[Federal Register Volume 81, Number 104 (Tuesday, May 31, 2016)]
[Rules and Regulations]
[Pages 34817-34854]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-12612]
[[Page 34817]]
Vol. 81
Tuesday,
No. 104
May 31, 2016
Part VI
Commodity Futures Trading Commission
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17 CFR Part 23
Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants--Cross-Border Application of the Margin Requirements;
Agency Information Collection Activities: Proposed Collection, Comment
Request: Final Rule, Margin Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants--Cross-Border Application of the
Margin Requirements; Final Rule and Notice
Federal Register / Vol. 81 , No. 104 / Tuesday, May 31, 2016 / Rules
and Regulations
[[Page 34818]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AC97
Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants--Cross-Border Application of the Margin
Requirements
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: On January 6, 2016, the Commodity Futures Trading Commission
(``Commission'' or ``CFTC'') published final regulations to implement
section 4s(e) of the Commodity Exchange Act, which requires the
Commission to adopt initial and variation margin requirements for
uncleared swaps of swap dealers and major swap participants that do not
have a Prudential Regulator (collectively, ``Covered Swap Entities'' or
``CSEs''). In this release, the Commission is adopting a rule to
address the cross-border application of the Commission's margin
requirements for CSEs' uncleared swaps.
DATES: The final rule is effective August 1, 2016.
FOR FURTHER INFORMATION CONTACT: Laura B. Badian, Assistant General
Counsel, 202-418-5969, [email protected]; Paul Schlichting, Assistant
General Counsel, 202-418-5884, [email protected]; or Elise
(Pallais) Bruntel, Counsel, (202) 418-5577, [email protected]; Office
of the General Counsel, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Introduction
B. Key Considerations in the Cross-Border Application of the
Margin Regulations
II. The Final Rule
A. Key Definitions
1. U.S. Person
a. Proposed Rule
b. Comments
c. Final Rule
2. Guarantees
a. Proposed Rule
b. Comments
c. Final Rule
3. Foreign Consolidated Subsidiary (``FCS'')
a. Proposed Rule
b. Comments
c. Final Rule
4. Counterparty Representations
B. Applicability of Margin Requirements To Cross-Border
Uncleared Swaps
1. Proposed Rule
2. Substituted Compliance
a. Comments
b. Final Rule
3. Exclusion
a. Comments
b. Final Rule
4. Special Provisions for Non-Segregation Jurisdictions
a. Comments
b. Final Rule
5. Special Provisions for Non-Netting Jurisdictions
a. Comments
b. Final Rule
C. Comparability Determinations
1. Proposed Rule
2. Comments
3. Final Rule
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. Information Collection--Comparability Determinations
2. Information Collection--Non-Segregation Jurisdictions
3. Information Collection--Non-Netting Jurisdictions
C. Cost-Benefit Considerations
1. Introduction
2. Key Definitions
a. U.S. Person
b. Guarantees
c. Foreign Consolidated Subsidiary
3. Application
a. Substituted Compliance
b. Exclusion
c. Non-Segregation Jurisdictions and Non-Netting Jurisdictions
4. Comparability Determinations
5. Section 15(a) Factors
a. Protection of Market Participants and the Public
b. Efficiency, Competitiveness, and Financial Integrity
c. Price Discovery
d. Sound Risk Management Practices
e. Other Public Interest Considerations
Table A--Application of the Final Rule
I. Background
A. Introduction
In the wake of the 2008 financial crisis, Congress enacted Title
VII of the Wall Street Reform and Consumer Protection Act (``Dodd-Frank
Act''),\1\ which modified the Commodity Exchange Act (``CEA'') \2\ to
establish a comprehensive regulatory framework for swaps. A cornerstone
of this framework is the reduction of systemic risk to the U.S.
financial system through the establishment of margin requirements for
uncleared swaps. CEA section 4s(e), added by section 731 of the Dodd-
Frank Act, directs the Commission to adopt rules establishing minimum
initial and variation margin requirements on all swaps that are not
cleared by a registered derivatives clearing organization (``DCO'').\3\
To offset the greater risk to the swap dealer or major swap participant
and the financial system arising from the use of uncleared swaps, the
Commission's margin requirements must (i) help ensure the safety and
soundness of the swap dealer or major swap participant, and (ii) be
appropriate for the risk associated with the uncleared swaps held as a
swap dealer or major swap participant.\4\ Under CEA section 4s(e), the
Commission's margin requirements apply to each swap dealer or major
swap participant for which there is no Prudential Regulator
(collectively, ``Covered Swap Entities'' or ``CSEs'').\5\ The
Commission published final margin requirements for CSEs in January
2016.\6\
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\1\ Public Law 111-203, 124 Stat. 1376 (2010).
\2\ 7 U.S.C. 1 et seq.
\3\ See 7 U.S.C. 6s(e)(2)(B)(ii).
\4\ 7 U.S.C. 6s(e)(3)(A).
\5\ See 7 U.S.C. 6s(e)(1)(B). Swap dealers and major swap
participants for which there is a Prudential Regulator must meet the
margin requirements for uncleared swaps established by the
applicable Prudential Regulator. 7 U.S.C. 6s(e)(1)(A). See also 7
U.S.C. 1a(39) (defining the term ``Prudential Regulator'' to include
the Board of Governors of the Federal Reserve System; the Office of
the Comptroller of the Currency; the Federal Deposit Insurance
Corporation; the Farm Credit Administration; and the Federal Housing
Finance Agency). The Prudential Regulators published final margin
requirements in November 2015. See Margin and Capital Requirements
for Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015) (``Prudential
Regulators' Final Margin Rule'').
\6\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016) (the ``Final
Margin Rule''). The Final Margin Rule, which became effective April
1, 2016, is codified in part 23 of the Commission's regulations. See
17 CFR 23.150-159, 161.
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In July 2015, consistent with its authority in CEA sections 4s(e)
and 2(i),\7\ the Commission proposed a rule to address the cross-border
application of the Commission's margin requirements (the ``proposed
rule'').\8\ The proposed rule set out the circumstances under which a
CSE would be allowed to satisfy the Commission's margin requirements by
complying with comparable foreign margin requirements
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(``substituted compliance''); offered certain CSEs a limited exclusion
from the Commission's margin requirements (the ``Exclusion''); and
outlined a framework for assessing whether a foreign jurisdiction's
margin requirements are comparable to the Commission's requirements
(``comparability determinations''). The Commission developed the
proposed rule after close consultation with the Prudential Regulators
and in light of comments from and discussions with market participants
and foreign regulators.\9\
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\7\ See 7 U.S.C. 2(i). Section 2(i) of the CEA states that the
provisions of the CEA relating to swaps that were enacted by the
Wall Street Transparency and Accountability Act of 2010 (including
any rule prescribed or regulation promulgated under that Act), shall
not apply to activities outside the United States unless those
activities (1) have a direct and significant connection with
activities in, or effect on, commerce of the United States; or (2)
contravene such rules or regulations as the Commission may prescribe
or promulgate as are necessary or appropriate to prevent the evasion
of any provision of this Act that was enacted by the Wall Street
Transparency and Accountability Act of 2010.
\8\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Cross-Border Application of the Margin
Requirements, 80 FR 41376 (July 14, 2015) (``Proposal'').
\9\ In 2014, in conjunction with reproposing its margin
requirements, the Commission requested comment on three alternative
approaches to the cross-border application of its margin
requirements: (i) A transaction-level approach consistent with the
Commission's guidance on the cross-border application of the CEA's
swap provisions, see Interpretive Guidance and Policy Statement
Regarding Compliance with Certain Swap Regulations, 78 FR 45292
(July 26, 2013) (``Guidance''); (ii) an approach consistent with the
Prudential Regulators' proposed cross-border framework for margin,
see Margin and Capital Requirements for Covered Swap Entities, 79 FR
57348 (Sept. 24, 2014) (``Prudential Regulators' Proposed Margin
Rule''); and (iii) an entity-level approach that would apply margin
rules on a firm-wide basis (without any exclusion for swaps with
non-U.S. counterparties). See Margin Requirements for Uncleared
Swaps for Swap Dealers and Major Swap Participants, 79 FR 59898
(Oct. 3, 2014) (``Proposed Margin Rule''). Following a review of
comments received in response to this release, the Commission's
Global Markets Advisory Committee (``GMAC'') hosted a public panel
discussion on the cross-border application of margin requirements.
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The Commission requested comment on all aspects of the proposed
rule. After a careful review of the comments,\10\ the Commission is
adopting a final rule largely as proposed but with some modifications,
as described below (the ``Final Rule'').\11\
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\10\ The Commission received eighteen comment letters in
response to the Proposal: Alternative Investment Management
Association and Investment Association (Sept. 11, 2015) (``AIMA/
IA''); American Bankers Association and ABA Securities Association
(Sept. 14, 2015) (``ABA/ABASA''); American Council of Life Insurers
(Sept. 14, 2015) (``ACLI''); Americans for Financial Reform (Sept.
