title, for an extension of time
to file audited annual financial statements. The registrant must also
file promptly with the National Futures Association copies of any
notice it receives from its designated examining authority to approve
or deny the requested extension of time. Upon the receipt by the
National Futures Association of a copy of any such notice of approval,
the requested extension of time referenced in the notice shall be
deemed approved under this paragraph (f)(1)(ii).
* * * * *
0
5. Amend Sec. 1.17 as follows:
0
a. Revise paragraphs (a)(1)(i)(A), (a)(1)(i)(B), (a)(1)(ii), (b)(9),
and (b)(10);
0
b. Add paragraph (b)(11);
0
c. Revise paragraphs (c)(1)(i), (c)(2)(i), (c)(2)(ii)(B), and
(c)(2)(ii)(D);
0
d. Add paragraphs (c)(2)(ii)(G) and (c)(5)(iii);
0
e. Revise paragraphs (c)(5)(viii), (c)(5)(ix), (c)(5)(x), and
(c)(5)(xiv);
0
f. Add paragraph (c)(5)(xv);
0
g. Revise paragraph (c)(6) introductory text and paragraphs (c)(6)(i)
and (c)(6)(iv)(A);
0
h. Add paragraphs (c)(6)(v) and (c)(6)(vi); and
0
i. Revise paragraph (g)(1).
The revisions and additions to read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
(a)(1)(i) * * *
(A) $1,000,000, Provided, however, that if the futures commission
merchant also is a swap dealer, the minimum amount shall be
$20,000,000;
(B) The futures commission merchant's risk-based capital
requirement, computed as eight percent of the sum of:
(1) The total risk margin requirement (as defined in paragraph
(b)(8) of this section) for positions carried by the futures commission
merchant in customer accounts and noncustomer accounts;
(2) The total initial margin that the futures commission merchant
is required to post with a clearing agency or broker for security-based
swap positions carried in customer and noncustomer accounts;
(3) The total uncleared swaps margin, as that term is defined in
Sec. 23.100 of this chapter;
(4) The total initial margin that the futures commission merchant
is required to post with a broker or clearing organization for all
proprietary cleared swaps positions carried by the futures commission
merchant;
(5) The total initial margin computed pursuant to Rule 18a-
3(c)(1)(i)(B) (Sec. 240.18a-3(c)(1)(B) of this title) of the
Securities and Exchange Commission for all uncleared security-based
swap positions carried by the futures commission merchant without
regard to any initial margin exemptions or exclusions that the rules of
the Securities and Exchange Commission may provide to such security-
based swap positions; and
(6) the total initial margin that the futures commission merchant
is required to post with a broker or clearing agency for proprietary
cleared security-based swaps;
* * * * *
(ii) A futures commission merchant that is registered as a swap
dealer and has received approval from the Commission, or from a
registered futures association of which the futures commission merchant
is a member, to use internal models to compute market risk and credit
risk charges for uncleared swaps must maintain net capital equal to or
in excess of $100 million and adjusted net capital equal to or in
excess of $20 million.
* * * * *
(b) * * *
(9) Cleared over the counter derivative positions means a swap
cleared by a derivatives clearing organization or a clearing
organization exempted by the Commission from registering as a
derivatives clearing organization, and further includes positions
cleared by any organization permitted to clear such positions under the
laws of the relevant jurisdiction.
(10) Cleared over the counter customer means any person that is not
a proprietary person as defined in Sec. 1.3(y) and for whom the
futures commission merchant carries on its books one or more accounts
for the cleared over the counter derivative positions of such person.
(11) Uncleared swap margin. This term means the amount of initial
margin that would be required to be collected by a swap dealer, as set
out in Sec. 23.152(a) of this chapter for each outstanding swap
(including the swaps that are exempt from the scope of Sec. 23.152 of
this chapter by Sec. 23.150 of this chapter), exempt foreign exchange
swaps or foreign exchange forwards, or netting set of swaps or foreign
exchange swaps, for each counterparty, as if that counterparty was an
unaffiliated swap dealer. In computing the uncleared swap margin
amount, a swap dealer may not exclude the initial margin threshold
amount or minimum transfer amount as such terms are defined in Sec.
23.151 of this chapter.
(c) * * *
(1) * * *
(i) Unrealized profits shall be added and unrealized losses shall
be deducted in the accounts of the applicant or registrant, including
unrealized profits and losses on fixed price commitments, uncleared
swaps, and forward contracts;
* * * * *
(2) * * *
(i) Exclude any unsecured commodity futures, options, cleared
swaps, or other Commission regulated account containing a ledger
balance and open trades, the combination of which liquidates to a
deficit or containing a debit ledger balance only: Provided, however,
deficits or debit ledger balances in unsecured customers', non-
customers', and proprietary accounts, which are the subject of calls
for margin or other required deposits may be included in current assets
until the close of business on the business day following the date on
which such deficit or debit ledger balance originated providing that
the account had timely satisfied, through the deposit of new funds, the
previous day's debit or deficits, if any, in its entirety.
(ii) * * *
(B)(1) Interest receivable, floor brokerage receivable, commissions
receivable from other brokers or dealers (other than syndicate
profits), mutual fund concessions receivable and management fees
receivable from registered investment companies and commodity pools
that are not outstanding more than thirty (30) days from the date they
are due;
[[Page 91307]]
(2) Dividends receivable that are not outstanding more than thirty
(30) days from the payable date; and
(3) Commissions or fees receivable, including from other brokers or
dealers, resulting from swap transactions that are not outstanding more
than sixty (60) days from the month end accrual date provided they are
billed promptly after the close of the month of their inception;
* * * * *
(D) Receivables from registered futures commission merchants or
brokers, resulting from commodity futures, options, cleared swaps,
foreign futures or foreign options transactions, except those
specifically excluded under paragraph (c)(2)(i) of this section;
* * * * *
(G) Receivables from third-party custodians that represent the
futures commission merchant's initial margin deposits associated with
uncleared swap transactions pursuant to Sec. 23.158 of this chapter or
uncleared security-based swap transactions under the rules of the
Securities and Exchange Commission.
* * * * *
(5) * * *
(iii) Swaps--(A) Uncleared swaps that are credit-default swaps
referencing broad-based securities indices--(1) Short positions
(selling protection). In the case of an uncleared short credit default
swap that references a broad-based securities index, deducting the
percentage of the notional amount based upon the current basis point
spread of the credit default swap and the maturity of the credit
default swap in accordance with the following table:
--------------------------------------------------------------------------------------------------------------------------------------------------------
Basis point spread (%)
Length of time to maturity of CDS contract -----------------------------------------------------------------------------------------------
100 or less 101-300 301-400 401-500 501-699 700 or more
--------------------------------------------------------------------------------------------------------------------------------------------------------
12 months or less....................................... 0.67 1.33 3.33 5.00 6.67 10.00
13 months to 24 months.................................. 1.00 2.33 5.00 6.67 8.33 11.67
25 months to 36 months.................................. 1.33 3.33 6.67 8.33 10.00 13.33
37 months to 48 months.................................. 2.00 4.00 8.33 10.00 11.67 15.00
49 months to 60 months.................................. 2.67 4.67 10.00 11.67 13.33 16.67
61 months to 72 months.................................. 3.67 5.67 11.67 13.33 15.00 18.33
73 months to 84 months.................................. 4.67 6.67 13.33 15.00 16.67 20.00
85 months to 120 months................................. 5.67 10.00 15.00 16.67 18.33 26.67
121 months and longer................................... 6.67 13.33 16.67 18.33 20.00 33.33
--------------------------------------------------------------------------------------------------------------------------------------------------------
(2) Long positions (purchasing protection). In the case of an
uncleared swap that is a long credit default swap referencing a broad-
based securities index, deducting 50 percent of the deduction that
would be required by paragraph (c)(5)(iii)(A)(1) of this section if the
swap was a credit default swap.
(3) Long and short positions--(i) Long and short uncleared credit
default swaps referencing the same broad-based security index. In the
case of uncleared swaps that are long and short credit default swaps
referencing the same broad-based security index, have the same credit
events which would trigger payment by the seller of protection, have
the same basket of obligations which would determine the amount of
payment by the seller of protection upon the occurrence of a credit
event, that are in the same or adjacent maturity spread category and
have a maturity date within three months of the other maturity
category, deducting the percentage of the notional amounts specified in
the higher maturity category under paragraph (c)(5)(iii)(A)(1) or
(c)(5)(iii)(A)(2) of this section on the excess of the long or short
position.
(ii) Long basket of obligors and uncleared long credit default swap
referencing a broad-based securities index. In the case of an uncleared
swap that is a long credit default swap referencing a broad-based
securities index and the futures commission merchant is long a basket
of debt securities comprising all of the components of the securities
index, deducting 50 percent of the amount specified in Sec. 240.15c3-
1(c)(2)(vi) of this title for the component of securities, provided the
futures commission merchant can deliver the component securities to
satisfy the obligation of the futures commission merchant on the credit
default swap.
(iii) Short basket of obligors and uncleared short credit default
swap referencing a broad-based securities index. In the case of an
uncleared swap that is a short credit default swap referencing a broad-
based securities index and the futures commission merchant is short a
basket of debt securities comprising all of the components of the
securities index, deducting the amount specified in Sec. 240.15c3-
1(c)(2)(vi) of this title for the component securities.
(B) Interest rate swaps. In the case of an uncleared interest rate
swap, deducting the percentage deduction specified in Sec. 240.15c3-
1(c)(2)(vi)(A) of this title based on the maturity of the interest rate
swap, provided that the percentage deduction must be no less than 0.5
percent;
(C) All other uncleared swaps. (1) In the case of any uncleared
swap that is not a credit default swap or interest rate swap, deducting
the amount calculated by multiplying the notional value of the swap by:
(i) The percentage specified in Sec. 240.15c3-1 of this title
applicable to the reference asset if Sec. 240.15c3-1 of this title
specifies a percentage deduction for the type of asset and this section
does not specify a percentage deduction;
(ii) Six percent in the case of a currency swap that references
euros, British pounds, Canadian dollars, Japanese yen, or Swiss francs,
and twenty percent in the case of currency swaps that reference any
other foreign currencies; or
(iii) In the case of over-the-counter swap transactions involving
commodities, 20 percent of the market value of the amount of the
underlying commodities; and
(iv) In the case of security-based swaps as defined in section 3(a)
of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)), the
percentage as specified in Sec. 240.15c3-1 of this title.
* * * * *
(viii) In the case of a futures commission merchant, for
undermargined customer accounts, the amount of funds required in each
such account to meet maintenance margin requirements of the applicable
board of trade or if there are no such maintenance margin requirements,
[[Page 91308]]
clearing organization margin requirements applicable to such positions,
after application of calls for margin or other required deposits which
are outstanding no more than one business day. If there are no such
maintenance margin requirements or clearing organization margin
requirements, then the amount of funds required to provide margin equal
to the amount necessary, after application of calls for margin or other
required deposits outstanding no more than one business day, to restore
original margin when the original margin has been depleted by 50
percent or more: Provided, to the extent a deficit is excluded from
current assets in accordance with paragraph (c)(2)(i) of this section
such amount shall not also be deducted under this paragraph. In the
event that an owner of a customer account has deposited an asset other
than cash to margin, guarantee or secure his account, the value
attributable to such asset for purposes of this subparagraph shall be
the lesser of:
(A) The value attributable to the asset pursuant to the margin
rules of the applicable board of trade, or
(B) The market value of the asset after application of the
percentage deductions specified in paragraph (c)(5) of this section;
(ix) In the case of a futures commission merchant, for
undermargined noncustomer and omnibus accounts the amount of funds
required in each such account to meet maintenance margin requirements
of the applicable board of trade or if there are no such maintenance
margin requirements, clearing organization margin requirements
applicable to such positions, after application of calls for margin or
other required deposits which are outstanding no more than one business
day. If there are no such maintenance margin requirements or clearing
organization margin requirements, then the amount of funds required to
provide margin equal to the amount necessary after application of calls
for margin or other required deposits outstanding no more than one
business day to restore original margin when the original margin has
been depleted by 50 percent or more: Provided, to the extent a deficit
is excluded from current assets in accordance with paragraph (c)(2)(i)
of this section such amount shall not also be deducted under this
paragraph. In the event that an owner of a noncustomer or omnibus
account has deposited an asset other than cash to margin, guarantee or
secure his account the value attributable to such asset for purposes of
this paragraph shall be the lesser of the value attributable to such
asset pursuant to the margin rules of the applicable board of trade, or
the market value of such asset after application of the percentage
deductions specified in paragraph (c)(5) of this section;
(x) In the case of open futures contracts, cleared swaps, and
granted (sold) commodity options held in proprietary accounts carried
by the applicant or registrant which are not covered by a position held
by the applicant or registrant or which are not the result of a
``changer trade'' made in accordance with the rules of a contract
market:
(A) For an applicant or registrant which is a clearing member of a
clearing organization for the positions cleared by such member, the
applicable margin requirement of the applicable clearing organization;
(B) For an applicant or registrant which is a member of a self-
regulatory organization, 150 percent of the applicable maintenance
margin requirement of the applicable board of trade, or clearing
organization, whichever is greater;
(C) For all other applicants or registrants, 200 percent of the
applicable maintenance margin requirements of the applicable board of
trade or clearing organization, whichever is greater; or
(D) For open contracts or granted (sold) commodity options for
which there are no applicable maintenance margin requirements, 200
percent of the applicable initial margin requirement: Provided, the
equity in any such proprietary account shall reduce the deduction
required by this paragraph (c)(5)(x) if such equity is not otherwise
includable in adjusted net capital;
* * * * *
(xiv) For securities brokers and dealers, all other deductions
specified in Sec. 240.15c3-1 of this title;
(xv) In the case of a futures commission merchant, the amount of
the uncleared swap margin that the futures commission merchant has not
collected from a swap counterparty, less any amounts owed by the
futures commission merchant to the swap counterparty for uncleared swap
transactions.