14, 2015) (``AFR''); Chris Barnard (Sept. 14, 2015) (``Barnard'');
Better Markets, Inc. (Sept. 14, 2015) (``Better Markets'');
Financial Services Roundtable (Sept. 14, 2015) (``FSR''); FMS-
Wertmanagement (Sept. 14, 2015) (``FMS-WM''); Institute for
Agriculture and Trade Policy (Sept. 14, 2015) (``IATP''); Investment
Company Institute Global (Sept. 14, 2015) (``ICI Global'');
International Swaps and Derivatives Association, Inc. (Sept. 11,
2015) (``ISDA''); Institute of International Bankers and Securities
Industry and Financial Markets Association (Sept. 14, 2015) (``IIB/
SIFMA''); Japanese Bankers Association (Sept. 13, 2015) (``JBA'');
LCH.Clearnet Group Ltd. (Sept. 14, 2015) (``LCH.Clearnet''); Managed
Funds Association (Sept. 14, 2015) (``MFA''); PensionsEurope (Sept.
14, 2015) (``PensionsEurope''); Asset Management Group of the
Securities Industry and Financial Markets Association (Sept. 14,
2015) (``SIFMA AMG''); and Vanguard (Sept. 14, 2015) (``Vanguard'').
The comment file is available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1600.
\11\ The Final Rule is codified at 17 CFR 23.160.
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B. Key Considerations in the Cross-Border Application of the Margin
Regulations
The overarching objective of the cross-border margin framework is
to further the congressional mandate to ensure the safety and soundness
of CSEs in order to offset the greater risk to CSEs and the financial
system arising from the use of swaps that are not cleared.\12\ Margin's
primary function is to protect a CSE from counterparty default,
allowing it to absorb losses and continue to meet its obligations using
collateral provided by the defaulting counterparty.\13\ While the
requirement to post margin protects the counterparty in the event of
the CSE's default, it also functions as a risk management tool,
limiting the amount of leverage a CSE can incur by requiring that it
have adequate eligible collateral to enter into an uncleared swap. In
this way, margin serves as a first line of defense not only in
protecting the CSE but in containing the amount of risk in the
financial system as a whole, reducing the potential for contagion
arising from uncleared swaps.\14\
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\12\ See 7 U.S.C. 6s(e)(3)(A).
\13\ See Proposal, 80 FR at 41377.
\14\ Although margin and capital are, by design, complementary,
they serve equally important but different risk mitigation
functions. Unlike margin, capital is difficult to rapidly adjust in
response to changing risk exposures. Capital therefore can be viewed
as a backstop in the event that margin is insufficient to cover
losses resulting from a counterparty default. The Commission
proposed capital rules in 2011. See Capital Requirements for Swap
Dealers and Major Swap Participants, 76 FR 27802 (May 12, 2011)
(``Proposed Capital Rule''). The Commission intends to repropose
capital rules later this year.
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The Commission recognizes that, to achieve the goals of the Dodd-
Frank Act, its cross-border framework must take into account the global
state of the swap market. The nature of modern financial markets means
that risk is not static or contained by geographic boundaries. Market
participants engage in swaps on a 24-hour basis in global markets, and
many financial entities operate through a complex web of branches,
subsidiaries, and affiliates that are scattered across the globe.\15\
These branches and affiliated entities are highly interdependent,
sharing not only information technology and operational support but
risk management, treasury, and custodial functions. Risks from a swap
entered into by an affiliated entity in one jurisdiction may be
transferred to another affiliate in a different jurisdiction through
inter-affiliate transactions. As part of their risk management
practices, swap dealers also commonly lay off the risk of client-facing
swaps in the interdealer market, which, as a result of consolidation
among global financial institutions, has become concentrated among a
relatively small number of dealers.\16\ These developments, along with
others, have led to a highly interconnected global swap market, where
risks originating in one jurisdiction and entity are easily transferred
to other jurisdictions and entities, increasing the possibility of
cascading defaults.
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\15\ The largest U.S. banks have somewhere between 2,000 to
3,000 affiliated global entities, hundreds of which are based in the
Cayman Islands. Data from the National Information Center (NIC), a
repository of financial data and institutional characteristics of
banks and other entities regulated by the Federal Reserve, show the
increasing complexity of U.S. banks' foreign operations. See NIC,
available at http://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx. For
instance, in 1990, there were 1,300 foreign nonbank subsidiaries in
the database; at the end of 2014, there were more than 6,000.
Foreign ownership is also highly concentrated in a few large firms:
Goldman Sachs and Morgan Stanley own more than 2,000 foreign nonbank
subsidiaries and, together with General Electric, own 63 percent of
all foreign bank subsidiaries. Citigroup, JPMorgan Chase, and Bank
of America account for 75 percent of all foreign branches.
\16\ According to the Quarterly Report on Bank Trading and
Derivatives Activities issued by the Office of the Comptroller of
the Currency (OCC) for the second quarter of 2015, the notional
value of derivative contracts held by insured U.S. commercial banks
and savings associations was $197.9 trillion. See Office of the
Comptroller of the Currency, Quarterly Report on Bank Trading and
Derivatives Activities Second Quarter 2015, 1 (2015), available at
http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq215.pdf. At the same time, four large commercial banks
with the most derivatives activity--Goldman Sachs, JPMorgan Chase
Bank NA, Citibank, and Bank of America NA--held 91.1% of the
notional amount of these derivatives contracts. Id. at 11, 16.
Contracts for swaps specifically accounted for $117.5 trillion of
the $197.9 trillion total notional. Id. at 16.
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As the 2008 financial crisis illustrated, the global nature of the
swap market heightens the potential that risks assumed by a firm
overseas stemming from its uncleared swaps can be transmitted across
national borders to cause or contribute to substantial losses to U.S.
persons and threaten the stability of the entire U.S. financial system.
Complex financial and operational relationships among domestic and
international affiliates, including guarantees from U.S. entities at
entities like American International Group (AIG) and Lehman Brothers
Holding Inc., demonstrated how the transfer of risk across
multinational affiliated entities, including risk associated with
swaps, is not always transparent and can be difficult to fully assess.
More recent events, including major losses from J.P. Morgan Chase &
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Co.'s ``London Whale'' or the near failure of FCXM Inc. following
trading losses at its London and Singapore affiliates, illustrate the
continued potential for cross-border activities to have a significant
impact on U.S. entities and markets.
The global nature of the swap market, coupled with the
interconnectedness of market participants, also necessitate that the
Commission recognize the supervisory interests of foreign regulatory
authorities and consider the impact of its choices on market efficiency
and competition, which are vital to a well-functioning global swap
market.\17\ Foreign jurisdictions are at various stages of implementing
margin reforms. To the extent that other jurisdictions adopt
requirements with different coverage or timelines, the Commission's
margin requirements may lead to competitive burdens for U.S. entities
and deter non-U.S. persons from transacting with U.S. CSEs and their
affiliates overseas. The Commission's substituted compliance regime--a
central element of the Final Rule--is intended to address these
concerns without compromising the congressional mandate to protect the
safety and soundness of CSEs and the stability of the U.S. financial
system.
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\17\ In determining the extent to which the Dodd-Frank swap
provisions apply to activities overseas, the Commission strives to
protect U.S. interests, as determined by Congress in Title VII, and
minimize conflicts with the laws of other jurisdictions, consistent
with principles of international comity. See Guidance, 78 FR at
45300-01 (referencing the Restatement (Third) of Foreign Relations
Law of the United States).
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Substituted compliance has long been a central element of the
Commission's cross-border policy.\18\ It is an approach that recognizes
that market participants in a globalized swap market are subject to
multiple regulators and potentially face duplicative or conflicting
regulations. Under the Final Rule's substituted compliance regime, the
Commission would, under certain circumstances, allow a CSE to satisfy
the Commission's margin requirements by instead complying with the
margin requirements in the relevant foreign jurisdiction. Substituted
compliance helps preserve the benefits of an integrated, global swap
market by reducing the degree to which market participants will be
subject to multiple sets of regulations. Further, substituted
compliance encourages collaboration and coordination among U.S. and
foreign regulators in establishing robust regulatory standards for the
global swap market.
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\18\ For example, under part 30 of the Commission's regulations,
if the Commission determines that the foreign regulatory regime
would offer comparable protection to U.S. customers transacting in
foreign futures and options and there is an appropriate information-
sharing arrangement between the home supervisor and the Commission,
the Commission has permitted foreign brokers to comply with their
home regulations (in lieu of the applicable Commission regulations),
subject to appropriate conditions. See, e.g., Foreign Futures and
Options Transactions, 67 FR 30785 (May 8, 2002); Foreign Futures and
Options Transactions, 71 FR 6759 (Feb. 9, 2006).
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The Commission is mindful of the challenges involved in
implementing a substituted compliance framework for margin. If
implemented properly, substituted compliance has the potential to
enhance market efficiency and liquidity and foster global coordination
of margin requirements without compromising the safety and soundness of
CSEs and the U.S. financial system. However, if substituted compliance
were extended to foreign jurisdictions that do not have adequate
oversight or protections with regard to uncleared swaps, the
effectiveness of the Commission's margin requirements could be
undermined, importing additional risk into the financial system. The
Commission therefore believes that close coordination with its foreign
counterparts is essential to ensuring that the benefits of substituted
compliance are achieved.
Consistent with the congressional mandate to coordinate rules ``to
the maximum extent practicable,'' \19\ in developing the Final Rule,
Commission staff worked closely with staff of the Prudential Regulators
to align the Final Rule with the cross-border framework in the
Prudential Regulators' Final Margin Rule.\20\ Aligning with the
Prudential Regulators' cross-border margin rule is particularly
important given the composition of the global swap market.\21\
Currently, approximately 106 swap dealers and major swap participants
are provisionally registered with the Commission. Of those entities, an
estimated 54 are CSEs subject to the Commission's margin rules, with
the remaining 52 entities falling within the scope of the Prudential
Regulators' margin rules. Of the 54 CSEs subject to the Commission's
margin requirements, approximately 33 CSEs are affiliated with a
prudentially-regulated swap entity. Therefore, substantial differences
between the Commission's and Prudential Regulators' cross-border
regulations could lead to competitive disparities between affiliates
within the same corporate structure, leading to market inefficiencies
and incentives to restructure their businesses in order to avoid the
more stringent cross-border margin framework.
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\19\ See 7 U.S.C. 6s(e)(3)(D)(ii).
\20\ See Prudential Regulators' Final Margin Rule, 80 FR 74840.
The cross-border provision is section __.9 of the Prudential
Regulators' Final Margin Rule and is substantially similar to the
Commission's Final Rule.
\21\ The Securities and Exchange Commission (``SEC'') has not
yet finalized similar rules imposing margin requirements for
security-based swap dealers and major security-based swap
participants. The SEC proposed its margin rule in October 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).
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In granting the Commission new authority over swaps under the Dodd-
Frank Act, Congress also called for coordination and cooperation with
foreign regulatory authorities.\22\ Consistent with that mandate, and
building on international efforts to develop a global margin
framework,\23\ the Commission closely consulted with its foreign
counterparts in developing the Final Rule. As other jurisdictions
finalize their margin rules and the Commission implements its cross-
border margin framework, the Commission is committed to continuing to
coordinate with foreign regulators, with a view toward mitigating any
conflicting or otherwise substantially divergent margin requirements
for uncleared swaps across jurisdictions.
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\22\ 15 U.S.C. 8325(a) (added by section 752 of the Dodd-Frank
Act).
\23\ In October 2011, the Basel Committee on Banking Supervision
(``BCBS'') and the International Organization of Securities
Commissions (``IOSCO''), in consultation with the Committee on
Payment and Settlement Systems (``CPSS'') and the Committee on
Global Financial Systems (``CGFS''), formed a Working Group on
Margining Requirements (``WGMR'') to develop international standards
for margin requirements for uncleared swaps. Representatives of 26
regulatory authorities participated, including the Commission. In
September 2013, the WGMR published a final report articulating eight
key principles for non-cleared derivatives margin rules. These
principles represent the minimum standards approved by BCBS and
IOSCO and their recommendations to the regulatory authorities in
member jurisdictions. See BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (updated March 2015) (``BCBS/IOSCO
framework''), available at http://www.bis.org/bcbs/publ/d317.pdf.
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II. The Final Rule
The Commission is adopting rules regarding how the Commission's
margin requirements will apply to cross-border uncleared swaps. Broadly
speaking, the final cross-border framework is designed to address the
risks to a CSE, as an entity, associated with its uncleared swaps,
consistent with CEA section 2(i) \24\ and the statutory objectives of
the margin requirements. As discussed above, section 4s(e) was enacted
to address the risks to CSEs and to the U.S. financial system arising
from uncleared swaps. The source of risk to a CSE is not confined to
its uncleared
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swaps with U.S. counterparties or to swaps transacted within the United
States. Risk arising from uncleared swaps involving non-U.S.
counterparties can potentially have a substantial adverse effect on a
CSE and therefore the stability of the U.S. financial system.
Nevertheless, certain categories of uncleared swaps will be eligible
for substituted compliance or the Exclusion based on the Commission's
consideration of comity principles and the impact of the Final Rule on
market efficiency and competition.
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\24\ See 7 U.S.C. 2(i).
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The sections that follow summarize, as appropriate, the approach
taken in the proposed rule, the comments received in response, and the
resulting Final Rule. Section A discusses certain key definitions
(``U.S. person,'' ``guarantee,'' and ``Foreign Consolidated
Subsidiary'' or ``FCS'') in the Final Rule, which inform how the
Commission's margin requirements apply to market participants in the
cross-border context. Section B describes the cross-border application
of the Commission's margin requirements, including the circumstances
under which substituted compliance and the limited Exclusion are
available and the application of two special provisions designed to
accommodate swap activities in jurisdictions that do not have a legal
framework to support custodial arrangements and netting in compliance
with the Final Margin Rule (``non-segregation jurisdictions'' \25\ and
``non-netting jurisdictions,'' respectively).\26\ Section C describes
the Commission's framework for issuing comparability determinations.
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\25\ As used in this release, a ``non-segregation jurisdiction''
is a jurisdiction where inherent limitations in the legal or
operational infrastructure of the foreign jurisdiction make it
impracticable for the CSE and its counterparty to post initial
margin pursuant to custodial arrangements that comply with the Final
Margin Rule, as further described in section II.B.4.b.
\26\ As used in this release, a ``non-netting jurisdiction'' is
a jurisdiction in which a CSE cannot conclude, with a well-founded
basis, that the netting agreement with a counterparty in that
foreign jurisdiction meets the definition of an ``eligible master
netting agreement'' set forth in the Final Margin Rule, as described
in section II.B.5.b.
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As a preliminary matter, the Commission notes that several
commenters requested Commission action outside the scope of the Final
Rule, including modifications to the substantive margin requirements
\27\ or the Guidance.\28\ The Commission notes that concerns regarding
the general nature and application of the initial and variation margin
requirements were addressed in the Final Margin Rule. Notably, the
Final Margin Rule included substantial modifications from the Proposed
Margin Rule that further aligned the Commission's margin requirements
with the BCBS-IOSCO framework, which should further reduce the
potential for conflicts with the margin requirements of foreign
jurisdictions.\29\ With respect to the Guidance, the Commission
reiterates its intention to periodically review its cross-border policy
in light of future developments, including its experience following
adoption of the Final Rule.\30\
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\27\ See, e.g., ACLI at 2-3 (Commission should defer to
International Standards with respect to acceptable forms of
collateral for margin); FMS-WM at 1-2 (legacy portfolio entity
backed by full faith and credit of sovereign government should be
considered a ``sovereign entity'' within scope of Commission's
margin requirements); ISDA at 14-15 (inter-affiliate swaps should be
exempt from initial margin requirements and accounting standards to
determine consolidation should be applied throughout margin rules);
JBA at 6 (Commission should work with foreign counterparts to
harmonize aspects of its margin rules, including treatment of
``legacy trades,'' inter-affiliate trades, and forms of eligible
collateral); LCH.Clearnet at 4 (differences in approach to margin
requirements between cleared and uncleared swaps should promote
central clearing).
\28\ See, e.g., AFR at 2 (adopting cross-border approach to
margin alone would create ``serious problems''); AIMA/IA at 4
(Commission should amend Guidance to include U.S. person definition
in the proposed rule); Better Markets at 6 (adopting cross-border
approach to margin alone would be ``a disservice to the
comprehensive existing Guidance;'' should instead make ``targeted,
limited changes'' to Guidance); ICI Global at 7-8 (one U.S. person
definition should apply consistently with respect to cross-border
application of all swap requirements); IIB/SIFMA at 17-19 (proposed
U.S. person and guarantee definitions should replace corresponding
interpretations in Guidance); ISDA at 12 (same); JBA at 11-12
(same); SIFMA AMG at 4, 9-13 (same); Vanguard at 5 (same).
\29\ For example, the Final Margin Rule raised the material
swaps exposure level from $3 billion to the BCBS-IOSCO standard of
$8 billion, which reduces the number of entities that must collect
and post initial margin. See Final Margin Rule, 81 FR at 644. In
addition, the definition of uncleared swaps was broadened to include
DCOs that are not registered with the Commission but pursuant to
Commission orders are permitted to clear for U.S. persons. See id.
at 638.
\30\ See Guidance, 78 FR at 45297. See also United States v.
Edge Broadcasting Co., 509 U.S. 418, 434 (1993) (``[A]n agency does
not have to make progress on every front before it can make progress
on any front.''). See also Personal Watercraft Indus. Ass'n v. Dep't
of Commerce, 48 F.3d 540, 544 (D.C. Cir. 1995).
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Commenters also requested that the Commission delay the cross-
border application of its margin rules until after it has made
comparability determinations.\31\ Although the Commission declines to
establish an open-ended delay in applying its margin rules, it remains
committed to coordinating with foreign regulators to implement its
cross-border margin framework in a workable manner.
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\31\ See, e.g., ABA/ABASA at 3 (``sufficient time'' for foreign
jurisdictions to adopt margin rules); AIMA/IA at 3 (``sufficient
time'' to reach agreement with foreign counterparts); ISDA at 16-17
(12 months after margin rules are finalized in U.S., EU, and Japan,
or two-year ``transitional comparability determination,'' providing
substituted compliance for all foreign jurisdictions that adopt
rules based on BCBS-IOSCO framework, while Commission undertakes
comparability analysis); JBA at 3, 4 (at least 18 months after
margin rules are finalized in the U.S., EU, and Japan);
PensionsEurope at 3 (12-18 months); SIFMA AMG at 4, 14-15 (at least
18 months).