(6)(i) Election of alternative capital deductions that have
received approval of Securities and Exchange Commission pursuant to
Sec. 240.15c3-1(a)(7) of this title. Any futures commission merchant
that is also registered with the Securities and Exchange Commission as
a securities broker or dealer, and who also satisfies the other
requirements of this paragraph (c)(6), may elect to compute its
adjusted net capital using the alternative capital deductions that,
under Sec. 240.15c3-1(a)(7) of this title, the Securities and Exchange
Commission has approved by written order in lieu of the deductions that
would otherwise be required under this section.
* * * * *
(iv) * * *
(A) Information that the futures commission merchant files on a
monthly basis with its designated examining authority or the Securities
and Exchange Commission, whether by way of schedules to its FOCUS
reports or by other filings, in satisfaction of Sec. 240.17a-5(a)(5)
of this title;
* * * * *
(v) Election of alternative market risk and credit risk capital
deductions for a futures commission merchant that is registered as a
swap dealer and has received approval of the Commission or a registered
futures association for which the futures commission merchant is a
member. For purposes of this paragraph (c)(6)(v) only, all references
to futures commission merchant means a futures commission merchant that
is also registered as a swap dealer.
(A) A futures commission merchant may apply in writing to the
Commission or a registered futures association of which it is a member
for approval to compute deductions for market risk and credit risk
using internal models in lieu of the standardized deductions otherwise
required under this section. The futures commission merchant must file
the application in accordance with instructions approved by the
Commission and specified on the Web site of the registered futures
association.
(B) A futures commission merchant's application must include the
information set forth in Appendix A to Sec. 23.102 of this chapter and
the market risk and credit risk charges must be computed in accordance
with Sec. 23.102 of this chapter.
(vi) A futures commission merchant that is also registered as a
swap dealer must comply with the liquidity requirements in Sec.
23.104(b)(1) of this chapter as though it were a swap dealer that
elected to follow Sec. 23.101(a)(1)(ii) of this chapter in computing
its minimum capital requirement.
* * * * *
(g)(1) The Commission may by order restrict, for a period of up to
twenty business days, any withdrawal by a futures commission merchant
of equity capital, or any unsecured advance or loan to a stockholder,
partner, limited liability company member, sole proprietor, employee or
affiliate if the Commission, based on the facts and information
available, concludes that
[[Page 91309]]
any such withdrawal, advance or loan may be detrimental to the
financial integrity of the futures commission merchant, or may unduly
jeopardize its ability to meet customer obligations or other
liabilities that may cause a significant impact on the markets.
* * * * *
0
6. In Sec. 1.65, revise paragraph (b) introductory text and paragraphs
(d) and (e) to read as follows:
Sec. 1.65 Notice of bulk transfers and disclosure obligations to
customers.
* * * * *
(b) Notice to the Commission. Each futures commission merchant or
introducing broker shall file with the Commission, at least ten
business days in advance of the transfer, notice of any transfer of
customer accounts carried or introduced by such futures commission
merchant or introducing broker that is not initiated at the request of
the customer, where the transfer involves the lesser of:
* * * * *
(d) The notice required by paragraph (b) of this section shall be
considered filed when submitted to the Director of the Division of Swap
Dealer and Intermediary Oversight, in electronic form using a form of
user authentication assigned in accordance with procedures established
by or approved by the Commission, and otherwise in accordance with
instructions issued by or approved by the Commission.
(e) In the event that the notice required by paragraph (b) of this
section cannot be filed with the Commission at least ten days prior to
the account transfer, the Commission hereby delegates to the Director
of the Division of Swap Dealer and Intermediary Oversight, or such
other employee or employees as the Director may designate from time to
time, the authority to accept a lesser time period for such
notification at the Director's or designee's discretion. In any event,
however, the transferee futures commission merchant or introducing
broker shall file such notice as soon as practicable and no later than
the day of the transfer. Such notice shall include a brief statement
explaining the circumstances necessitating the delay in filing.
* * * * *
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
7. The authority citation for part 23 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b),
Pub. L. 111-203, 124 Stat. 1641 (2010).
0
8. Revise subpart E of part 23 to read as follows:
Subpart E--Capital and Margin Requirements for Swap Dealers and Major
Swap Participants
Sec.
23.100 Definitions applicable to capital requirements.
23.101 Minimum financial requirements for swap dealers and major
swap participants.
23.102 Calculation of market risk exposure requirement and credit
risk exposure requirement using internal models.
23.103 Calculation of market risk exposure requirement and credit
risk exposure requirement when models are not approved.
23.104 Liquidity requirements and equity withdrawal restrictions.
23.105 Financial recordkeeping, reporting and notification
requirements for swap dealers and major swap participants.
23.106 Comparability determination for substituted compliance.
23.107-23.149 [Reserved]
Subpart E--Capital and Margin Requirements for Swap Dealers and
Major Swap Participants
Sec. 23.100 Definitions applicable to capital requirements.
For purposes of Sec. Sec. 23.101 through 23.108 of subpart E of
this part, the following terms are defined as follows:
Actual daily net trading profit and loss. This term is used in
assessing the performance of a swap dealer's VaR measure and refers to
changes in the swap dealer's portfolio value that would have occurred
were end-of-day positions to remain unchanged (therefore, excluding
fees, commissions, reserves, net interest income, and intraday
trading).
Credit risk. This term refers to the risk that the counterparty to
an uncleared swap transaction could default before the final settlement
of the transaction's cash flows.
Credit risk exposure requirement. This term refers to the amount
that the swap dealer is required to compute under Sec. 23.102 if
approved to use internal credit risk models, or to compute under Sec.
23.103 if not approved to use internal credit risk models.
Exempt foreign exchange swaps and foreign exchange forwards are
those foreign exchange swaps and foreign exchange forwards that were
exempted from the definition of a swap by the U.S. Department of the
Treasury.
Market risk exposure. This term means the risk of loss in a
position or portfolio of positions resulting from movements in market
prices and other factors. Market risk exposure is the sum of:
(1) General market risks including changes in the market value of a
particular assets that result from broad market movements, such as a
changes in market interest rates, foreign exchange rates, equity
prices, and commodity prices;
(2) Specific risk, which includes risks that affect the market
value of a specific instrument, such as the credit risk of the issuer
of the particular instrument, but do not materially alter broad market
conditions;
(3) Incremental risk, which means the risk of loss on a position
that could result from the failure of an obligor to make timely
payments of principal and interest; and
(4) Comprehensive risk, which is the measure of all material price
risks of one or more portfolios of correlation trading positions.
Market risk exposure requirement. This term refers to the amount
that the swap dealer is required to compute under Sec. 23.102 if
approved to use internal market risk models, or Sec. 23.103 if not
approved to use internal market risk models.
Predominantly engaged in non-financial activities. A swap dealer is
predominantly engaged in non-financial activities if:
(1) The swap dealer's consolidated annual gross financial revenues
in either of its two most recently completed fiscal years represents
less than 15 percent of the swap dealer's consolidated gross revenue in
that fiscal year (``15% revenue test''), and
(2) The consolidated total financial assets of the swap dealer at
the end of its two most recently completed fiscal years represents less
than 15 percent of the swap dealer's consolidated total assets as of
the end of the fiscal year (``15% asset test''). For purpose of
computing the 15% revenue test or the 15% asset test, a swap dealer's
activities shall be deemed financial activities if such activities are
defined as financial activities under 12 CFR 242.3 and Appendix A of 12
CFR part 242, including lending, investing for others, safeguarding
money or securities for others, providing financial or investment
advisory services, underwriting or making markets in securities,
providing securities brokerage services, and engaging as principal in
investing and trading activities; provided, however, a swap dealer may
exclude from its financial activities accounts receivable resulting
from non-financial activities.
Prudential regulator. This term has the same meaning as set forth
in section
[[Page 91310]]
1a(39) of the Act, and includes the Board of Governors of the Federal
Reserve System, the Office of the Comptroller of the Currency, the
Federal Deposit Insurance Corporation, the Farm Credit Administration,
and the Federal Housing Finance Agency, as applicable to a swap dealer
or major swap participant.
Regulatory capital. This term shall mean the amount of tier 1
capital or ratio based capital, tangible net worth, or calculated net
capital of a swap dealer or major swap participant relevant to the
associated applicable regulatory capital requirement.
Regulatory capital requirement. This term refers to each of the
capital requirements that Sec. 23.101 applies to a swap dealer or
major swap participant.
Tangible net worth. This term means the net worth of a swap dealer
or major swap participant as determined in accordance with generally
accepted accounting principles in the United States, excluding goodwill
and other intangible assets. In determining net worth, all long and
short positions in swaps, security-based swaps and related positions
must be marked to their market value. A swap dealer or major swap
participant must include in its computation of tangible net worth all
liabilities or obligations of a subsidiary or affiliate that the swap
dealer or major swap participant guarantees, endorses, or assumes
either directly or indirectly.
Uncleared swap margin. This term means the amount of initial
margin, computed in accordance with Sec. 23.154, that a swap dealer
would be required to collect from each counterparty for each
outstanding swap position of the swap dealer. A swap dealer must
include all swap positions in the calculation of the uncleared margin
amount, including swaps that are exempt from the scope of the
Commission's margin for uncleared swaps rules pursuant to Sec. 23.150,
exempt foreign exchange swaps or foreign exchange forwards, or netting
set of swaps or foreign exchange swaps, for each counterparty, as if
that counterparty was an unaffiliated swap dealer. Furthermore, in
computing the uncleared swap margin amount, a swap dealer may not
exclude the initial margin threshold amount or minimum transfer amount
as such terms are defined in Sec. 23.151.
Sec. 23.101 Minimum financial requirements for swap dealers and major
swap participants.
(a)(1) Except as provided in paragraphs (a)(2) through (a)(5) of
this section, each swap dealer must elect to be subject to the minimum
capital requirements set forth in either paragraphs (a)(1)(i) or
(a)(1)(ii) of this section:
(i) A swap dealer that elects to meet the capital requirements in
this paragraph (a)(1)(i) must maintain regulatory capital that equals
or exceeds the greatest of the following:
(A) $20 million of common equity tier 1 capital, as defined under
the bank holding company regulations in 12 CFR 217.20, as if the swap
dealer itself were a bank holding company subject to 12 CFR part 217;
(B) Common equity tier 1 capital, as defined under the bank holding
company regulations in 12 CFR 217.20, equal to or greater than eight
percent of the swap dealer's risk-weighted assets computed under the
bank holding company regulations in 12 CFR part 217, as if the swap
dealer itself were a bank-holding company subject to 12 CFR part 217;
provided, however, that the swap dealer must add to its risk-weighted
assets market risk capital charges computed in accordance with Sec.
1.17 of this chapter if the swap dealer has not obtained the approval
of the Commission or of a registered futures association to use
internal capital models under Sec. 23.102;
(C) Common equity tier 1 capital, as defined under 12 CFR 217.20,
equal to or greater than eight percent of the sum of:
(1) The amount of uncleared swap margin, as that term is defined in
Sec. 23.100, for each uncleared swap position open on the books of the
swap dealer, computed on a counterparty by counterparty basis pursuant
to Sec. 23.154;
(2) The amount of initial margin that would be required for each
uncleared security-based swap position open on the books of the swap
dealer, computed on a counterparty by counterparty basis pursuant to
Sec. 240.18a-3(c)(1)(i)(B) of this title without regard to any initial
margin exemptions or exclusions that the rules of the Securities and
Exchange Commission may provide to such security-based swap positions;
and
(3) The amount of initial margin required by clearing organizations
for cleared proprietary futures, foreign futures, swaps, and security-
based swaps positions open on the books of the swap dealer; or,
(D) The amount of capital required by a registered futures
association of which the swap dealer is a member.
(ii) A swap dealer that elects to meet the capital requirements in
this paragraph (a)(1)(ii) must maintain regulatory capital that equals
or exceeds the greatest of the following:
(A) The amount of tentative net capital and net capital required
by, and computed in accordance with, Sec. 240.18a-1 of this title as
if the swap dealer were a security-based swap dealer registered with
the Securities and Exchange Commission and subject to Sec. 240.18a-1
of this title; Provided, however, that the swap dealer's computation is
subject to the following adjustments:
(1) In computing its minimum capital requirement, a swap dealer
shall adjust the ``risk margin amount'' subject to the eight percent
computation under Sec. 240.18a-1(a)(1) and (2) of this title to be the
sum of:
(i) The amount of uncleared swap margin, as that term is defined in
Sec. 23.100, for each uncleared swap position open on the books of the
swap dealer, computed on a counterparty by counterparty basis pursuant
to Sec. 23.154;
(ii) The amount of initial margin that would be required for each
uncleared security-based swap position open on the books of the swap
dealer, computed on a counterparty by counterparty basis pursuant to
Sec. 240.18a-3(c)(1)(i)(B) of this title without regard to any initial
margin exemptions or exclusions that the rules of the Securities and
Exchange Commission may provide to such security-based swap positions;
(iii) The amount of risk margin, as defined in Sec. 1.17(b)(8) of
this chapter, required by a clearing organization for proprietary
futures, swaps, and foreign futures positions open on the books of the
swap dealer; and
(iv) The amount of initial margin required by a clearing
organization for proprietary security-based swaps open on the books of
the swap dealer;
(2) A swap dealer that uses internal models to compute market risk
for its proprietary positions under Sec. 240.18a-1(d) of this title
must calculate the total market risk as the sum of the VaR measure,
stressed VaR measure, specific risk measure, comprehensive risk
measure, and incremental risk measure of the portfolio of proprietary
positions in accordance with Sec. 23.102 and Appendix A of Sec.