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A. Key Definitions
The extent to which substituted compliance and the Exclusion are
available depends on whether the relevant swap involves a U.S. person,
a guarantee by a U.S. person, or a ``Foreign Consolidated Subsidiary''
(or ``FCS''). The Final Rule adopts definitions of ``U.S. person,''
``guarantee,'' and ``Foreign Consolidated Subsidiary'' solely for
purposes of the margin rules. These definitions are discussed below.
1. U.S. Person
Under the Final Rule, the term ``U.S. person'' is defined to
include individuals or entities whose activities have a significant
nexus to the U.S. market as a result of their being domiciled or
organized in the United States or by virtue of the strength of their
connection to the U.S. markets, even if they are domiciled or organized
outside the United States. As discussed in section II.B.2.b.i. below,
U.S. CSEs \32\ are generally subject to the margin rules with only
partial substituted compliance and are not eligible for the Exclusion.
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\32\ See 17 CFR 23.160(a)(8) (defining ``U.S. CSE'' as a CSE
that is a ``U.S. person,'' as defined in the Final Rule). See also
17 CFR 23.160(a)(4) (defining ``non-U.S. CSE'' as a CSE that is not
a U.S. person).
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a. Proposed Rule
In the proposed rule, the term ``U.S. person'' was defined to mean
the following:
Any natural person who is a resident of the United States
(proposed Sec. 23.160(a)(10)(i));
Any estate of a decedent who was a resident of the United
States at the time of death (proposed Sec. 23.160(a)(10)(ii));
Any corporation, partnership, limited liability company,
business or other trust, association, joint-stock company, fund or any
form of entity similar to any of the foregoing (other than an entity as
described in paragraph (a)(10)(iv) or (v) of proposed Sec. 23.160) (a
legal entity), in each case that is organized or incorporated under the
laws of the United States or that has its principal place of business
in the United States, including any branch of
[[Page 34822]]
the legal entity (proposed Sec. 23.160(a)(10)(iii));
Any pension plan for the employees, officers or principals
of a legal entity as described in paragraph (a)(10)(iii) of proposed
Sec. 23.160, unless the pension plan is primarily for foreign
employees of such an entity (proposed Sec. 23.160(a)(10)(iv));
Any trust governed by the laws of a state or other
jurisdiction in the United States, if a court within the United States
is able to exercise primary supervision over the administration of the
trust (proposed Sec. 23.160(a)(10)(v));
Any legal entity (other than a limited liability company,
limited liability partnership or similar entity where all of the owners
of the entity have limited liability) owned by one or more persons
described in paragraphs (a)(10)(i) through (v) of proposed Sec. 23.160
who bear(s) unlimited responsibility for the obligations and
liabilities of the legal entity, including any branch of the legal
entity (proposed Sec. 23.160(a)(10)(vi)); and
Any individual account or joint account (discretionary or
not) where the beneficial owner (or one of the beneficial owners in the
case of a joint account) is a person described in paragraphs (a)(10)(i)
through (vi) of proposed Sec. 23.160 (proposed Sec.
23.160(a)(10)(vii)).\33\
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\33\ See proposed 17 CFR 23.160(a)(10). See also proposed 17 CFR
23.160(a)(5) (defining ``non-U.S. person'' as any person that is not
a ``U.S. person'').
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The Commission explained that, as indicated in paragraphs (iii) and
(vi) of the proposed rule, a legal entity's status as a U.S. person
would be determined at the entity level and would therefore include a
foreign branch of a U.S. person.\34\ An affiliate or subsidiary of a
U.S. person that is organized or incorporated outside the United
States, however, would not be deemed a ``U.S. person'' solely by virtue
of its affiliation with the U.S. person.\35\ The Commission also stated
that a swap counterparty should generally be permitted to reasonably
rely on its counterparty's written representation with regard to its
status as a U.S. person.\36\
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\34\ See Proposal, 80 FR at 41383 (stating that the definition
includes any foreign operations that are part of the U.S. legal
person, regardless of their location); proposed 17 CFR 23.160
(a)(10)(iii), (vi) (defining such U.S. persons to include ``any
branch of the legal entity'').
\35\ See Proposal, 80 FR at 41383 (explaining that the status of
a legal person as a U.S. person would not affect whether a
separately incorporated or organized legal person in the affiliated
corporate group is a U.S. person).
\36\ See id. (recognizing that the information necessary to
accurately assess a counterparty's U.S. person status may be
available only through overly burdensome due diligence).
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The proposed rule was generally consistent with the U.S. person
interpretation set forth in the Guidance, with certain exceptions.\37\
Notably, the proposed rule did not define ``U.S. person'' to include a
commodity pool, pooled account, investment fund, or other collective
investment vehicle that is majority-owned by one or more U.S. persons
(the ``U.S. majority-owned fund prong'').\38\ The proposed rule also
did not include a catchall provision, thereby limiting the definition
of ``U.S. person'' for purposes of the margin rule to persons
enumerated in the rule.\39\ Finally, paragraph (vi) of the proposed
rule (the ``unlimited U.S. responsibility prong'') represented a
modified version of a similar concept from the Guidance, which
interprets ``U.S. person'' to include a legal entity ``directly or
indirectly majority-owned'' by one or more U.S. person(s) that bear
unlimited responsibility for the legal entity's liabilities and
obligations.\40\
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\37\ See Proposal, 80 FR at 41382-84. See also Guidance, 78 FR
at 45308-17 (setting forth the interpretation of ``U.S. person'' for
purposes of the Guidance).
\38\ See Proposal, 80 FR at 41383. See also Guidance, 78 FR
45313-14 (discussing the U.S. majority-ownership prong for purposes
of the Guidance). The Guidance interpreted ``majority-owned'' in
this context to mean the beneficial ownership of more than 50
percent of the equity or voting interests in the collective
investment vehicle. See id. at 45314.
\39\ See Proposal, 80 FR at 41383. See also Guidance, 78 FR at
45316 (discussing the inclusion of the prefatory phrase ``include,
but not be limited to'' in the interpretation of ``U.S. person'' in
the Guidance).
\40\ See Proposal, 80 FR at 41383. See also Guidance, 78 FR at
45312-13 (discussing the unlimited U.S. responsibility prong for
purposes of the Guidance).
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The Commission requested comment on all aspects of the proposed
definition of ``U.S person,'' including whether the definition should
include a U.S. majority-owned fund prong or an unlimited U.S.
responsibility prong and whether it should be identical to the U.S.
person definition adopted by the SEC.\41\
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\41\ See Proposal, 80 FR at 41384. See also 17 CFR 240.3a71-
3(a)(4) (setting forth the definition of ``U.S. person'' adopted by
the SEC for purposes of security-based swap regulation).
---------------------------------------------------------------------------
b. Comments
In general, commenters raised few objections to the proposed ``U.S.
person'' definition. Nearly all commenters supported the absence of a
U.S. majority-owned fund prong,\42\ and several expressly supported the
absence of a catchall provision.\43\ With respect to the U.S. majority-
owned funds prong, commenters argued that U.S. ownership alone is not
indicative of whether a fund's activities have a direct and significant
effect on the U.S. financial system \44\ and that identifying and
tracking a fund's beneficial ownership may pose a significant challenge
in certain circumstances.\45\ Commenters added that characterizing such
U.S. majority-owned funds as U.S. persons may lead to duplicative
margin requirements because such funds will likely also be subject to
foreign regulation.\46\
---------------------------------------------------------------------------
\42\ See e.g., AIMA/IA at 3-4; FSR at 2, 8; IATP at 4; IIB/SIFMA
at 18; ISDA at 12; JBA at 11; MFA at 3, 5-6; SIFMA AMG at 10,
Vanguard at 5.
\43\ See e.g., IIB/SIFMA at 17; ISDA at 12 (the absence the
prefatory phrase ``includes, but is not limited to'' would
``increase legal certainty''); SIFMA AMG at 10-11.
\44\ See e.g., AIMA/IA at 3; FSR at 8; IATP at 4; IIB/SIFMA at
18 (fund owners are not direct counterparties to swap and their risk
of loss is limited to extent of their investment in the fund); MFA
at 6.
\45\ See e.g., AIMA/IA at 3-4 (highlighting challenges presented
by nominee accounts); IATP at 4 (ownership can be complex and
variable over the life of a fund); IIB/SIFMA at 18 (highlighting
challenges associated with funds formed before adoption of
Guidance); SIFMA AMG at 10. But see MFA at 5-6 (funds organized or
having a principal place of business in the United States are
properly included in the U.S. person definition).
\46\ See AIMA/IA at 4 (``comparable foreign rules'' will apply
to limit the likelihood and impact of a counterparty default); FSR
at 8 (neither SEC nor EU regulators have proposed exercising
jurisdiction over an entity on the basis of majority control); ISDA
at 12 (neither BCBS-IOSCO framework nor proposed EU rules impose
rules on funds based on jurisdiction of its owners).
---------------------------------------------------------------------------
A few commenters, however, requested changes regarding the
unlimited U.S. responsibility prong. ISDA and JBA recommended that,
consistent with the Guidance, the Commission require that the U.S.
person(s) bearing unlimited responsibility for the obligations and
liabilities of the legal entity have a majority ownership stake in the
entity. ISDA argued broadly that, to avoid confusion and regulatory
overlap, legal entities that have multiple owners with unlimited
liability for the obligations and liabilities of the legal entity
should only be subject to the jurisdiction of the majority owner.\47\
JBA argued that the definition should be consistent with the Guidance
in order to avoid the possibility that the Commission's margin
requirements would apply to a ``broader scope of U.S. persons relative
to other swap regulations.'' \48\ IIB/SIFMA requested that the
unlimited U.S. responsibility prong be removed altogether, arguing that
unlimited responsibility is ``largely equivalent'' to a guarantee and
should therefore be afforded the same treatment.\49\
---------------------------------------------------------------------------
\47\ See ISDA at 12.
\48\ See JBA at 11-12.
\49\ See IIB/SIFMA at 17-18 (while guarantor may have legal
defenses to enforcement of guarantee, both U.S. guarantee and
unlimited U.S. responsibility prong create risk to U.S. persons only
to the extent that legal entity incurs losses and fails to perform
obligations).
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[[Page 34823]]
Commenters also made certain other recommendations to further
conform the U.S. person definition to the interpretation of ``U.S.
person'' in the Guidance.\50\ ICI Global, SIFMA AMG, and Vanguard
requested that the Commission confirm that, as indicated in the
Guidance, a pool, fund or other collective investment vehicle that is
publicly offered only to non-U.S. persons and not offered to U.S.
persons would not fall within the scope of the U.S. person
definition.\51\ SIFMA AMG also added that language in paragraphs (iii)
and (vi) specifying that a legal entity deemed a U.S. person would
include ``any branch of the legal entity'' was unnecessarily
confusing.\52\
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\50\ As indicated above, several commenters recommended
generally that the Commission establish a uniform definition of
``U.S. person'' that would apply both in the context of the cross-
border application of the margin rules and with respect to the other
swaps regulatory topics covered by the Guidance. See supra note 28.
\51\ See ICI Global at 5-7 (clarification is necessary to avoid
imposing Dodd-Frank Act swap provisions on entities that only have
``nominal nexus'' to United States); SIFMA AMG at 10-12
(reclassifying such funds as U.S. persons solely for purposes of
margin rule would be extremely complicated and burdensome for asset
managers and their clients); Vanguard at 5. See also Guidance, 78 FR
at 45314 (providing that a collective investment vehicle that is
publicly offered only to non-U.S. persons and not offered to U.S.
persons generally would not fall within any of the prongs of the
``U.S. person'' interpretation in the Guidance).
\52\ SIFMA AMG at 12 (such language, which is not present in
corresponding prongs of U.S. person interpretation in Guidance,
could ``cause confusion in terms of whether a person having any
branches in the United States needs to take into account its U.S.
person status, including in assessing the entity's principal place
of business'').
---------------------------------------------------------------------------
Finally, FSR and JBA requested that, in the interest of harmonizing
margin requirements and reducing compliance costs, the Commission
should, consistent with the SEC's cross-border rules, exclude from the
U.S. person definition certain designated international
organizations.\53\ IATP argued, however, that such exclusion would be
either unnecessary or inappropriate.\54\
---------------------------------------------------------------------------
\53\ See FSR at 8; JBA at 12 (while international financial
institutions ``are invested by the U.S. government, financial
institutions generally separate them from the U.S. country risk in
evaluating their credit risk in practice''). See also 17 CFR
240.3a71-3(a)(4)(iii) (defining ``U.S. person'' for purposes of the
SEC's regulation of security-based swaps to exclude the
International Monetary Fund, the International Bank for
Reconstruction and Development, the Inter-American Development Bank,
the Asian Development Bank, the African Development Bank, the United
Nations, and their agencies and pension plans, and any other similar
international organizations, their agencies and pension plans).
\54\ See IATP at 4 (intergovernmental organizations should
``voluntarily practice'' the margin requirements in order to
``realize the objectives of the [sic] intergovernmental investment
charters'').
---------------------------------------------------------------------------
c. Final Rule
The Final Rule defines ``U.S. person'' as proposed, but the
Commission is providing some additional clarifications in response to
commenters. As stated in the Proposal, the definition generally follows
a traditional, territorial approach to defining a U.S. person, and the
Commission believes that this definition offers a clear, objective
basis for determining those individuals or entities that should be
identified as U.S. persons.
Under the Final Rule, a legal person's status as a U.S. person is
determined at the entity level and therefore includes any foreign
operations that are part of the legal person, regardless of their
location. Consistent with this approach, the definition includes any
foreign branch of a U.S. person.\55\ The status of a legal entity as a
U.S. person would not generally affect whether a separately
incorporated or organized legal entity in the affiliated corporate
group is a U.S. person. Therefore, an affiliate or a subsidiary of a
U.S. person that is organized or incorporated in a non-U.S.
jurisdiction would not be deemed a U.S. person solely by virtue of
being affiliated with a U.S. person.\56\
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\55\ The Commission clarifies that the inclusion of ``any branch
of the legal entity'' in sections 23.160(a)(10)(iii) and (vi) of the
Final Rule is intended to make clear that the definition includes
both foreign and U.S. branches of an entity and does not introduce
any additional criteria for determining an entity's U.S. person
status.
\56\ See also 17 CFR 23.160(a)(5) (defining ``non-U.S. person''
as any person that is not a U.S. person).
---------------------------------------------------------------------------
Sections 23.160(a)(10)(i) through (v) and (vii) of the Final Rule
identify certain persons as U.S. persons by virtue of being domiciled
or organized in the United States. The Commission has traditionally
looked to where a legal entity is organized or incorporated (or, in the
case of a natural person, where he or she resides) to determine whether
it is a U.S. person.\57\ Persons domiciled or organized in the United
States are likely to have significant financial and legal relationships
in the United States and are therefore appropriately included within
the definition of ``U.S. person.''
---------------------------------------------------------------------------
\57\ See, e.g., 17 CFR 4.7(a)(1)(iv) (defining ``Non-United
States person'' for purposes of part 4 of the Commission
regulations, which applies to commodity pool operators).
---------------------------------------------------------------------------
Consistent with this traditional approach, section
23.160(a)(10)(iii) of the Final Rule includes persons that are
organized or incorporated outside the United States but have their
principal place of business in the United States. For purposes of this
section, the Commission interprets ``principal place of business'' to
mean the location from which the officers, partners, or managers of the
legal person primarily direct, control, and coordinate the activities
of the legal person. This interpretation is consistent with the Supreme
Court's decision in Hertz Corp. v. Friend, which described a
corporation's principal place of business, for purposes of diversity
jurisdiction, as the ``place where the corporation's high level
officers direct, control, and coordinate the corporation's
activities.'' \58\
---------------------------------------------------------------------------
\58\ 559 U.S. 77, 80 (2010).
---------------------------------------------------------------------------
The Commission is of the view that determining the principal place
of business of an investment fund may require consideration of
additional factors beyond those applicable to operating companies. In
the case of a fund, the senior personnel that direct, control, and
coordinate a fund's activities are generally not the named directors or
officers of the fund but rather persons employed by the fund's
investment adviser or the fund's promoter. Therefore, consistent with
the Guidance, the Commission would generally consider the principal
place of business of a fund to be in the United States if the senior
personnel responsible for either (1) the formation and promotion of the
fund or (2) the implementation of the fund's investment strategy are
located in the United States, depending on the facts and circumstances
that are relevant to determining the center of direction, control and
coordination of the fund.\59\
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\59\ See Guidance, 78 FR at 45309-12 (providing guidance on
application of the principal place of business test to funds and
other collective investment vehicles in the context of cross-border
swaps, including examples of how the Commission's approach could
apply to a consideration of whether the ``principal place of
business'' of a fund is in the United States in particular
hypothetical situations). Note that the examples included in the
Guidance are for illustrative purposes only and do not purport to
address all potential variations in the structure of collective
investment vehicles or all factors relevant to determining whether a
collective investment vehicle's principal place of business is in
the United States.
---------------------------------------------------------------------------
Section 23.160(a)(10)(vi) of the Final Rule defines ``U.S. person''
to include certain legal entities owned by one or more U.S. person(s)
and for which such person(s) bear unlimited responsibility for the
obligations and liabilities of the legal entity.\60\ In such cases, the
U.S.
[[Page 34824]]
person owner(s) serve as a financial backstop for all of the legal
entity's obligations and liabilities. Creditors and counterparties
accordingly look to the U.S. person owner(s) when assessing the risk of
dealing with the entity.\61\ Because the U.S. person owner(s)'
responsibility is unlimited, the amount of equity the U.S. owner(s)
have in the legal entity would not be relevant.
---------------------------------------------------------------------------
\60\ The Commission does not view the unlimited U.S.
responsibility prong as equivalent to a U.S. guarantee (as
``guarantee'' is defined in the Final Rule). As stated in the
Guidance, a guarantee does not necessarily provide for ``unlimited
responsibility for the obligations and liabilities of the guaranteed
entity'' in the same sense that the owner of an unlimited liability
corporation bears such unlimited liability. See 78 FR at 45312.