23.102;
(3) A swap dealer that has obtained approval from the Commission or
from a registered futures association of which it is a member to uses
internal models to compute credit risk capital charges for receivables
resulting from uncleared swap and security-based swap transactions may
use such models in computing the credit risk charge for receivables
resulting from swap and security-based swap transactions under Sec.
240.18a-1(d) of this title from all counterparties, including
commercial end users as defined in Sec. 240.18a-3(b)(2) of this title;
(4) A swap dealer may recognize as a current asset, receivables
from third-
[[Page 91311]]
party custodians that maintain the swap dealer's initial margin
deposits associated with uncleared swap transactions under Sec. 23.152
and the swap dealer's initial margin deposits associated with uncleared
security-based swap transactions under Sec. 240.18a-1(c)(1) of this
title; and
(5) A swap dealer may not deduct the margin difference as that term
is defined in Sec. 240.18a-1(c)(1)(viii) of this title for swap and
security-based swap transactions in lieu of collecting margin on such
transactions; or
(B) The amount of capital required by a registered futures
association of which the swap dealer is a member.
(2)(i) A swap dealer that is ``predominantly engaged in non-
financial activities'' as defined in Sec. 23.100 may elect to meet the
minimum capital requirements in this paragraph (a)(2) in lieu of the
capital requirements in paragraph (a)(1) of this section.
(ii) A swap dealer that satisfies the requirements of paragraph
(a)(2)(i) of this section and elects to meet the requirements of this
paragraph (a)(2) must maintain tangible net worth, as defined in Sec.
23.100, equal to or in excess of the greatest of the following:
(A) $20 million plus the amount of the swap dealer's market risk
exposure requirement (as defined in Sec. 23.100) and its credit risk
exposure requirement (as defined in Sec. 23.100) associated with the
swap dealer's swap and related hedge positions that are part of the
swap dealer's swap dealing activities. The swap dealer shall compute
its market risk exposure requirement and credit risk exposure
requirement for its swap positions in accordance with Sec. 23.102 if
the swap dealer has obtained the approval of the Commission or a
registered futures association of which it is a member to use internal
capital models. The swap dealer shall compute its market risk exposure
requirement and credit risk exposure requirement in accordance with the
standardized approach of paragraphs (b)(1) and (c)(1) of Sec. 23.103
if it has not been approved by the Commission or a registered futures
association to use internal capital models;
(B) Eight percent of the sum of:
(1) The amount of uncleared swap margin, as that term is defined in
Sec. 23.100, for each uncleared swap positions open on the books of
the swap dealer, computed on a counterparty by counterparty basis
pursuant to Sec. 23.154;
(2) The amount of initial margin that would be required for each
uncleared security-based swap position open on the books of the swap
dealer, computed on a counterparty by counterparty basis pursuant to
Sec. 240.18a-3(c)(1)(i)(B) of this title without regard to any initial
margin exemptions or exclusions that the rules of the Securities and
Exchange Commission may provide to such security-based swap positions;
and
(3) The amount of initial margin required by clearing organizations
for cleared proprietary futures, foreign futures, swaps, security-based
swaps positions on the books of the swap dealer; or,
(C) The amount of capital required by a registered futures
association of which the swap dealer is a member.
(3) A swap dealer that is subject to minimum capital requirements
established by the rules or regulations of a prudential regulator
pursuant to section 4s(e) of the Act is not subject to the regulatory
capital requirements set forth in paragraph (a)(1) or (2) of this
section.
(4) A swap dealer that is a futures commission merchant is subject
to the minimum capital requirements of Sec. 1.17 of this chapter, and
is not subject to the regulatory capital requirements set forth in
paragraph (a)(1) or (2) of this section.
(5) A swap dealer that is organized and domiciled outside of the
United States, including a swap dealer that is an affiliate of a person
organized and domiciled in the United States, may satisfy its
requirements for capital adequacy under paragraphs (a)(1) or (2) of
this section by substituted compliance with the capital adequacy
requirement of its home country jurisdiction. In order to qualify for
substituted compliance, a swap dealer's home country jurisdiction must
receive from the Commission a Capital Comparability Determination under
Sec. 23.106, and the swap dealer must obtain a confirmation to rely on
the Capital Comparability Determination from a registered futures
association as provided under Sec. 23.106.
(6) A swap dealer that elects to meet the capital requirements of
paragraph (a)(1)(i), (a)(1)(ii), or (a)(2) of this section may not
subsequently change its election without the prior written approval of
the Commission. A swap dealer that wishes to change its election must
submit a written request to the Commission and must provide any
additional information and documentation requested by the Commission.
(b)(1) Every major swap participant for which there is not a
prudential regulator must at all time have and maintain positive
tangible net worth.
(2) Notwithstanding paragraph (b)(1) of this section, each major
swap participant for which there is no prudential regulator must meet
the minimum capital requirements established by a registered futures
association of which the major swap participant is a member.
(c)(1) Before any applicant may be registered as a swap dealer or
major swap participant, the applicant must demonstrate to the
satisfaction of a registered futures association of which it is a
member, or applying for membership, one of the following:
(i) That the applicant complies with the applicable regulatory
capital requirements in paragraph (a)(1), (a)(2), (b)(1) or (b)(2) of
this section;
(ii) That the applicant is a futures commission merchant that
complies with Sec. 1.17 of this chapter;
(iii) That the applicant is subject to minimum capital requirements
established by the rules or regulations of a prudential regulator under
paragraph (a)(3) of this section;
(iv) That the applicant is organized and domiciled in a non-U.S.
jurisdiction and is regulated in a jurisdiction for which the
Commission has issued a Capital Comparability Determination under Sec.
23.106, and the non-U.S. person has obtained confirmation from a
registered futures association of which it is a member that it may rely
upon the Commission's Comparability Determination under Sec. 23.106.
(2) Each swap dealer and major swap participant subject to the
minimum capital requirements set forth in paragraphs (a) and (b) of
this section must be in compliance with such requirements at all times,
and must be able to demonstrate such compliance to the satisfaction of
the Commission and to the registered futures association of which the
swap dealer or major swap dealer is a member.
Sec. 23.102 Calculation of market risk exposure requirement and
credit risk exposure requirement using internal models.
(a) A swap dealer may apply to the Commission, or to a registered
futures association of which the swap dealer is a member, for approval
to use internal models under terms and conditions required by the
Commission and by these regulations, or under the terms and conditions
required by the registered futures association of which the swap dealer
is a member, when calculating the swap dealer's market risk exposure
and credit risk exposure under Sec. 23.101(a)(1)(i)(B), (a)(1)(ii)(A),
or (a)(2)(ii)(A).
(b) The swap dealer's application to use internal models to compute
market risk exposure and credit risk exposure must be in writing and
must be filed with the Commission and with the registered futures
association of which
[[Page 91312]]
the swap dealer is a member. The swap dealer must file the application
in accordance with instructions established by the Commission and the
registered futures association.
(c) A swap dealer's application must include the information set
forth in Appendix A of this section.
(d) The Commission or the registered futures association 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 or registered futures association may
require, if the Commission or registered futures association finds the
approval to be appropriate in the public interest, after determining,
among other things, whether the applicant has met the requirements of
this section, and the appendices to this section. A swap dealer that
has received Commission or registered futures association approval to
compute market risk exposure requirements and credit risk exposure
requirements pursuant to internal models must compute such charges in
accordance with Appendix A of this section.
(e) A swap dealer must cease using internal models to compute its
market risk exposure requirement and credit risk exposure requirement,
upon the occurrence of any of the following:
(1) The swap dealer has materially changed a mathematical model
described in the application or materially changed its internal risk
management control system without first submitting amendments
identifying such changes and obtaining the approval of the Commission
or the registered futures association for such changes;
(2) The Commission or the registered futures association of which
the swap dealer is a member determines that the internal models are no
longer sufficient for purposes of the capital calculations of the swap
dealer as a result of changes in the operations of the swap dealer;
(3) The swap dealer fails to come into compliance with its
requirements under this section, after having received from the
Director of the Commission's Division of Swap Dealer and Intermediary
Oversight, or from the registered futures association of which the swap
dealer is a member, written notification that the swap dealer is not in
compliance with its requirements, and must come into compliance by a
date specified in the notice; or
(4) The Commission by written order finds that permitting the swap
dealer to continue to use the internal models is no longer appropriate.
Appendix A to Sec. 23.102--Application for Internal Models To Compute
Market Risk Exposure Requirement and Credit Risk Exposure Requirement
(a) A swap dealer that is requesting the approval of the
Commission, or the approval of a registered futures association of
which the swap dealer is a member, to use internal models to compute
its market risk exposure requirement and credit risk exposure
requirement under Sec. 23.102 must include the following
information as part of its application:
(1) An executive summary of the information within its
application and, if applicable, an identification of the ultimate
holding company of the swap dealer;
(2) A list of the categories of positions that the swap dealer
holds in its proprietary accounts and a brief description of the
methods that the swap dealer will use to calculate deductions for
market risk and credit risk on those categories of positions;
(3) A description of the mathematical models used by the swap
dealer under this Appendix A to compute the VaR of the swap dealer's
positions; the stressed VaR of the swap dealer's positions; the
specific risk of the swap dealer's positions subject to specific
risk; comprehensive risk of the swap dealer's positions; and the
incremental risk of the swap dealer's positions, and deductions for
credit risk exposure. The description should encompass the creation,
use, and maintenance of the mathematical models; a description of
the swap dealer's internal risk management controls over the models,
including a description of each category of persons who may input
data into the models; if a mathematical model incorporates empirical
correlations across risk categories, a description of the process
for measuring correlations; a description of the backtesting
procedures the swap dealer will use to backtest the mathematical
models; a description of how each mathematical model satisfies the
applicable qualitative and quantitative requirements set forth in
this Appendix A and a statement describing the extent to which each
mathematical model used to compute deductions for market risk
exposures and credit risk exposures will be used as part of the risk
analyses and reports presented to senior management;
(4) If the swap dealer is applying to the Commission or a
registered futures association for approval to use scenario analysis
to calculate deductions for market risk for certain positions, a
list of those types of positions, a description of how those
deductions will be calculated using scenario analysis, and an
explanation of why each scenario analysis is appropriate to
calculate deductions for market risk on those types of positions;
(5) A description of how the swap dealer will calculate current
exposure;
(6) A description of how the swap dealer will determine internal
credit ratings of counterparties and internal credit risk weights of
counterparties, if applicable;
(7) For each instance in which a mathematical model to be used
by the swap dealer to calculate a deduction for market risk exposure
or to calculate maximum potential exposure for a particular product
or counterparty differs from the mathematical model used by the swap
dealer's ultimate holding company or the swap dealer's affiliates
(if applicable) to calculate an allowance for market risk exposure
or to calculate maximum potential exposure for that same product or
counterparty, a description of the difference(s) between the
mathematical models;
(8) A description of the swap dealer's process of re-estimating,
re-evaluating, and updating internal models to ensure continued
applicability and relevance; and
(9) Sample risk reports that are provided to management at the
swap dealer who are responsible for managing the swap dealer's risk.
(b) The application of the swap dealer shall be supplemented by
other information relating to the internal risk management control
system, mathematical models, and financial position of the swap
dealer that the Commission or a registered futures association may
request to complete its review of the application.
(c) A person who files an application pursuant to this section
for which it seeks confidential treatment may clearly mark each page
or segregable portion of each page with the words ``Confidential
Treatment Requested.'' All information submitted in connection with
the application will be accorded confidential treatment, to the
extent permitted by law.
(d) If any of the information filed with the Commission or a
registered futures association as part of the application of the
swap dealer is found to be or becomes inaccurate before the
Commission or a registered futures association approves the
application, the swap dealer must notify the Commission or
registered futures association promptly and provide the Commission
or registered futures associations with a description of the
circumstances in which the information was found to be or has become
inaccurate along with updated, accurate information.
(e) The Commission or registered futures association may approve
the application or an amendment to the application, in whole or in
part, subject to any conditions or limitations the Commission or the
registered futures association may require if the Commission or the
registered futures association finds the approval to be appropriate
in the public interest, after determining, among other things,
whether the swap dealer has met all the requirements of this
Appendix A.
(f) A swap dealer shall amend its application under this
Appendix A and submit the amendment to the Commission and the
registered futures association for approval before it may materially
change a mathematical model used to calculate market risk exposure
requirements or credit risk exposure requirements or before it may
materially change its internal risk management control system with
respect to such model.
(g) As a condition for a swap dealer to use internal models to
compute deductions for market risk exposure and credit risk exposure
under this Appendix A, the swap dealer agrees that:
[[Page 91313]]
(1) It will notify the Commission and registered futures
association 45 days before it ceases to use internal models to
compute deductions for market risk exposure and credit risk exposure
under this Appendix A; and
(2) The Commission or the registered futures association may
determine that the notice will become effective after a shorter or
longer period of time if the swap dealer consents or if the
Commission or the registered futures association determines that a
shorter or longer period of time is appropriate in the public
interest.
(h) The Commission may by written order, or the registered
futures association by written notice, revoke a swap dealer's
approval to use internal models to compute market risk exposures and
credit risk exposures on certain credit exposures arising from
transactions in derivatives instruments if the Commission or the
registered futures association of which the swap dealer is a member
finds that such approval is no longer appropriate in the public
interest. In making its finding, the Commission or the registered
futures association will consider the compliance history of the swap
dealer related to its use of models and the swap dealer's compliance
with its internal risk management controls. If the Commission or
registered futures association withdraws all or part of a swap
dealer's approval to use internal models, the swap dealer shall
compute market risk exposure requirements and credit risk exposure
requirements in accordance with Sec. 23.103.
(i) VaR models. A value-at-risk (``VaR'') model must meet the
following minimum requirements in order to be approved:
(1) Qualitative requirements.