\61\ By extension, by virtue of their unlimited responsibility
for the legal entity's swap obligations, the U.S. person owner(s)
have an interest in the swap activities of the legal entity to the
same extent as if the swap activities were conducted by the U.S.
person directly.
---------------------------------------------------------------------------
In line with the proposed rule, the Final Rule does not include a
U.S. majority-owned funds prong. Although the U.S. owners of such funds
may be adversely impacted in the event of a counterparty default, the
Commission believes that, on balance, the majority-ownership test
should not be included in the definition of U.S. person for purposes of
the margin rules. Non-U.S. funds with U.S. majority-ownership, even if
treated as a non-U.S. person, are excluded from the Commission's margin
rules only in limited circumstances (namely, when these funds transact
with a non-U.S. CSE that is not a consolidated subsidiary of a U.S.
entity or a U.S. branch of a non-U.S. CSE). This result, coupled with
the implementation issues raised by commenters, persuade the Commission
that including a U.S. majority-owned funds prong in the scope of the
``U.S. person'' definition would not be appropriate for purposes of the
margin rules.\62\ The Final Rule's U.S. person definition also does not
include the prefatory phrase ``includes, but is not limited to'' that
was included in the Guidance. As stated in the proposed rule, the
Commission believes that this catchall should not be included in order
to provide legal certainty regarding the application of U.S. margin
requirements to cross-border swaps.
---------------------------------------------------------------------------
\62\ Such a fund may nevertheless be a U.S. person by virtue of
fitting within the scope of Sec. 23.160(a)(10)(iii) (entities
organized or having a principal place of business in the United
States). In response to commenters, the Commission further clarifies
that whether a pool, fund or other collective investment vehicle is
publicly offered only to non-U.S. persons and not offered to U.S.
persons would not be relevant in applying Sec. 23.160(a)(10)(iii).
---------------------------------------------------------------------------
The Commission notes that, as discussed in the proposed rule, the
Final Rule defines ``U.S. person'' in a manner that is substantially
similar to the definition used by the SEC in the context of cross-
border regulation of security-based swaps.\63\ The Commission further
believes that any differences, such as the inclusion of an unlimited
U.S. responsibility prong, are necessary and appropriate in the context
of the cross-border application of margin requirements for uncleared
swaps, for the reasons discussed above.\64\ With respect to the
designated international organizations excluded from the SEC's U.S.
person definition, the Commission notes that a similar exclusion is
unnecessary in the context of the cross-border application of the
Commission's margin rules, given that such entities are generally
considered non-financial end users under the Final Margin Rule and are
therefore unaffected by application of the margin requirements for
uncleared swaps.\65\
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\63\ See Proposal, 80 FR at 41382 n.46 (discussing the SEC's
``U.S. person'' definition for purposes of security-based swap
regulation).
\64\ The SEC does not include the U.S. responsibility prong in
its U.S. person definition, but instead treats a legal entity where
one or more U.S. person(s) bears unlimited responsibility for the
obligations and liabilities of the legal entity as a non-U.S. person
with a guarantee. The Commission believes that, for the reasons
stated above, these entities should be included as a U.S. person
rather than being treated as a non-U.S. person with a guarantee for
purposes of the margin requirements for uncleared swaps.
\65\ Under the Final Margin Rule, the following international
organizations are expressly considered non-financial end users: (1)
The International Bank for Reconstruction and Development; (2) The
Multilateral Investment Guarantee Agency; (3) The International
Finance Corporation; (4) The Inter-American Development Bank; (5)
The Asian Development Bank; (6) The African Development Bank; (7)
The European Bank for Reconstruction and Development; (8) The
European Investment Bank; (9) The European Investment Fund; (10) The
Nordic Investment Bank; (11) The Caribbean Development Bank; (12)
The Islamic Development Bank; (13) The Council of Europe Development
Bank; and (14) Any other entity that provides financing for national
or regional development in which the U.S. government is a
shareholder or contributing member or which the Commission
determines poses comparable credit risk). See 17 CFR 23.151
(defining ``financial end user,'' ``non-financial end user,'' and
``multilateral development bank''). Under the Final Margin Rule,
CSEs are not required to exchange margin with non-financial end
users.
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2. Guarantees
Under the Final Rule, the term ``guarantee'' is defined to include
arrangements, pursuant to which one party to an uncleared swap has
rights of recourse against a guarantor, with respect to its
counterparty's obligations under the uncleared swap. As discussed in
section II.B.2.b.i. below, non-U.S. CSEs whose obligations under the
relevant swap are guaranteed by a U.S. person (``U.S. Guaranteed
CSEs'') \66\ are eligible for substituted compliance to the same extent
as U.S. CSEs and are similarly ineligible for the Exclusion.
---------------------------------------------------------------------------
\66\ This release uses the term ``U.S. Guaranteed CSE'' for
convenience only. Whether a non-U.S. CSE falls within the meaning of
the term ``U.S. Guaranteed CSE'' varies on a swap-by-swap basis,
such that a non-U.S. CSE may be considered a U.S. Guaranteed CSE for
one swap and not another, depending on whether the non-U.S. CSE's
obligations under such swap are guaranteed by a U.S. person.
---------------------------------------------------------------------------
a. Proposed Rule
The proposed rule defined the term ``guarantee'' as an arrangement
pursuant to which one party to a swap with a non-U.S. counterparty has
rights of recourse against a U.S. person, with respect to the non-U.S.
counterparty's obligations under the swap. The proposed rule defined
``rights of recourse'' as a conditional or unconditional legally
enforceable right to receive or otherwise collect payment, in whole or
in part. An arrangement would constitute a ``guarantee'' regardless of
whether the rights of recourse were conditioned upon the non-U.S.
counterparty's insolvency or failure to meet its obligations under the
relevant swap or whether the counterparty seeking to enforce the
guarantee is required to make a demand for payment or performance from
the non-U.S. counterparty before proceeding against the U.S. guarantor.
The Commission requested comment on all aspects of its proposed
definition of ``guarantee,'' including whether it would be appropriate
to distinguish guarantee arrangements with a legally enforceable right
of recourse from those without direct recourse.\67\
---------------------------------------------------------------------------
\67\ See Proposal, 80 FR at 41385.
---------------------------------------------------------------------------
b. Comments
Most commenters supported the proposed definition of ``guarantee.''
\68\ Commenters generally preferred it to the broader interpretation of
``guarantee'' in the Guidance, which includes other types of financial
arrangements and support (e.g., keepwell agreements and liquidity
puts),\69\ and agreed that it would promote legal certainty and lower
compliance costs as a result.\70\ IIB/SIFMA further argued the proposed
definition is appropriate in the margin context and consistent with CEA
section 2(i) because, absent such a legal relationship to a U.S.
person, a non-U.S. person would not have a sufficient connection with
activities in U.S. commerce to warrant the application of
[[Page 34825]]
U.S. margin rules.\71\ Commenters expressed concern, however, that
multiple ``guarantee'' definitions could lead to confusion and
recommended that the Commission apply the proposed ``guarantee''
definition throughout its cross-border policy.\72\
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\68\ See FSR at 2, 9; IATP at 5; IIB/SIFMA at 18-19; ISDA at 12;
JBA at 12; SIFMA AMG at 4, 13.
\69\ See IIB/SIFMA at 18-19; ISDA at 12; JBA at 12; SIFMA AMG at
13.
\70\ See IIB/SIFMA at 18-19; ISDA at 12 (interpretation of
``guarantee'' in Guidance requires facts-and-circumstances analysis
to determine whether arrangement supports a party's ability to pay
or perform under swap); JBA at 12; SIFMA AMG at 13 (expressing
approval that the proposed definition aligns with guarantee
definition adopted by SEC).
\71\ See IIB/SIFMA at 18-19. See also FSR at 9 (``transaction-
level'' swap risk would not transfer back to United States absent
right of recourse against a U.S. person and ``entity-level'' risk
would be captured by other regulatory requirements, such as capital
rules).
\72\ See ISDA at 12; JBA at 12; SIFMA AMG at 13.
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AFR and Better Markets opposed the proposed ``guarantee''
definition.\73\ Both expressed a preference for the broader
interpretation of ``guarantee'' in the Guidance and, like other
commenters, recommended that the term have one consistent meaning.\74\
AFR argued that both implicit guarantees, such as when a parent entity
faces reputational incentives to provide financial support for a
subsidiary, and other formal agreements that obligate a U.S. person to
provide financial support, create a direct and significant nexus to the
U.S. financial system and should be included within the scope of the
term ``guarantee.'' \75\ Accordingly, the proposed definition of
``guarantee'' may not fully capture the risk to the U.S. financial
markets.\76\ AFR suggested that the policy objective of increasing the
availability of substituted compliance in the margin context would be
better achieved by adopting the broad interpretation of ``guarantee''
in the Guidance and instead limiting the availability of substituted
compliance with respect to swaps involving an ``explicit recourse
guarantee.'' \77\
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\73\ AFR at 3, 5-7; Better Markets at 4.
\74\ See AFR at 3 (adopting different definition solely for
purposes of margin rules would not only complicate overall set of
cross-border rules, but establish an ``extremely poor precedent''
for narrowing guarantee concept in applying rest of Guidance);
Better Markets at 4 (proposed definition is ``less robust'' than
interpretation of guarantee in Guidance and should not be different
in margin context).
\75\ See AFR at 6.
\76\ See id.
\77\ See id. at 5-6.
---------------------------------------------------------------------------
c. Final Rule
The Final Rule defines ``guarantee'' for purposes of the cross-
border application of the Commission's margin rules to mean an
arrangement pursuant to which one party to an uncleared swap has rights
of recourse against a guarantor, with respect to its counterparty's
obligations under the uncleared swap.\78\ For these purposes, a party
to an uncleared swap has rights of recourse against a guarantor if the
party has a conditional or unconditional legally enforceable right to
receive or otherwise collect, in whole or in part, payments from the
guarantor with respect to its counterparty's obligations under the
uncleared swap. A counterparty has a right of recourse against a
guarantor even if the right of recourse is conditioned upon its
counterparty's insolvency or failure to meet its obligations under the
swap, and regardless of whether the counterparty seeking to enforce the
guarantee is first required to make a demand for payment or performance
from its counterparty before proceeding against the guarantor. Further,
the term ``guarantee'' applies equally regardless of whether the U.S.
guarantor is affiliated with either counterparty or is an unaffiliated
third party. In addition, the terms of the guarantee need not
necessarily be included within the swap documentation or even otherwise
reduced to writing, so long as a party to the swap has legally
enforceable rights of recourse under the laws of the relevant
jurisdiction.
---------------------------------------------------------------------------
\78\ See 17 CFR 23.160(a)(2).
---------------------------------------------------------------------------
The Final Rule's definition of guarantee is generally consistent
with the proposed rule's definition of guarantee, but reflects certain
changes that are intended to more closely align it with the definition
included in the Prudential Regulators' Final Margin Rule.\79\ Language
has been added to the Final Rule to address the concerns of the
Commission and Prudential Regulators that swaps could be structured in
a manner that would avoid application of the margin requirements to
swaps that are guaranteed by a U.S. person.\80\ Under this additional
language, the term ``guarantee'' also encompasses any arrangement
pursuant to which the guarantor itself has a conditional or
unconditional legally enforceable right to receive or otherwise
collect, in whole or in part, payments from any other guarantor with
respect to the counterparty's obligations under the uncleared swap.
Under the Final Rule, such arrangement will be deemed a guarantee of
the counterparty's obligations under the uncleared swap by the other
guarantor.
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\79\ The Final Rule also includes certain technical edits that
would not affect the substance of the rule as compared to the
proposed rule.
\80\ Based on this change to the definition of ``guarantee,''
the Final Rule differs from the proposed rule in that it treats
certain non-U.S. persons as if they were U.S. persons.
---------------------------------------------------------------------------
To illustrate, consider a swap between a non-U.S. CSE (``Party A'')
and a non-U.S. person (``Party B''). Party B's obligations under the
swap are guaranteed by a non-U.S. affiliate (``Party C''), who in turn
has a guarantee from its U.S. CSE parent entity on Party C's swap
obligations (``Parent D''). The Final Rule would deem a guarantee to
exist between Party B and Parent D with respect to Party B's
obligations under the swap with Party A.\81\
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\81\ This example is included for illustrative purposes only,
and is not intended to cover all examples of swaps that could be
affected by changes in the Final Rules.
---------------------------------------------------------------------------
The Commission is cognizant that many other financial arrangements
or support, other than a recourse guarantee as defined in the Final
Rule, may be provided by a U.S. person to a non-U.S. CSE. The
Commission acknowledges that these other financial arrangements or
support may transfer risk directly back to the U.S. financial system,
with possible significant adverse effects, in a manner similar to an
arrangement that is covered by the definition of a ``guarantee'' in the
Final Rule. However, the Commission believes that, in the context of
the Final Rule, non-U.S. CSEs benefitting from such other forms of U.S.
financial support will likely meet the definition of an FCS, a concept
included in the final margin rules adopted by the Prudential
Regulators, and thereby be adequately covered by the Commission's
margin requirements. In this way, the Commission believes that the
Final Rule achieves the dual goals of protecting the U.S. markets while
promoting a workable cross-border margin framework that closely tracks
the cross-border application of the Prudential Regulators' Final Margin
Rule.\82\
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\82\ The Commission has determined that using the term
``explicit recourse guarantee'' in lieu of the broader ``guarantee''
would, in light of the Prudential Regulators' use of the comparable
term ``guarantee,'' likely only cause confusion without making any
substantive difference with respect to the cross-border application
of the Commission's margin requirements.
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3. Foreign Consolidated Subsidiary (``FCS'')
Under the Final Rule, the term ``Foreign Consolidated Subsidiary''
identifies non-U.S. CSEs that are consolidated for accounting purposes
with an ultimate parent entity that is a U.S. person (a ``U.S. ultimate
parent entity''). As further discussed in section II.B.2.b.ii. below,
substituted compliance would be broadly available to an FCS to the same
extent as any other non-U.S. CSE, but such an FCS would not be eligible
for the Exclusion.
a. Proposed Rule
The proposed rule defined a ``Foreign Consolidated Subsidiary'' as
a non-U.S. CSE in which an ``ultimate parent entity'' \83\ that is a
U.S. person has a
[[Page 34826]]
controlling interest, in accordance with U.S. generally accepted
accounting principles (``U.S. GAAP'') such that the U.S. ultimate
parent entity includes the non-U.S. CSE's operating results, financial
position and statement of cash flows in its consolidated financial
statements, in accordance with U.S. GAAP.\84\ The Commission explained
that the fact that an entity is included in the consolidated financial
statements of another entity is an indication of potential risk to the
other entity that offers a clear and objective standard for the
application of margin requirements. The Commission further explained
that, as a result of the FCS' direct connection to, and the possible
negative impact of its swap activities on, its U.S. ultimate parent
entity and the U.S. financial system, an FCS raises a more substantial
supervisory concern in the United States relative to other non-U.S.
CSEs.
---------------------------------------------------------------------------
\83\ See proposed 17 CFR 23.160(a)(6) (defining ``ultimate
parent entity'' as the parent entity in a consolidated group in
which none of the other entities in the consolidated group has a
controlling interest, in accordance with U.S. GAAP).
\84\ Under U.S. GAAP, consolidated financial statements report
the financial position, results of operations and statement of cash
flows of a parent entity together with subsidiaries in which the
parent entity has a controlling financial interest (which are
required to be consolidated under U.S. GAAP).
---------------------------------------------------------------------------
The Commission requested comment on all aspects of its proposed FCS
definition, including whether the Commission should instead adopt the
``control test'' proposed by the Prudential Regulators, which focused
solely on the level of ownership and control a U.S. person would have
over a non-U.S. subsidiary.\85\
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\85\ See Proposal, 80 FR at 41386. See also Prudential
Regulators' Proposed Margin Rule, 79 FR at 57379.
---------------------------------------------------------------------------
b. Comments
A few commenters expressed strong support for the FCS concept.\86\
AFR and Better Markets characterized it as an improvement to the cross-
border approach to margin taken in the Guidance, calling it a ``logical
and reasonable approach'' to capturing non-U.S. subsidiaries of U.S.
swap entities that may expect an implicit guarantee from a U.S. parent
and an ``effective remedy to evasion.'' \87\ AFR stated that, by virtue
of being included in the same consolidated financial statement, an FCS
has a direct financial impact on its U.S. ultimate parent entity, even
absent a direct recourse guarantee.\88\
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\86\ See AFR at 4-5; Better Markets at 5; IATP at 3, 5-6.
\87\ See AFR at 4 (FCS concept ``economizes'' Commission
resources by tying regulatory coverage to ``easily available''
accounting information). See also Better Markets at 5 (Guidance
should be amended to apply FCS concept to all Title VII
requirements).
\88\ See AFR at 4. See also IATP at 3 (inclusion in another's
consolidated financial statement indicates a potential risk to that
entity).
---------------------------------------------------------------------------
Nevertheless, AFR and IATP expressed some concern over the reliance
on U.S. GAAP, particularly with respect to its ability to capture off-
balance sheet entities.\89\ IATP suggested that the Commission consider
including in the FCS definition an option to carry out the consolidated
financial reporting according to International Financial Reporting
Standards (``IFRS'').\90\ AFR also expressed concern that reliance on
U.S. GAAP may not capture all entities that could expect an implicit
guarantee from a U.S. parent, including privately held entities that
are not required to prepare consolidated financial statements under
U.S. GAAP, and certain variable interest entities or owned funds.\91\
---------------------------------------------------------------------------
\89\ See AFR at 5 (prior to the passage of U.S. Financial
Accounting Standards Board (``U.S. FASB'') Statements Nos. 166 and
167, U.S. GAAP accounting failed to properly require the
consolidation of many securitization entities and such gaps could
appear in the future).
\90\ See IATP at 6 (reliance on IFRS should be predicated on the
IFRS agreeing with U.S. FASB participation and offering improved
handling of off-balance sheet entities compared to U.S. GAAP).