(i) The VaR model used to calculate market risk exposure or
credit risk exposure for a position must be integrated into the
daily internal risk management system of the swap dealer;
(ii) The VaR model must be reviewed both periodically and
annually. The periodic review may be conducted by personnel of the
swap dealer that are independent from the personnel that perform the
VaR model calculations. The annual review must be conducted by a
qualified third party service. The review must include:
(A) An evaluation of the conceptual soundness of, and empirical
support for, the internal models;
(B) An ongoing monitoring process that includes verification of
processes and the comparison of the swap dealer's model outputs with
relevant internal and external data sources or estimation
techniques; and
(C) An outcomes analysis process that includes backtesting. This
process must include a comparison of the changes in the swap
dealer's portfolio value that would have occurred were end-of-day
positions to remain unchanged (therefore, excluding fees,
commissions, reserves, net interest income, and intraday trading)
with VaR-based measures during a sample period not used in model
development.
(iii) For purposes of computing market risk, the swap dealer
must determine the appropriate multiplication factor as follows:
(A) Beginning three months after the swap dealer begins using
the VaR model to calculate the market risk exposure, the swap dealer
must conduct monthly backtesting of the model by comparing its
actual daily net trading profit or loss with the corresponding VaR
measure generated by the VaR model, using a 99 percent, one-tailed
confidence level with price changes equivalent to a one business-day
movement in rates and prices, for each of the past 250 business
days, or other period as may be appropriate for the first year of
its use;
(B) On the last business day of each quarter, the swap dealer
must identify the number of backtesting exceptions of the VaR model
using actual daily net trading profit and loss, as that term is
defined in Sec. 23.100. An exception has occurred when for a
business day the actual net trading loss, if any, exceeds the
corresponding VaR measure. The counting period shall be for the
prior 250 business days except that during the first year of use of
the model another appropriate period may be used; and
(C) The swap dealer must use the multiplication factor indicated
in Table 1 of this Appendix A in determining its market risk until
it obtains the next quarter's backtesting results;
Table 1--Multiplication Factor Based on the Number of Backtesting
Exceptions of the VaR Model
------------------------------------------------------------------------
Multiplication
Number of exceptions factor
------------------------------------------------------------------------
4 or fewer............................................ 3.00
5..................................................... 3.40
6..................................................... 3.50
7..................................................... 3.65
8..................................................... 3.75
9..................................................... 3.85
10 or more............................................ 4.00
------------------------------------------------------------------------
(iv) For purposes of computing the credit equivalent amount of
the swap dealer's exposures to a counterparty, the swap dealer must
determine the appropriate multiplication factor as follows:
(A) Beginning three months after it begins using the VaR model
to calculate maximum potential exposure, the swap dealer must
conduct backtesting of the model by comparing, for at least 80
counterparties (or the actual number of counterparties if the swap
dealer does not have 80 counterparties) with widely varying types
and sizes of positions with the firm, the ten business day change in
its current exposure to the counterparty based on its positions held
at the beginning of the ten-business day period with the
corresponding ten-business day maximum potential exposure for the
counterparty generated by the VaR model;
(B) As of the last business day of each quarter, the swap dealer
must identify the number of backtesting exceptions of the VaR model,
that is, the number of ten-business day periods in the past 250
business days, or other period as may be appropriate for the first
year of its use, for which the change in current exposure to a
counterparty, assuming the portfolio remains static for the ten-
business day period, exceeds the corresponding maximum potential
exposure; and
(C) The swap dealer will propose, as part of its application, a
schedule of multiplication factors, which must be approved by the
Commission, or a registered futures association of which the swap
dealer is a member, based on the number of backtesting exceptions of
the VaR model. The swap dealer must use the multiplication factor
indicated in the approved schedule in determining the credit
equivalent amount of its exposures to a counterparty until it
obtains the next quarter's backtesting results, unless the
Commission or the registered futures association determines, based
on, among other relevant factors, a review of the swap dealer's
internal risk management control system, including a review of the
VaR model, that a different adjustment or other action is
appropriate.
(2) Quantitative requirements. (i) For purposes of determining
market risk exposure, the VaR model must use a 99 percent, one-
tailed confidence level with price changes equivalent to a ten
business-day movement in rates and prices;
(ii) For purposes of determining maximum potential exposure, the
VaR model must use a 99 percent, one-tailed confidence level with
price changes equivalent to a one-year movement in rates and prices;
or based on a review of the swap dealer's procedures for managing
collateral and if the collateral is marked to market daily and the
swap dealer has the ability to call for additional collateral daily,
the Commission, or the registered futures association of which the
swap dealer is a member, may approve a time horizon of not less than
ten business days;
(iii) The VaR model must use an effective historical observation
period of at least one year. The swap dealer must consider the
effects of market stress in its construction of the model.
Historical data sets must be updated at least monthly and reassessed
whenever market prices or volatilities change significantly or
portfolio composition warrant; and
(iv) The VaR model must take into account and incorporate all
significant, identifiable market risk factors applicable to
positions in the accounts of the swap dealer, including:
(A) Risks arising from the non-linear price characteristics of
derivatives and the sensitivity of the fair value of those positions
to changes in the volatility of the derivatives' underlying rates,
prices, or other material risk factors. A swap dealer with a large
or complex portfolio with non-linear derivatives (such as options or
positions with embedded optionality) must measure the volatility of
these positions at different maturities and/or strike prices, where
material;
(B) Empirical correlations within and across risk factors
provided that the swap dealer validates and demonstrates the
reasonableness of its process for measuring correlations, if the
VaR-based measure does not incorporate empirical correlations across
risk categories, the swap dealer must add the separate measures from
its internal models used to calculate the VaR-based measure for the
appropriate risk categories (interest rate risk, credit spread risk,
equity price risk, foreign exchange rate risk, and/or commodity
[[Page 91314]]
price risk) to determine its aggregate VaR-based measure, or,
alternatively, risk factors sufficient to cover all the market risk
inherent in the positions in the proprietary or other trading
accounts of the swap dealer, including interest rate risk, equity
price risk, foreign exchange risk, and commodity price risk; and
(C) Spread risk, where applicable, and segments of the yield
curve sufficient to capture differences in volatility and imperfect
correlation of rates along the yield curve for securities and
derivatives that are sensitive to different interest rates. For
material positions in major currencies and markets, modeling
techniques must incorporate enough segments of the yield curve--in
no case less than six--to capture differences in volatility and less
than perfect correlation of rates along the yield curve.
(j) Stressed VaR-based Measure. A stressed VaR model must meet
the following minimum requirements in order to be approved:
(1) Requirements for stressed VaR-based measure. (i) A swap
dealer must calculate a stressed VaR-based measure for its positions
using the same model(s) used to calculate the VaR-based measure
under paragraph (i) of this appendix, subject to the same confidence
level and holding period applicable to the VaR-based measure, but
with model inputs calibrated to historical data from a continuous
12-month period that reflects a period of significant financial
stress appropriate to the swap dealer's current portfolio.
(ii) The stressed VaR-based measure must be calculated at least
weekly and be no less than the swap dealer's VaR-based measure.
(iii) A swap dealer must have policies and procedures that
describe how it determines the period of significant financial
stress used to calculate the swap dealer's stressed VaR-based
measure under this section and must be able to provide empirical
support for the period used. The swap dealer must obtain the prior
approval of the Commission, or a registered futures association of
which the swap dealer is a member, if the swap dealer makes any
material changes to these policies and procedures. The policies and
procedures must address:
(A) How the swap dealer links the period of significant
financial stress used to calculate the stressed VaR-based measure to
the composition and directional bias of its current portfolio; and
(B) The swap dealer's process for selecting, reviewing, and
updating the period of significant financial stress used to
calculate the stressed VaR-based measure and for monitoring the
appropriateness of the period to the swap dealer's current
portfolio.
(iv) Nothing in this appendix prevents the Commission or the
registered futures association of which the swap dealer is a member
from requiring a swap dealer to use a different period of
significant financial stress in the calculation of the stressed VaR-
based measure.
(k) Specific Risk. A specific risk model must meet the following
minimum requirements in order to be approved:
(1) General requirement. A swap dealer must use one of the
methods in this paragraph (k) to measure the specific risk for each
of its debt, equity, and securitization positions with specific
risk.
(2) Modeled specific risk. A swap dealer may use models to
measure the specific risk of its proprietary positions. A swap
dealer must use models to measure the specific risk of correlation
trading positions that are modeled under paragraph (m) of this
appendix.
(i) Requirements for specific risk modeling.
(A) If a swap dealer uses internal models to measure the
specific risk of a portfolio, the internal models must:
(1) Explain the historical price variation in the portfolio;
(2) Be responsive to changes in market conditions;
(3) Be robust to an adverse environment, including signaling
rising risk in an adverse environment; and
(4) Capture all material components of specific risk for the
debt and equity positions in the portfolio. Specifically, the
internal models must:
(i) Capture name-related basis risk;
(ii) Capture event risk and idiosyncratic risk; and
(iii) Capture and demonstrate sensitivity to material
differences between positions that are similar but not identical and
to changes in portfolio composition and concentrations.
(B) If a swap dealer calculates an incremental risk measure for
a portfolio of debt or equity positions under paragraph (l) of this
appendix, the swap dealer is not required to capture default and
credit migration risks in its internal models used to measure the
specific risk of those portfolios.
(C) A swap dealer shall validate a specific risk model through
backtesting.
(ii) Specific risk fully modeled for one or more portfolios. If
the swap dealer's VaR-based measure captures all material aspects of
specific risk for one or more of its portfolios of debt, equity, or
correlation trading positions, the swap dealer has no specific risk
add-on for those portfolios.
(3) Specific risk not modeled.
(i) If the swap dealer's VaR-based measure does not capture all
material aspects of specific risk for a portfolio of debt, equity,
or correlation trading positions, the swap dealer must calculate a
specific-risk add-on for the portfolio under the standardized
measurement method as described in 12 CFR 217.210.
(ii) A swap dealer must calculate a specific risk add-on under
the standardized measurement method as described in 12 CFR 217.200
for all of its securitization positions that are not modeled under
this paragraph (k).
(l) Incremental Risk. An incremental risk model must meet the
following minimum requirements in order to be approved:
(1) General requirement. A swap dealer that measures the
specific risk of a portfolio of debt positions under paragraph (k)
of this appendix using internal models must calculate at least
weekly an incremental risk measure for that portfolio according to
the requirements in this section. The incremental risk measure is
the swap dealer's measure of potential losses due to incremental
risk over a one-year time horizon at a one-tail, 99.9 percent
confidence level, either under the assumption of a constant level of
risk, or under the assumption of constant positions. With the prior
approval of the Commission or a registered futures association of
which the swap dealer is a member, a swap dealer may choose to
include portfolios of equity positions in its incremental risk
model, provided that it consistently includes such equity positions
in a manner that is consistent with how the swap dealer internally
measures and manages the incremental risk of such positions at the
portfolio level. If equity positions are included in the model, for
modeling purposes default is considered to have occurred upon the
default of any debt of the issuer of the equity position. A swap
dealer may not include correlation trading positions or
securitization positions in its incremental risk measure.
(2) Requirements for incremental risk modeling. For purposes of
calculating the incremental risk measure, the incremental risk model
must:
(i) Measure incremental risk over a one-year time horizon and at
a one-tail, 99.9 percent confidence level, either under the
assumption of a constant level of risk, or under the assumption of
constant positions.
(A) A constant level of risk assumption means that the swap
dealer rebalances, or rolls over, the swap dealer's trading
positions at the beginning of each liquidity horizon over the one-
year horizon in a manner that maintains the swap dealer's initial
risk level. The swap dealer must determine the frequency of
rebalancing in a manner consistent with the liquidity horizons of
the positions in the portfolio. The liquidity horizon of a position
or set of positions is the time required for a swap dealer to reduce
its exposure to, or hedge all of its material risks of, the
position(s) in a stressed market. The liquidity horizon for a
position or set of positions may not be less than the shorter of
three months or the contractual maturity of the position.
(B) A constant position assumption means that the swap dealer
maintains the same set of positions throughout the one-year horizon.
If a swap dealer uses this assumption, it must do so consistently
across all portfolios.
(C) A swap dealer's selection of a constant position or a
constant risk assumption must be consistent between the swap
dealer's incremental risk model and its comprehensive risk model
described in paragraph (m) of this appendix, if applicable.
(D) A swap dealer's treatment of liquidity horizons must be
consistent between the swap dealer's incremental risk model and its
comprehensive risk model described in paragraph (m) of this
appendix, if applicable.
(ii) Recognize the impact of correlations between default and
migration events among obligors.
(iii) Reflect the effect of issuer and market concentrations, as
well as concentrations that can arise within and across product
classes during stressed conditions.
(iv) Reflect netting only of long and short positions that
reference the same financial instrument.
(v) Reflect any material mismatch between a position and its
hedge.
[[Page 91315]]
(vi) Recognize the effect that liquidity horizons have on
dynamic hedging strategies. In such cases, a swap dealer must:
(A) Choose to model the rebalancing of the hedge consistently
over the relevant set of trading positions;
(B) Demonstrate that the inclusion of rebalancing results in a
more appropriate risk measurement;
(C) Demonstrate that the market for the hedge is sufficiently
liquid to permit rebalancing during periods of stress; and
(D) Capture in the incremental risk model any residual risks
arising from such hedging strategies.
(vii) Reflect the nonlinear impact of options and other
positions with material nonlinear behavior with respect to default
and migration changes.
(viii) Maintain consistency with the swap dealer's internal risk
management methodologies for identifying, measuring, and managing
risk.
(m) Comprehensive Risk. A comprehensive risk model must meet the
following minimum requirements in order to be approved:
(1) General requirement.
(i) Subject to the prior approval of the Commission or a
registered futures association of which the swap dealer is a member,
a swap dealer may use the method in this paragraph to measure
comprehensive risk, that is, all price risk, for one or more
portfolios of correlation trading positions.
(ii) A swap dealer that measures the price risk of a portfolio
of correlation trading positions using internal models must
calculate at least weekly a comprehensive risk measure that captures
all price risk according to the requirements of this paragraph (m).
The comprehensive risk measure is either:
(A) The sum of:
(1) The swap dealer's modeled measure of all price risk
determined according to the requirements in paragraph (m)(2) of this
appendix; and
(2) A surcharge for the swap dealer's modeled correlation
trading positions equal to the total specific risk add-on for such
positions as calculated under paragraph (k) of this appendix
multiplied by 8.0 percent; or
(B) With approval of the Commission, or the registered futures
association of which the swap dealer is member, and provided the
swap dealer has met the requirements of this paragraph (m) for a
period of at least one year and can demonstrate the effectiveness of
the model through the results of ongoing model validation efforts
including robust benchmarking, the greater of:
(1) The swap dealer's modeled measure of all price risk
determined according to the requirements in paragraph (b) of this
appendix; or
(2) The total specific risk add-on that would apply to the swap
dealer's modeled correlation trading positions as calculated under
paragraph (k) of this appendix multiplied by 8.0 percent.
(2) Requirements for modeling all price risk. If a swap dealer
uses an internal model to measure the price risk of a portfolio of
correlation trading positions:
(i) The internal model must measure comprehensive risk over a
one-year time horizon at a one-tail, 99.9 percent confidence level,
either under the assumption of a constant level of risk, or under
the assumption of constant positions.
(ii) The model must capture all material price risk, including
but not limited to the following:
(A) The risks associated with the contractual structure of cash
flows of the position, its issuer, and its underlying exposures;
(B) Credit spread risk, including nonlinear price risks;
(C) The volatility of implied correlations, including nonlinear
price risks such as the cross-effect between spreads and
correlations;
(D) Basis risk;
(E) Recovery rate volatility as it relates to the propensity for
recovery rates to affect tranche prices; and
(F) To the extent the comprehensive risk measure incorporates
the benefits of dynamic hedging, the static nature of the hedge over
the liquidity horizon must be recognized. In such cases, a swap
dealer must:
(1) Choose to model the rebalancing of the hedge consistently
over the relevant set of trading positions;
(2) Demonstrate that the inclusion of rebalancing results in a
more appropriate risk measurement;
(3) Demonstrate that the market for the hedge is sufficiently
liquid to permit rebalancing during periods of stress; and
(4) Capture in the comprehensive risk model any residual risks
arising from such hedging strategies;
(iii) The swap dealer must use market data that are relevant in
representing the risk profile of the swap dealer's correlation
trading positions in order to ensure that the swap dealer fully
captures the material risks of the correlation trading positions in
its comprehensive risk measure in accordance with this section; and
(iv) The swap dealer must be able to demonstrate that its model
is an appropriate representation of comprehensive risk in light of
the historical price variation of its correlation trading positions.
(3) Requirements for stress testing.
(i) A swap dealer must at least weekly apply specific,
supervisory stress scenarios to its portfolio of correlation trading
positions that capture changes in:
(A) Default rates;
(B) Recovery rates;
(C) Credit spreads;
(D) Correlations of underlying exposures; and
(E) Correlations of a correlation trading position and its
hedge.
(ii) Other requirements. (A) A swap dealer must retain and make
available to the Commission and to the registered futures
association of which the swap dealer is a member the results and all
assumptions and parameters of the supervisory stress testing,
including comparisons with the capital requirements generated by the
swap dealer's comprehensive risk model.
(B) A swap dealer must report promptly to the Commission and to
the registered futures association of which it is a member promptly
any instances where the stress tests indicate any material
deficiencies in the comprehensive risk model.
(n) Securitization Exposures. (1) To use the simplified
supervisory formula approach (SSFA) to determine the specific risk-
weighting factor for a securitization position, a swap dealer must
have data that enables it to assign accurately the parameters
described in paragraph (n)(2) of this appendix. Data used to assign
the parameters described in paragraph (n)(2) of this appendix must
be the most currently available data; if the contracts governing the
underlying exposures of the securitization require payments on a
monthly or quarterly basis, the data used to assign the parameters
described in paragraph (n)(2) of this appendix must be no more than
91 calendar days old. A swap dealer that does not have the
appropriate data to assign the parameters described in paragraph
(n)(2) of this appendix must assign a specific risk-weighting of 100
percent to the position.
(2) SSFA parameters. To calculate the specific risk-weighting
factor for a securitization position using the SSFA, a swap dealer
must have accurate information on the five inputs to the SSFA
calculation described in paragraphs (n)(2)(i) through (n)(2)(v) of
this appendix.
(i) KG is the weighted-average (with unpaid principal
used as the weight for each exposure) total capital requirement of
the underlying exposures calculated for a swap dealer's credit risk.
KG is expressed as a decimal value between zero and one
(that is, an average risk weight of 100 percent presents a value of
KG equal to 0.08).
(ii) Parameter W is expressed as a decimal value between zero
and one. Parameter W is the ratio of the sum of the dollar amounts
of any underlying exposures of the securitization that meet any of
the criteria as set forth in paragraphs (n)(2)(ii)(A) through (F) of
this appendix to the balance, measured in dollars, of underlying
exposures:
(A) Ninety days or more past due;
(B) Subject to a bankruptcy or insolvency proceeding;
(C) In the process of foreclosure;
(D) Held as real estate owned;
(E) Has contractually deferred payments for 90 days or more,
other than principal or interest payments deferred on;
(1) Federally-guaranteed student loans, in accordance with the
terms of those guarantee programs; or
(2) Consumer loans, including non-federally guaranteed student
loans, provided that such payments are deferred pursuant to
provisions included in the contract at the time funds are disbursed
that provide for period(s) of deferral that are not initiated based
on changes in the creditworthiness of the borrower; or
(F) Is in default.
(iii) Parameter A is the attachment point for the position,
which represents the threshold at which credit losses will first be
allocated to the position. Except as provided in 12 CFR
217.210(b)(2)(vii)(D) for n\th\ to default derivatives, parameter A
equals the ratio of the current dollar amount of underlying
exposures that are subordinated to the position of the swap dealer
to the current dollar amount of underlying exposures. Any reserve
account funded by
[[Page 91316]]
the accumulated cash flows from the underlying exposures that is
subordinated to the position that contains the swap dealer's
securitization exposure may be included in the calculation of
parameter A to the extent that cash is present in the account.
Parameter A is expressed as a decimal value between zero and one.
(iv) Parameter D is the detachment point for the position, which
represents the threshold at which credit losses of principal
allocated to the position would result in a total loss of principal.
Except as provided in 12 CFR 217.210(b)(2)(vii)(D) for n\th\-to-
default credit derivatives, parameter D equals parameter A plus the
ratio of the current dollar amount of the securitization positions
that are pari passu with the position (that is, have equal seniority
with respect to credit risk) to the current dollar amount of the
underlying exposures. Parameter D is expressed as a decimal value
between zero and one.
(v) A supervisory calibration parameter, p, is equal to 0.5 for
securitization positions that are not resecuritization positions and
equal to 1.5 for resecuritization positions.
(3) Mechanics of the SSFA. KG and W are used to
calculate KA, the augmented value of KG, which
reflects the observed credit quality of the underlying exposures.
KA is defined in paragraph (n)(4) of this section. The
values of parameters A and D, relative to KA determine
the specific risk-weighting factor assigned to a securitization
position, or portion of a position, as appropriate, is the larger of
the specific risk-weighting factor determined in accordance with
paragraphs (n)(3) and (n)(4) of this appendix, and a specific risk-
weighting factor of 1.6 percent.
(i) When the detachment point, parameter D, for a securitization
position is less than or equal to KA, the position must
be assigned a specific risk-weighting factor of 100 percent.
(ii) When the attachment point, parameter A, for a
securitization position is greater than or equal to KA,
the swap dealer must calculate the specific risk-weighting factor in
accordance with paragraph (n)(4) of this section.
(iii) When A is less than KA and D is greater than
KA, the specific risk-weighting factor is a weighted-
average of 1.00 and KSSFA calculated under paragraphs
(n)(3)(iii)(A) and (3)(iii)(B) of this appendix. For the purpose of
this calculation:
(A) The weight assigned to 1.00 equals
[GRAPHIC] [TIFF OMITTED] TP16DE16.000
(o) Additional conditions. As a condition for the swap dealer to
use this Appendix A to calculate certain of its capital charges, the
Commission, or registered futures association of which the swap
dealer is a member, may impose additional conditions on the swap
dealer, which may include, but are not limited to restricting the
swap dealer's business on a product-specific, category-specific, or
general basis; submitting to the Commission or registered futures
association a plan to increase the swap dealer's regulatory capital;
filing more frequent reports with the Commission or registered
futures association; modifying the swap dealer's internal risk
management control procedures; or computing the swap dealer's
deductions for market and credit risk in accordance with Sec.
23.102 as appropriate. If the Commission or registered futures
association finds it is necessary or appropriate in the public
interest, the Commission or registered futures association may
impose additional conditions on the swap dealer, if:
(1) The swap dealer is required to provide notice to the
Commission or a registered
[[Page 91317]]
futures association that the swap dealer's regulatory capital is
less than $100 million;
(2) The swap dealer fails to meet the reporting requirements set
forth in Sec. 23.105;
(3) Any event specified in Sec. 23.105 occurs;
(4) There is a material deficiency in the internal risk
management control system or in the mathematical models used to
price securities or to calculate deductions for market and credit
risk or allowances for market and credit risk, as applicable, of the
swap dealer;
(5) The swap dealer fails to comply with this Appendix A; or
(6) The Commission finds that imposition of other conditions is
necessary or appropriate in the public interest.
Sec. 23.103 Calculation of market risk exposure requirement and
credit risk requirement when models are not approved.
(a) Non-model approach. A swap dealer that has not received
approval from the Commission, or from a registered futures association
of which the swap dealer is a member, to compute its market risk
exposure requirement and/or credit risk exposure requirement pursuant
to internal models under Sec. 23.102, or a swap dealer that has had
its approval to compute its market risk exposure requirement and/or
credit risk exposure requirement pursuant to internal models under
Sec. 23.102 revoked by the Commission or the registered futures
association, must compute its market risk exposure requirements and/or
credit risk exposure requirements pursuant to paragraphs (b) and (c) of
this section.
(b) Market risk exposure requirements. (1) A swap dealer that
computes its regulatory capital under Sec. 23.101(a)(1)(i),
(a)(1)(ii), or (a)(2) shall compute a market risk capital charge for
the positions that the swap dealer holds in its proprietary accounts
using the applicable standardized market risk charges set forth in
Sec. 240.18a-1 of this title and Sec. 1.17 of this chapter for such
positions.
(2) In computing its regulatory capital under Sec.
23.101(a)(1)(i), a swap dealer shall increase its risk-weighted assets
by an amount equal to 1250 percent of the sum of the market risk
capital charges computed under paragraph (b)(1) of this section.
(3) In computing its net capital under Sec. 23.101(a)(1)(ii), a
swap dealer shall deduct from its tentative net capital the sum of the
market risk capital charges computed under paragraph (b)(1) of this
section.
(4) In computing its minimum capital requirement under Sec.
23.101(a)(2), a swap dealer must add the amount of the market risk
capital charge computed under this section to the $20 million minimum
capital requirement.
(c) Credit risk charges. (1) A swap dealer that computes its
regulatory capital under Sec. 23.101(a)(1)(i) shall compute
counterparty credit risk capital charges in accordance with subpart D
of 12 CFR part 217. A swap dealer that computes regulatory capital
under Sec. 23.101(a)(1)(ii) shall compute counterparty credit risk
capital charges using the applicable standardized credit risk charges
set forth in Sec. 240.18a-1 of this title and Sec. 1.17 of this
chapter for such positions; Provided, however, that a swap dealer may
reduce the counterparty credit risk for a particular counterparty by
the amount of margin deposited by such counterparty for its uncleared
swap positions that is maintained with a third party custodian in
accordance with Sec. 23.157 and by the amount of margin deposited by
such counterparty for its uncleared security-based swap positions that
is maintained with a third party custodian in accordance with Sec.
240.18a-3 of this title.
(2) In computing its regulatory capital under Sec.
23.101(a)(1)(i), a swap dealer shall increase its risk-weighted assets
by the sum of the counterparty credit risk capital charges computed
under paragraph (c)(1) of this section.
(3) In computing its net capital under Sec. 23.101(a)(1)(ii), a
swap dealer shall reduce its tentative net capital by the sum of the
counterparty credit risk capital charges computed under paragraph
(c)(1) of this section.
(4) In computing its minimum capital requirement under Sec.
23.101(a)(2), a swap dealer must add the amount of the credit risk
capital charge computed under this section to the $20 million minimum
capital requirement.
Sec. 23.104 Liquidity requirements and equity withdrawal
restrictions.
(a)(1) Liquidity coverage ratio. A swap dealer that is subject to
the minimum capital requirements of Sec. 23.101(a)(1)(i) must meet the
liquidity coverage ratio as defined in 12 CFR part 249 as if the swap
dealer were regulated by the Federal Reserve Board and subject to the
provisions of 12 CFR part 249; Provided, however, that a swap dealer
may include cash deposited with banks that is readily available for
withdrawal as level 1 assets under 12 CFR 249.20, and a swap dealer
organized and domiciled outside of the U.S. may include high quality
liquid assets maintained in its home country jurisdiction, in meeting
its minimum liquidity coverage ratio.
(2) Notification of senior management. The senior management of the
swap dealer that is responsible for risk management must be promptly
informed if the swap dealer's liquidity coverage ratio falls below 1.0.
In addition, the assumptions underlying the calculation of the
liquidity coverage ratio must be reviewed at least quarterly by senior
management of the swap dealer that is responsible for risk management,
and at least annually by the full senior management of the swap dealer.
(3) Restrictions on the disposition or transfer of high quality
liquid assets. A swap dealer may not dispose of, or transfer to an
affiliate, a high quality liquid asset (as that term is defined in 12
CFR 249.20) without prior notice to and approval by the Commission if
such disposition or transfer would result in the swap dealer failing to
meet the liquidity coverage ratio in paragraph (a)(1) of this section.
(4) Contingency funding plan. The swap dealer must have a written
contingency funding plan that addresses the swap dealer's policies and
the roles and responsibilities of relevant personnel for meeting the
liquidity needs of the swap dealer and communications with the public
and other market participants during a liquidity stress event.
(b)(1) Liquidity stress test. A swap dealer that computes
regulatory capital under paragraph (a)(1)(ii) of Sec. 23.101 must
perform a liquidity stress test at least monthly, the results of which
must be provided within ten business days to senior management that has
responsibility to oversee risk management at the swap dealer. The
assumptions underlying the liquidity stress test must be reviewed at
least quarterly by senior management that has responsibility to oversee
risk management at the swap dealer and at least annually by senior
management of the swap dealer. The liquidity stress test must include,
at a minimum, the following assumed conditions lasting for 30
consecutive days:
(i) A stress event includes a decline in creditworthiness of the
swap dealer severe enough to trigger contractual credit-related
commitment provisions of counterparty agreements;
(ii) The loss of all existing unsecured funding at the earlier of
its maturity or put date and an inability to acquire a material amount
of new unsecured funding, including intercompany advances and unfunded
committed lines of credit;
(iii) The potential for a material net loss of secured funding;
(iv) The loss of the ability to procure repurchase agreement
financing for less liquid assets;
(v) The illiquidity of collateral required by and on deposit at
clearing agencies or other entities which is not
[[Page 91318]]
deducted from net worth or which is not funded by customer assets;
(vi) A material increase in collateral required to be maintained at
registered clearing agencies of which it is a member; and
(vii) The potential for a material loss of liquidity caused by
market participants exercising contractual rights and/or refusing to
enter into transactions with respect to the various businesses,
positions, and commitments of the swap dealer.
(2) Stress test of consolidated entity. If applicable, the swap
dealer must justify and document any differences in the assumptions
used in the liquidity stress test of the swap dealer from those used in
the liquidity stress test of the consolidated entity of which the swap
dealer is a part.
(3) Liquidity reserves. The swap dealer must maintain at all times
liquidity reserves based on the results of the liquidity stress test.
The liquidity reserves used to satisfy the liquidity stress test must
be:
(i) Cash, obligations of the United States, or obligations fully
guaranteed as to principal and interest by the United States; and
(ii) Unencumbered and free of any liens at all times.
(4) Contingency funding plan. The swap dealer must have a written
contingency funding plan that addresses the swap dealer's policies and
the roles and responsibilities of relevant personnel for meeting the
liquidity needs of the swap dealer and communications with the public
and other market participants during a liquidity stress event.
(c) Equity withdrawal restrictions. The capital of a swap dealer,
including the capital of any affiliate or subsidiary whose liabilities
or obligations are guaranteed, endorsed, or assumed by the swap dealer
may not be withdrawn by action of the swap dealer or its equity
holders, or by redemption of shares of stock by the swap dealer or by
such affiliates or subsidiaries, or through the payment of dividends or
any similar distribution, nor may any unsecured advance or loan be made
to an equity holder or employee if, after giving effect thereto and to
any other such withdrawals, advances, or loans which are scheduled to
occur within six months following such withdrawal, advance or loan, the
swap dealer's regulatory capital is less than 120 percent of the
minimum regulatory capital required under Sec. 23.101. The equity
withdrawal restrictions, however, do not preclude a swap dealer from
making required tax payments or from paying reasonable compensation to
equity holders. The Commission may, upon application by the swap
dealer, grant relief from this paragraph (c) if the Commission deems
such relief to be in the public interest.
(d) Temporary equity withdrawal restrictions by Commission order.
(1) The Commission may by order restrict, for a period of up to twenty
business days, any withdrawal by a swap dealer of capital or any
unsecured loan or advance to a stockholder, partner, member, employee
or affiliate under such terms and conditions as the Commission deems
appropriate in the public interest if the Commission, based on the
information available, concludes that such withdrawal, loan or advance
may be detrimental to the financial integrity of the swap dealer, or
may unduly jeopardize the swap dealer's ability to meet its financial
obligations to counterparties or to pay other liabilities which may
cause a significant impact on the markets or expose the counterparties
and creditors of the swap dealer to loss.
(2) An order temporarily prohibiting the withdrawal of capital
shall be rescinded if the Commission determines that the restriction on
capital withdrawal should not remain in effect. A hearing on an order
temporarily prohibiting withdrawal of capital will be held within two
business days from the date of the request in writing by the swap
dealer.
Sec. 23.105 Financial recordkeeping, reporting and notification
requirements for swap dealers and major swap participants.
(a) Scope. (1) Except as provided in paragraphs (a)(2) and (a)(3)
of this section, a swap dealer or major swap participant must comply
with the applicable requirements set forth in paragraphs (b) through
(q) of this section.
(2) The requirements in paragraphs (b) through (o) of this section
do not apply to any swap dealer or major swap participant that is
subject to the capital requirements of a prudential regulator.
(3) The requirements in paragraph (p) of this section do not apply
to any swap dealer or major swap participant that is subject to the
capital requirements of the Commission.
(4) The requirements of paragraph (q) of this section apply to swap
dealers or major swap participants that are subject to the capital
requirements of the Commission or of a prudential regulator.
(b) Current books and records. A swap dealer or major swap
participant shall prepare and keep current ledgers or other similar
records which show or summarize, with appropriate references to
supporting documents, each transaction affecting its asset, liability,
income, expense and capital accounts, and in which all its asset,
liability and capital accounts are classified in accordance with U.S.
generally accepted accounting principles, and as otherwise may be
necessary for the capital calculations required under Sec. 23.101:
Provided, however, that a swap dealer or major swap participant that is
not organized under the laws of a state or other jurisdiction in the
United States, and is not otherwise required to prepare financial
statements in accordance with U.S. generally accepted accounting
principles, may prepare and keep records required by this section in
accordance with International Financial Reporting Standards issued by
the International Accounting Standards Board. Such records must be
maintained in accordance with Sec. 1.31 of this chapter.
(c) Notices. (1) A swap dealer or major swap participant subject to
minimum regulatory capital requirements under Sec. 23.101 and who
knows or should have known that its regulatory capital at any time is
less than the minimum required by Sec. 23.101, must:
(i) Provide immediate written notice that the swap dealer's or
major swap participant's regulatory capital is less than that required
by Sec. 23.101; and
(ii) Provide together with such notice, documentation in such form
as necessary to adequately reflect the swap dealer's or major swap
participant's regulatory capital condition as of any date such person's
regulatory capital is less than the minimum required. The swap dealer
or major swap participant must provide similar documentation for other
days as the Commission may request.
(2) A swap dealer or major swap participant who is subject to the
minimum regulatory capital requirements under Sec. 23.101 and who
knows or should have known that its regulatory capital at any time is
less than 120 percent of its minimum regulatory capital requirement as
determined under Sec. 23.101, must provide written notice to that
effect within 24 hours of such event.
(3) If a swap dealer or major swap participant at any time fails to
make or to keep current the books and records required by these
regulations, such swap dealer or major swap participant must, on the
same day such event occurs, provide notice of such fact, specifying the
books and records which have not been made or which are not current,
and within 48 hours after giving such notice file a written report
stating what steps have been and are being taken to correct the
situation.
[[Page 91319]]
(4) Each swap dealer that fails to comply with the liquidity
requirements set forth in Sec. 23.104 must file written notice within
24 hours of when it knows or should have known that the swap dealer is
not in compliance.
(5) A swap dealer or major swap participant must provide notice of
a substantial reduction in capital as compared to that last reported in
a financial report filed with the Commission pursuant to this section.
The notice shall be provided if the swap dealer or major swap
participant experiences a 30 percent or more decrease in the amount of
capital that the swap dealer or major swap participant holds in excess
of its regulatory capital requirement as computed under Sec. 23.101.
(6) A swap dealer must provide the Commission with notice two
business days prior to the withdrawal of capital by action of the
equity holders of the swap dealer where the withdrawal exceeds 30
percent of the swap dealer's excess regulatory capital as computed
under Sec. 23.101.
(7) A swap dealer or major swap participant that is registered with
the Securities and Exchange Commission as a security-based swap dealer
or as a major security based swap participant and files a notice with
the Securities and Exchange Commission under Sec. 240.18a-8 of this
title, must file a copy of such notice with the Commission at the time
the swap dealer or major security-based swap participant files the
notice with the Securities and Exchange Commission.
(8) A swap dealer or major swap participant must submit a notice to
the Commission within 24 hours of the occurrence of any of the
following events:
(i) A single counterparty or group of counterparties that are under
common ownership or control fails to post initial margin or pay
variation margin to the swap dealer or major swap participant for swap
positions in compliance with Sec. 23.152 and security-based swap
positions in compliance with proposed Sec. 240.18a-3(c)(1)(i)(b) of
this title and such initial margin and variation margin, in the
aggregate, is equal to or greater than 25 percent of the swap dealer's
minimum capital requirement or 25 percent of the major swap
participant's tangible net worth;
(ii) Counterparties fail to post initial margin or pay variation
margin to the swap dealer or major swap participant for swap positions
in compliance with Sec. 23.152 and security-based swap positions in
compliance with proposed Sec. 240.18a-3(c)(1)(i)(B) in an amount that,
in the aggregate, exceeds 50 percent of the swap dealer's minimum
capital requirement or 50 percent of the major swap participant's
tangible net worth;
(iii) A swap dealer or major swap participant fails to post initial
margin or pay variation margin to a single counterparty or group of
counterparties under common ownership and control for swap positions in
compliance with Sec. 23.152 and security-based swap positions in
compliance with proposed Sec. 240.18a-3(c)(1)(i)(B) of this title and
such initial margin and variation margin, in the aggregate, exceeds 25
percent of the swap dealer's minimum capital requirement or 25 percent
of the major swap participant's tangible net worth; or
(iv) A swap dealer or major swap participant fails to post initial
margin or pay variation margin to counterparties for swap positions in
compliance with Sec. 23.152 and security-based swap positions in
compliance with proposed Sec. 240.18a-3(c)(1)(i)(B) in an amount that,
in the aggregate, exceeds 50 percent of the swap dealer's s minimum
capital requirement or 50 percent of the major swap participants
tangible net worth.
(d) Monthly unaudited financial reports. (1) A swap dealer or major
swap participant shall file monthly financial reports meeting the
requirements in paragraph (d)(2) of this section as of the close of
business each month. Such financial reports must be filed no later than
17 business days after the date for which the report is made.
(2) The monthly financial reports must be prepared in the English
language and be denominated in United States dollars. The monthly
financial reports shall include a statement of financial condition, a
statement of income/loss, a statement of cash flows, a statement of
changes in ownership equity, a statement demonstrating compliance with
and calculation of the applicable regulatory capital requirement under
Sec. 23.101, and such further material information as may be necessary
to make the required statements not misleading. The monthly report and
schedules must be prepared in accordance with generally accepted
accounting principles as established in the United States: Provided,
however, that a swap dealer or major swap participant that is not
organized under the laws of a state or other jurisdiction in the United
States, and does not otherwise prepare financial statements in
accordance with U.S. generally accepted accounting principles, may
prepare the monthly report and schedules required by this section in
accordance with International Financial Reporting Standards issued by
the International Accounting Standards Board.
(3) A swap dealer or major swap participant that is also registered
with the Securities and Exchange Commission as a security-based swap
dealer or a major security-based swap participant and files a monthly
Form SBS with the Securities and Exchange Commission pursuant to Sec.
240.18a-7 of this title, may file such Form SBS with the Commission in
lieu of the financial reports required under paragraphs (d)(1) and (2)
of this section. The swap dealer or major swap participant must file
the Form SBS with the Commission when it files the Form SBS with the
Securities and Exchange Commission, provided, however, that the swap
dealer or major swap participant must file the Form SBS with the
Commission no later than 17 business days from the date the report is
made.
(4) A swap dealer or major swap participant that is also registered
with the Commission as a futures commission merchant may file a Form 1-
FR-FCM in lieu of the monthly financial reports required under
paragraphs (d)(1) and (2) of this section.
(e) Annual audited financial reports. (1) A swap dealer and major
swap participant shall file an annual audited financial report as of
the close of its fiscal year, certified in accordance with paragraph
(e)(2) of this section, and including the information specified in
paragraph (e)(3) of this section no later than 60 days after the close
of the swap dealer's and major swap participant's fiscal year-end.
(2) The annual certified financial report shall be audited and
reported upon with an opinion expressed by an independent certified
public accountant or independent licensed accountant that is in good
standing in the accountant's home jurisdiction.
(3) The annual audited financial reports shall be prepared in
accordance with generally accepted accounting principles as established
in the United States, be prepared in the English language, and
denominated in United States dollars: Provided, however, that a swap
dealer or major swap participant that is not organized under the laws
of a state or other jurisdiction in the United States, and does not
otherwise prepare financial statements in accordance with U.S.
generally accepted accounting principles, may prepare the annual
audited financial reports required by this section in accordance with
International Financial Reporting Standards issued by the International
Accounting Standards Board.
[[Page 91320]]
(4) The annual audited financial report must include the following:
(i) A statement of financial condition as of the date for which the
report is made;
(ii) Statements of income (loss), cash flows, and changes in
ownership equity for the period between the date of the most recent
certified statement of financial condition filed with the Commission
and the date for which the report is made;
(iii) Appropriate footnote disclosures;
(iv) A statement demonstrating the swap dealer's or major swap
participant's compliance with and calculation of the applicable
regulatory capital requirement under Sec. 23.101;
(v) A reconciliation of any material differences from the monthly
unaudited financial report prepared as of the swap dealer's or major
swap participant's year-end date and the swap dealer's or major swap
participant's annual financial report prepared under this paragraph
(e); and
(vi) Such further material information as may be necessary to make
the required statements not misleading.
(5) A swap dealer or major swap participant that is also registered
with the Securities and Exchange Commission as a security-based swap
dealer or a major security-based swap participant and files an annual
financial report with the Securities and Exchange Commission pursuant
to Sec. 240.18a-7 of this title, may file such annual report with the
Commission in lieu of the annual financial report required under this
paragraph (e). The swap dealer or major swap participant must file its
annual report with the Commission at the same time that it files the
annual report with the Securities and Exchange Commission, provided
that the annual report is filed with the Commission no later than 60
days from the swap dealer's or major swap participant's fiscal year-end
date.
(6) A swap dealer or major swap participant that is also registered
with the Commission as a futures commission merchant may file an
audited Form 1-FR-FCM in lieu of the annual financial reports required
under this paragraph (e).
(f) Oath or affirmation. Attached to each financial report, or
other filing made pursuant to this section, must be an oath or
affirmation that to the best knowledge and belief of the individual
making such oath or affirmation the information contained in the
financial report is true and correct. The individual making such oath
or affirmation must be: If the swap dealer or major swap participant is
a sole proprietorship, the proprietor; if a partnership, any general
partner; if a corporation, the chief executive officer or chief
financial officer; and, if a limited liability company or limited
liability partnership, the chief executive officer, the chief financial
officer, the manager, the managing member, or those members vested with
the management authority for the limited liability company or limited
liability partnership.
(g) Change of fiscal year-end. A swap dealer or major swap
participant may not change the date of its fiscal year-end from that
used in its most recent annual report filed under paragraph (e) of this
section unless the swap dealer or major swap participant has requested
and received written approval for the change from a registered futures
association of which it is a member.
(h) Additional information requirements. From time to time the
Commission may, by written notice, require any swap dealer or major
swap participant to file financial or operational information on a
daily basis or at such other times as may be specified by the
Commission. Such information must be furnished in accordance with the
requirements included in the written Commission notice.
(i) Public disclosure and nonpublic treatment of reports. (1) A
swap dealer or major swap participant must no less than quarterly make
publicly available on its Web site the following information:
(i) The statement of financial condition; and
(ii) A statement disclosing the amount of the swap dealer's or
major swap participant's regulatory capital as of the end of the
quarter and the amount of its minimum regulatory capital requirement,
computed in accordance with Sec. 23.101.
(2) A swap dealer or major swap participant must no less than
annually make publicly available on its Web site the following
information:
(i) The statement of financial condition from the swap dealer or
major swap participant's audited financial statements including
applicable footnotes; and
(ii) A statement disclosing the amount of the swap dealer's or
major swap participant's regulatory capital as of the fiscal year end
and its minimum regulatory capital requirement, computed in accordance
with Sec. 23.101.
(3) Financial information required to be made publicly available
pursuant to this section must be posted within 10 business days after
the firm is required to file applicable financial reports with the
Commission pursuant to paragraph (d) or (e) of this section.
(4) Financial information required to be filed pursuant to this
section, and not otherwise publicly available, will be treated as
exempt from mandatory public disclosure for purposes of the Freedom of
Information Act and the Government in the Sunshine Act and parts 145
and 147 of this chapter; Provided, however, that all information that
is exempt from mandatory public disclosure will be available for
official use by any official or employee of the United States or any
State, by the National Futures Association and by any other person to
whom the Commission believes disclosure of such information is in the
public interest.
(j) Extension of time to file financial reports. A swap dealer or
major swap participant may file a request with the registered futures
association of which it is a member for an extension of time to file a
monthly unaudited financial report or an annual audited financial
report required under paragraphs (d) and (e) of this section. Such
request will be approved, conditionally or unconditionally, or
disapproved by the registered futures association.
(k) Additional reporting requirements for swap dealers approved to
use models to calculate market risk and credit risk for computing
capital requirements. (1) A swap dealer that has received approval
under Sec. 23.102(d) from the Commission, or from a registered futures
association of which the swap dealer is a member, to use internal
models to compute its market risk exposure requirement and credit risk
exposure requirement in computing its regulatory capital under Sec.
23.101 must file with the Commission and with the registered futures
association of which the swap dealer is a member the following
information within 17 business days of the end of each month:
(i) For each product for which the swap dealer calculates a
deduction for market risk other than in accordance with a model
approved pursuant to Sec. 23.102(d), the product category and the
amount of the deduction for market risk;
(ii) A graph reflecting, for each business line, the daily intra-
month VaR;
(iii) The aggregate VaR for the swap dealer;
(iv) For each product for which the swap dealer uses scenario
analysis, the product category and the deduction for market risk;
(v) Credit risk information on swap, mixed swap and security-based
swap exposures including:
(A) Overall current exposure;
[[Page 91321]]
(B) Current exposure (including commitments) listed by counterparty
for the 15 largest exposures;
(C) The 10 largest commitments listed by counterparty;
(D) The swap dealer's maximum potential exposure listed by
counterparty for the 15 largest exposures;
(E) The swap dealer's aggregate maximum potential exposure;
(F) A summary report reflecting the swap dealer's current and
maximum potential exposures by credit rating category; and
(G) A summary report reflecting the swap dealer's current exposure
for each of the top ten countries to which the swap dealer is exposed
(by residence of the main operating group of the counterparty); and
(vi) The results of the liquidity stress test required by Sec.
23.104.
(2) A swap dealer that has received approval under Sec. 23.102(d)
from the Commission or from a registered futures association of which
the swap dealer is a member to use internal models to compute its
market risk exposure requirement and credit risk exposure requirement
in computing its regulatory capital under Sec. 23.101 must file with
the Commission and with the registered futures association of which the
swap dealer is member the following information within 17 business days
of the end of each calendar quarter:
(i) A report identifying the number of business days for which the
actual daily net trading loss exceeded the corresponding daily VaR; and
(ii) The results of backtesting of all internal models used to
compute allowable capital, including VaR, and credit risk models,
indicating the number of backtesting exceptions.
(l) Additional position and counterparty reporting requirements. A
swap dealer or major swap participant must provide on a monthly basis
to the Commission and to the registered futures association of which
the swap dealer or major swap participant is a member the specific
information required in Appendix A to this section.
(m) Margin reporting. A swap dealer or major swap participant must
file with the Commission and with the registered futures association of
which the swap dealer or major swap participant is member the following
information as of the end of each month within 17 business days of the
end of each month:
(1) The name and address of each custodian holding initial margin
or variation margin collected by the swap dealer or major swap
participant for uncleared swap transactions pursuant to Sec. Sec.
23.152 and 23.153;
(2) The amount of initial margin and variation margin collected by
the swap dealer or major swap participant that is held by each
custodian listed in paragraph (m)(1) of this section;
(3) The aggregate amount of initial margin that the swap dealer or
major swap participant is required to collect from swap counterparties
pursuant to Sec. 23.152(a);
(4) The name and address of each custodian holding initial margin
or variation margin posted by the swap dealer or major swap participant
for uncleared swap transaction pursuant to Sec. Sec. 23.152 and
23.153;
(5) The amount of initial margin and variation margin posted by the
swap dealer or major swap participant that is held by each custodian
listed in paragraph (m)(4) of this section; and
(6) The aggregate amount of initial margin that the swap dealer or
majors swap participant is required to post to its swap counterparties
pursuant to Sec. 23.152(b).
(n) Electronic filing. All filings of financial reports, notices
and other information required to be submitted to the Commission under
paragraphs (b) through (m) of this section must be filed in electronic
form using a form of user authentication assigned in accordance with
procedures established by or approved by the Commission, and otherwise
in accordance with instructions issued by or approved by the
Commission. A swap dealer or major swap participant must provide the
Commission with the means necessary to read and to process the
information contained in such report. Any such electronic submission
must clearly indicate the swap dealer or major swap participant on
whose behalf such filing is made and the use of such user
authentication in submitting such filing will constitute and become a
substitute for the manual signature of the authorized signer. In the
case of a financial report required under paragraphs (d), (e), or (h)
of this section and filed via electronic transmission in accordance
with procedures established by or approved by the Commission, such
transmission must be accompanied by the user authentication assigned to
the authorized signer under such procedures, and the use of such user
authentication will constitute and become a substitute for the manual
signature of the authorized signer for the purpose of making the oath
or affirmation referred to in paragraph (f) of this section.
(o) Comparability determination for certain financial reporting. A
swap dealer or major swap participant that is subject to the monthly
financial reporting requirements of paragraph (d) of this section and
the annual financial reporting requirements of paragraph (e) of this
section may petition the Commission for a Comparability Determination
under Sec. 23.106 to file monthly financial reports and/or annual
financial reports prepared in accordance with the rules a foreign
regulatory authority in lieu of the requirements contained in this
section.
(p) Quarterly financial reporting and notification provisions for
swap dealers and major swap participants that are subject to the
capital requirements of a prudential regulator.
(1) Scope. A swap dealer or major swap participant that is subject
to the capital requirements of a prudential regulator must comply with
the requirements of this paragraph.
(2) Financial report and position information. A swap dealer or
major swap participant that is subject to the capital requirements of a
prudential regulator shall file on a quarterly basis with the
Commission the financial reports and specific position information set
forth in Appendix B of this section. The swap dealer or major swap
participant must file Appendix B with the Commission within 17 business
days of the date of the end of the swap dealer's fiscal quarter.
(3) Notices. A swap dealer or major swap participant that is
subject to the capital requirements of a prudential regulator must
comply with the following notice provisions:
(i) A swap dealer or major swap participant that files a notice of
adjustment of its reported capital category with the Federal Reserve
Board, the Office of the Comptroller of the Currency, or the Federal
Deposit Insurance Corporation, or files a similar notice with its home
country supervisor(s), must give notice of this fact that same day by
transmitting a copy of the notice of the adjustment of reported capital
category, or the similar notice provided to its home country
supervisor(s), to the Commission.
(ii) A swap dealer or major swap participant must provide immediate
written notice that the swap dealer's or major swap participant's
regulatory capital is less than the applicable minimum capital
requirements set forth in 12 CFR 217.10, 12 CFR 3.10, or 12 CFR 324.10,
or the minimum capital requirements established by its home country
supervisor(s).
(iii) A swap dealer or major swap participant must submit a notice
to the Commission within 24 hours of the occurrence of any of the
following events:
[[Page 91322]]
(A) A single counterparty or group of counterparties that are under
common ownership or control fails to post initial margin or pay
variation margin to the swap dealer for swap positions and security-
based swap positions and such initial margin and variation margin, in
the aggregate, is equal to or greater than 25 percent of the swap
dealer's minimum capital requirement;
(B) Counterparties fail to post initial margin or pay variation
margin to the swap dealer for swap positions and security-based swap
positions in an amount that, in the aggregate, exceeds 50 percent of
the swap dealer's minimum capital requirement;
(C) A swap dealer fails to post initial margin or pay variation
margin to a single counterparty or group of counterparties under common
ownership and control for swap positions and security-based swap
positions and such initial margin and variation margin, in the
aggregate, exceeds 25 percent of the swap dealer's minimum capital
requirement; or
(D) A swap dealer fails to post initial margin or pay variation
margin to counterparties for swap positions and security-based swap
positions in an amount that, in the aggregate, exceeds 50 percent of
the swap dealer's s minimum capital requirement.
(iv) If a swap dealer or major swap participant at any time fails
to make or to keep current the books and records required by these
regulations, such swap dealer or major swap participant must, on the
same day such event occurs, provide notice of such fact, specifying the
books and records which have not been made or which are not current,
and within 48 hours after giving such notice file a written report
stating what steps have been and are being taken to correct the
situation.
(4) Additional information. From time to time the Commission may,
by written notice, require a swap dealer or major swap participant that
is subject to the capital rules of a prudential regulator to file
financial or operational information on a daily basis or at such other
times as may be specified by the Commission. Such information must be
furnished in accordance with the requirements included in the written
Commission notice.
(5) Oath or affirmation. Attached to each financial report, notice
filing, or other filing made pursuant to this paragraph (p) must be an
oath or affirmation that to the best knowledge and belief of the
individual making such oath or affirmation the information contained in
the filing is true and correct. With respect to financial reports, the
individual making such oath or affirmation must be: If the swap dealer
or major swap participant is a sole proprietorship, the proprietor; if
a partnership, any general partner; if a corporation, the chief
executive officer or chief financial officer; and, if a limited
liability company or limited liability partnership, the chief executive
officer, the chief financial officer, the manager, the managing member,
or those members vested with the management authority for the limited
liability company or limited liability partnership.
(6) Electronic filing. All filings of financial reports, notices,
and other information made pursuant to this paragraph (p) must be
submitted to the Commission in electronic form using a form of user
authentication assigned in accordance with procedures established by or
approved by the Commission, and otherwise in accordance with
instructions issued by or approved by the Commission. Each swap dealer
and major swap participant must provide the Commission with the means
necessary to read and to process the information contained in such
report. Any such electronic submission must clearly indicate the swap
dealer or major swap participant on whose behalf such filing is made
and the use of such user authentication in submitting such filing will
constitute and become a substitute for the manual signature of the
authorized signer. In the case of a financial report required under
this paragraph (p) and filed via electronic transmission in accordance
with procedures established by or approved by the Commission, such
transmission must be accompanied by the user authentication assigned to
the authorized signer under such procedures, and the use of such user
authentication will constitute and become a substitute for the manual
signature of the authorized signer for the purpose of making the oath
or affirmation referred to in paragraph (p)(5) of this section. Every
notice or report required to be transmitted to the Commission pursuant
to this paragraph (p) must also be filed with the Securities and
Exchange Commission if the swap dealer or major swap participant also
is registered with the Securities and Exchange Commission.
(7) Public disclosure and nonpublic treatment of reports. (i) A
swap dealer or major swap participant that is subject to the capital
requirements of a prudential regulator must no less than quarterly make
publicly available on its Web site the following information:
(A) The statement of financial condition; and
(B) A statement disclosing the amount of the swap dealer's or major
swap participant's regulatory capital as of the end of the quarter and
the amount of its minimum regulatory capital requirement.
(ii) Financial information required to be made publicly available
pursuant to this section must be posted within 10 business days after
the firm is required to file applicable financial reports with the
Commission pursuant to paragraph (p)(2) of this section.
(iii) Financial information required to be filed pursuant to this
section, and not otherwise publicly available, will be treated as
exempt from mandatory public disclosure for purposes of the Freedom of
Information Act and the Government in the Sunshine Act and parts 145
and 147 of this chapter; Provided, however, that all information that
is exempt from mandatory public disclosure will be available for
official use by any official or employee of the United States or any
State, by the National Futures Association and by any other person to
whom the Commission believes disclosure of such information is in the
public interest.
(q) Weekly position and margin reporting--(1) Positions. On the
first business day of every week, a swap dealer or major swap
participant shall file with the Commission a report showing, in a
format specified by the Commission, all open uncleared swap positions
as of the close of business on the last business day of the previous
week, sorted as follows:
(i) By counterparty, and
(ii) For each counterparty, by the following asset classes--
commodity, credit, equity, and foreign exchange or interest rate.
(2) Margin. On the first business day of every week, a swap dealer
or major swap participant shall file with the Commission a report
showing, in a format specified by the Commission, for open uncleared
swap positions as of the close of business on the last business day of
the previous week:
(i) The total initial margin posted by the swap dealer or major
swap participant with each counterparty;
(ii) The total initial margin collected by the swap dealer or major
swap participant from each counterparty; and
(iii) The net variation margin paid or collected over the previous
week with each counterparty.
Appendix A to Sec. 23.105--Swap Dealer and Major Swap Participant
Position Information
BILLING CODE 6351-01-P
[[Page 91323]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.001
[[Page 91324]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.002
[[Page 91325]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.003
[[Page 91326]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.004
[[Page 91327]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.005
[[Page 91328]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.006
[[Page 91329]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.007
[[Page 91330]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.008
[[Page 91331]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.009
[[Page 91332]]
[GRAPHIC] [TIFF OMITTED] TP16DE16.010
BILLING CODE 6351-01-C
Sec. 23.106 Comparability determination for substituted compliance.
(a)(1) Eligibility requirements. The following persons may, either
individually or collectively, request a Capital Comparability
Determination with respect to the Commission's capital adequacy and
financial reporting requirements for swap dealers or major swap
participants:
(i) A swap dealer or major swap participant that is eligible for
substituted compliance under Sec. 23.101; or
(ii) A foreign regulatory authority that has direct supervisory
authority over one or more swap dealers or major swap participants that
are eligible for substituted compliance under Sec. 23.101, and such
foreign regulatory authority is responsible for administering the
relevant foreign jurisdiction's capital adequacy and financial
reporting requirements over the swap dealer or major swap participant.
(2) Submission requirements. A person requesting a Capital
Comparability Determination must electronically submit to the
Commission:
(i) A description of the objectives of the relevant foreign
jurisdiction's capital adequacy and financial reporting requirements
over entities that are subject to the Commission's capital adequacy and
financial reporting requirements in this part;
(ii) A description (including specific legal and regulatory
provisions) of how the relevant foreign jurisdiction's capital adequacy
and financial reporting requirements address the elements of the
Commission's capital adequacy and financial reporting requirements for
swap dealers and major swap participants, including, at a minimum, the
methodologies for establishing and calculating capital adequacy
requirements and whether such methodologies comport with any
international standards, including Basel-based capital requirements for
banking institutions; and
(iii) A description of the ability of the relevant foreign
regulatory authority or authorities to supervise and enforce compliance
with the relevant foreign jurisdiction's capital adequacy and financial
reporting requirements. Such description should discuss the powers of
the foreign regulatory authority or authorities to supervise,
investigate, and discipline entities for compliance with capital
adequacy and financial reporting requirements, and the ongoing efforts
of the regulatory authority or authorities to detect and deter
violations, and ensure compliance with capital adequacy and financial
reporting requirements. The description should address how foreign
authorities and foreign laws and regulations address situations where a
swap dealer or major swap participant is unable to comply with the
foreign jurisdictions capital adequacy or financial reporting
requirements.
(iv) Upon request, such other information and documentation that
the Commission deems necessary to evaluate the comparability of the
capital adequacy and financial reporting requirements of the foreign
jurisdiction.
(v) All supplied documents shall be provided in English, or
provided translated to the English language, with currency amounts
stated in or converted to USD (conversions to be noted with applicable
date).
(3) Standard of Review. The Commission will issue a Capital
Comparability Determination to the extent that it determines that some
or all of the relevant foreign jurisdiction's capital adequacy and
financial reporting requirements and related financial recordkeeping
and reporting requirements for swap dealing financial intermediaries
are comparable to the Commission's corresponding capital adequacy and
financial recordkeeping and reporting requirements. In determining
whether the requirements are comparable, the Commission will consider
all relevant factors, including:
(i) The scope and objectives of the foreign jurisdiction's capital
adequacy and financial reporting requirements;
(ii) How and whether the relevant foreign jurisdiction's capital
adequacy requirements compare to international Basel capital standards
for banking institutions or to other standards such as those used for
securities brokers or dealers;
(iii) Whether the relevant foreign jurisdiction's capital adequacy
and financial reporting requirements achieve comparable outcomes to the
Commission's corresponding capital adequacy and financial reporting
requirements for swap dealers and major swap participants;
(iv) The ability of the relevant regulatory authority or
authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's capital adequacy and financial reporting
requirements; and
(v) Any other facts or circumstances the Commission deems relevant.
(4) Reliance. (i) A swap dealer or major swap participant that is
subject to the supervision of a foreign jurisdiction that has received
a Capital Comparability Determination from the Commission must file a
notice of its intent to comply with the capital adequacy and financial
reporting requirements of the foreign jurisdiction with the registered
futures association of which the swap dealer or major swap participant
is a member. The registered futures association will determine the
information that the swap dealer or major swap participant must include
in the notice. A swap dealer or major swap participant must obtain a
confirmation from the registered futures association that it may comply
with the capital
[[Page 91333]]
adequacy and financial reporting requirements of the foreign
jurisdiction in lieu of some or all of the capital adequacy and
financial reporting requirements in the part.
(ii) Any swap dealer or major swap participant that has obtained a
confirmation from a registered futures association and, in accordance
with a Capital Comparability Determination, complies with a foreign
jurisdiction's capital adequacy and financial reporting requirements
will be deemed to be in compliance with the Commission's corresponding
capital adequacy and financial reporting requirements. Accordingly, the
failure of such a swap dealer or major swap participant to comply with
the foreign jurisdictions capital adequacy and financial reporting
requirements may constitute a violation of the Commission's capital
adequacy and financial reporting requirements. All swaps dealer and
major swap participants, regardless of whether they rely on a Capital
Comparability Determination, remain subject to the Commission's
examination and enforcement authority.
(5) Conditions. In issuing a Capital Comparability Determination,
the Commission may impose any terms and conditions it deems
appropriate, including certain capital adequacy and financial reporting
requirements on swap dealers or major swap participants. The violation
of such terms and conditions may constitute a violation of the
Commission's capital adequacy or financial reporting requirements and/
or result in the modification or revocation of the Capital
Comparability Determination.
(6) Modifications. The Commission reserves the right to further
condition, modify, suspend or terminate or otherwise restrict a Capital
Comparability Determination in the Commission's discretion.
Sec. Sec. 23.107-23.149 [Reserved]
PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION
0
9. The authority citation for part 140 continues to read as follows:
Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and
16(b).
0
10. Amend Sec. 140.91 as follows:
0
a. Redesignate paragraph (a)(12) as paragraph (a)(13);
0
b. Redesignate paragraph (a)(11) as paragraph (a)(12);
0
c. Add new paragraph (a)(11).
The addition to read as follows:
Sec. 140.91 Delegation of authority to the Director of the Division
of Clearing and Risk and to the Director of the Division of Swap Dealer
and Intermediary Oversight.
(a) * * *
(11) All functions reserved to the Commission in Sec. Sec. 23.100
through 23.107 of this chapter, except for those related to the
revocation of a swap dealer's or major swap participant's approval to
use internal models to compute capital requirements under Sec. 23.102
of this chapter, and the issuance of Capital Comparability
Determinations under Sec. 23.106 of this chapter.
* * * * *
Issued in Washington, DC, on December 2, 2016, by the
Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Capital Requirements of Swap Dealers and Major Swap
Participants--Commission Voting Summary, Chairman's Statement, and
Commissioner's Statement
Appendix 1--Commission Voting Summary
On this matter, Chairman Massad and Commissioners Bowen and
Giancarlo voted in the affirmative. No Commissioner voted in the
negative.
Appendix 2--Statement of Chairman Timothy G. Massad
I support the proposed rulemaking the Commission unanimously
approved today.
Capital requirements for swap dealers are among the most
important reforms of the over-the-counter swap market agreed to by
the leaders of the G20 nations in 2009. They complement margin
requirements for uncleared swaps, which the Commission finalized
earlier this year. While margin is the front line defense against a
default, adequate capital is critical to the ability of swap dealers
to absorb losses.
One of my priorities this year has been to issue a reproposal of
our rule setting these capital requirements. Our original proposal
was issued at a time when margin requirements for uncleared swaps
had not yet been established and bank capital rules were still being
finalized. It is important that our rules are harmonized with
prudential requirements, which is why it was appropriate to update
and repropose our rule.
As with margin, the law provides that swap dealers for which
there is a prudential regulator shall comply with the capital rules
of the prudential regulators, and the CFTC must adopt capital rules
for all others. Because capital requirements are entity-wide, and
not specific to transactions, I believe the requirements should take
into account the fact that there are different types of firms that
act as swap dealers--such as bank affiliates, broker-dealers,
futures commission merchants and others primarily engaged in non-
financial activities. Requiring all firms to follow one approach
could favor one business model over another, and cause even greater
concentration in the industry.
The reproposal we have approved today recognizes this diversity.
It supports competition as well as safety and soundness, by
providing three different approaches. First, for swap dealers that
are affiliates of prudentially regulated firms, the proposal permits
them to use a method based on that of our banking regulators. Swap
dealers that are also broker-dealers can use an approach that is
based on the Securities and Exchange Commission's net liquid assets
approach. And for those dealers that are engaged primarily in non-
financial activities, we have proposed a third approach based on net
worth. And we have harmonized these requirements, where appropriate,
with the capital rules of our prudential regulators and the
Securities and Exchange Commission.
I thank the CFTC's hardworking staff for the significant time
and effort they have devoted to this rule. I thank my fellow
Commissioners for their support of this measure. And I encourage
public comment on this proposal.
Appendix 3--Statement of Commissioner J. Christopher Giancarlo
For some time now, I have been asking whether the amount of
capital which regulators have caused financial institutions to take
out of trading markets is at all calibrated to the amount of capital
which is needed to be kept in global markets to support the health
and durability of the global financial system. I have called on the
Financial Stability Oversight Council and domestic and foreign
financial regulators to conduct a thorough analysis in this regard.
Those calls have been largely ignored. So, I hope that commenters to
this capital proposal can help provide some insight into my
question.
Along those lines, I have included several questions in this
proposal that ask for feedback on whether the capital requirements
under the different capital approaches are appropriate. I thank
staff of the Division of Swap Dealer and Intermediary Oversight for
including my questions in the proposal. I am particularly interested
in how the proposed capital requirements will affect smaller swap
dealers and how much additional capital they may have to raise to
comply with the proposal. I have included several questions in the
cost-benefit section in this regard. I am also interested in the
impact of the proposed rule on any potential new registrants if the
swap dealer de minimis level falls to $3 billion.
I have also included several questions about the scope of the
proposal. For example, the proposed minimum capital requirement is
based upon eight percent of the margin required on the swap dealer's
cleared and uncleared swaps and security-based swaps and the margin
required on the swap dealer's futures and foreign futures. However,
Commodity Exchange Act section 4s(e)(3)(A) only cites the risk of
uncleared swaps in
[[Page 91334]]
setting standards for capital.\1\ Additionally, in the Commission's
final swap dealer definition rule, it said it will ``in connection
with promulgation of final rules relating to capital requirements
for swap dealers and major swap participants, consider institution
of reduced capital requirements for entities or individuals that
fall within the swap dealer definition and that execute swaps only
on exchanges, using only proprietary funds.'' \2\ Given these
pronouncements, I welcome commenters' views on the broad scope of
the proposed capital requirements.
---------------------------------------------------------------------------
\1\ 7 U.S.C. 6s(e)(3)(A).
\2\ 77 FR 30596, 30610 fn. 199 (May 23, 2012).
---------------------------------------------------------------------------
Finally, I am concerned about the proposed capital model review
and approval process. The proposal states that the Commission
expects that a prudential regulator's or foreign regulator's review
and approval of capital models that are used in the corporate family
of a swap dealer would be a significant factor in the National
Futures Association's (NFA) determination of the scope of its
review, provided that appropriate information sharing agreements are
in place. Given the large number of models that will need to be
reviewed, the complexity of those models and the practical resource
constraints at the NFA, I am concerned that the proposed process
will be unworkable. We have already seen the challenges in the model
approval process for initial margin under tight implementation
timelines, and in that case there was a standard initial margin
model. We should learn from that lesson. So, I am interested to hear
commenters' views on alternative model approval processes, such as
automatic or temporary approval of capital models that have been
previously approved by a prudential or foreign regulator.
I look forward to reviewing thoughtful and well-considered
comments.
[FR Doc. 2016-29368 Filed 12-15-16; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: December 16, 2016