\91\ See AFR at 4-5.
---------------------------------------------------------------------------
AFR and IATP therefore urged the Commission to expand the FCS
definition in a few ways. Both recommended that the FCS definition
include entities whose U.S. parent entity is not required to prepare
consolidated financial statements (e.g., a private partnership) but
that would otherwise meet the standard for consolidation.\92\ AFR
argued that failing to include such entities within the meaning of
``FCS'' could result in entities with a similar nexus to the U.S.
financial system being treated differently based on factors such as
whether the ultimate parent is publicly traded.\93\ AFR also urged the
Commission to incorporate a facts-and-circumstances test for
determining when a foreign subsidiary's relationship with its U.S.
parent may create a sufficient nexus to require compliance with U.S.
margin rules.\94\
---------------------------------------------------------------------------
\92\ See AFR at 4-5; IATP at 6 (it would not be
``inconceivable'' for U.S. CSE to spin off swaps trading activities
as private partnerships).
\93\ See AFR at 5.
\94\ See id.
---------------------------------------------------------------------------
A few commenters opposed the FCS concept altogether.\95\ IIB/SIFMA
argued that, absent a legal obligation to provide support, an FCS's
potential effect on its U.S. ultimate parent entity is not sufficiently
``direct'' to create a nexus to the U.S. financial system within the
meaning of CEA section 2(i).\96\ Nevertheless, most commenters,
including IIB/SIFMA, preferred the proposed FCS definition to the
control test proposed by the Prudential Regulators.\97\ IIB/SIFMA also
appreciated that the proposed FCS definition would foreclose the
possibility of such a non-U.S. CSE having multiple parent entities.\98\
---------------------------------------------------------------------------
\95\ See, e.g., AIMA/IA at 3 (touting potential operational
costs involved with obtaining counterparty representations regarding
FCS status); FSR at 10 (FCS concept is ``not necessary'' because
FCSs will be subject to foreign regulation); IIB/SIFMA at 19-20
(Commission should not distinguish FCSs from other non-U.S. CSEs).
\96\ See IIB/SIFMA at 14 (``chain of intervening factors and
events,'' including ``materiality'' of FCS to parent entity, that
could affect a U.S. parent's decision to provide support is too long
and uncertain).
\97\ See FSR at 10 (a control test may not clearly identify the
non-U.S. covered swap entities that are likely to raise greater
supervisory concerns); IATP at 6; IIB/SIFMA at 19-20 (reliance on
the familiar standards of U.S. GAAP would promote legal certainty);
ISDA at 13 (a control test is not appropriate for the application of
margin rules).
\98\ See IIB/SIFMA at 19-20.
---------------------------------------------------------------------------
c. Final Rule
The Final Rule defines ``Foreign Consolidated Subsidiary'' as
proposed.\99\ Specifically, ``Foreign Consolidated Subsidiary'' means a
non-U.S. CSE in which an ultimate parent entity that is a U.S. person
has a controlling financial interest, in accordance with U.S. GAAP,
such that the U.S. ultimate parent entity includes the non-U.S. CSE's
operating results, financial position and statement of cash flows in
the U.S. ultimate parent entity's consolidated financial statements, in
accordance with U.S. GAAP. The term ``ultimate parent entity'' means
the parent entity in a consolidated group in which none of the other
entities in the consolidated group has a controlling interest, in
accordance with U.S. GAAP.\100\
---------------------------------------------------------------------------
\99\ See 17 CFR 23.160(a)(1).
\100\ See 17 CFR 23.160(a)(6). The definition of ``Foreign
Consolidated Subsidiary'' refers only to the U.S ultimate parent
entity. The Commission believes that this is appropriate because
consolidated financial statements are the financial statements of a
group under the control of the ultimate parent entity. Where the
ultimate parent entity is a non-U.S. person, the non-U.S. CSE is not
categorized as an FCS and therefore would be eligible for the
Exclusion (assuming that the other conditions of the Exclusion are
satisfied), for the reasons discussed in section II.B.3.
---------------------------------------------------------------------------
The Commission believes that the FCS concept offers a clear,
bright-line test for identifying those non-U.S. CSEs whose uncleared
swap activities present a greater supervisory interest relative to
other non-U.S. CSEs. Under U.S. GAAP, an FCS' financial statements are
consolidated with its U.S. ultimate parent entity by virtue of the
parent's
[[Page 34827]]
controlling financial interest in the FCS. By virtue of having its
financial statements consolidated with those of its U.S. ultimate
parent, the financial position, operating results and statement of cash
flows of an FCS are included in the financial statements of its U.S.
ultimate parent entity and therefore affect the financial position,
risk profile and market value of the U.S. ultimate parent. Because of
the FCS' direct relationship with, and the possible negative impact of
its swap activities on, its U.S. ultimate parent entity and the U.S.
financial system, an FCS raises greater supervisory concern in the
United States relative to other non-U.S. CSEs (in each case provided
that the obligations under the relevant swap are not guaranteed by a
U.S. person).\101\
---------------------------------------------------------------------------
\101\ The Commission notes that it has a relatively greater
supervisory interest in FCSs than other non-U.S. CSEs, even if they
have a U.S. subsidiary or affiliate, because an FCS's ultimate
parent entity is a U.S. person.
---------------------------------------------------------------------------
Further, the Commission continues to believe that, in the absence
of a direct recourse guarantee from a U.S. person, an FCS should not be
treated in the same manner as a U.S. CSE or U.S. Guaranteed CSE. In
contrast with a U.S. Guaranteed CSE, in the event of the FCS's default,
the U.S. ultimate parent entity does not have a legal obligation to
fulfill the obligations of the FCS. Rather that decision would depend
on the business judgment of its parent.
By relying on a consolidation test, the FCS concept is intended to
provide a clear, bright-line test for identifying those non-U.S. CSEs
whose uncleared swaps are likely to raise greater supervisory concerns
relative to other non-guaranteed non-U.S. CSEs. The Commission further
believes that, as some commenters noted, reliance on familiar U.S. GAAP
accounting standards will promote legal certainty. In particular, the
Commission notes that consolidation accounting is a longstanding part
of U.S. GAAP and that all non-U.S. CSEs with a U.S. ultimate parent
entity currently prepare consolidated financial statements.
With respect to the definition's reliance on U.S. GAAP, the
Commission notes that since the 2008 financial crisis, the U.S. FASB
made significant changes to the consolidation model for variable
interest entities (``VIEs'') and that as a result of these changes,
more VIEs (including special purpose vehicles) are being consolidated
with other entities (i.e., their parent entities) under U.S. GAAP.
Furthermore, because the U.S. GAAP consolidation requirement adequately
addresses these VIEs, the Commission believes that the addition of IFRS
as an option is likely to inject unnecessary complexity and costs in
many circumstances.\102\ Accordingly, the Commission believes that the
U.S. GAAP consolidation test in the FCS definition is sufficiently
similar to the IFRS consolidation standard with respect to VIEs so that
additional reliance on the IFRS standard would be neither necessary nor
beneficial.\103\
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\102\ The Commission notes that the standards for consolidation
under U.S. GAAP's VIE model are similar to the consolidation
standards that would apply under IFRS, as both consider control over
one entity by the other. The Commission further notes that it does
not believe that special purpose vehicles are likely to be used to
conduct swaps business. Even if such vehicles transact in swaps and,
consequently, register as CSEs, the ultimate parent entity would
likely exercise control over them because these vehicles typically
rely on parental support or guarantees to maintain their credit
standards. Such control would lead to consolidation under U.S. GAAP.
\103\ The Commission notes that although privately held
companies are not under a regulatory obligation to prepare and file
consolidated financial statements pursuant to U.S. GAAP, they
nevertheless are likely to prepare consolidated financial statements
for other purposes (e.g., to provide to creditors as a condition to
loan or to private investors), in which case their foreign
subsidiaries may fall within the parameters of the FCS definition.
---------------------------------------------------------------------------
4. Counterparty Representations
The proposed rule provided that market participants should
generally be permitted to reasonably rely on counterparty
representations with regard to their status as a U.S. person. The
Commission received comments regarding its proposed reliance standard
\104\ and a request that the Commission also permit reliance on
counterparty representations with respect to the guarantee and FCS
definitions.\105\
---------------------------------------------------------------------------
\104\ See, e.g., SIFMA AMG at 12 (standard for reliance on
counterparty representations with respect to U.S. person status is
consistent with that articulated in Guidance and Commission's
external business conduct rules; proposed rule could be read to
require ``further, unnecessary diligence'').
\105\ See, e.g., id.
---------------------------------------------------------------------------
The Commission acknowledges that the information necessary for a
swap counterparty to accurately assess the status of its counterparties
as U.S. persons or FCSs, or to determine whether a non-U.S.
counterparty's obligations under a swap are guaranteed by a U.S.
person, may be unavailable, or available only through overly burdensome
due diligence. For this reason, the Commission believes that a market
participant should generally be permitted to reasonably rely on written
counterparty representations in each of these respects. The Commission
clarifies that, consistent with the reliance standard articulated in
the Commission's external business conduct rules,\106\ market
participants may reasonably rely on such a counterparty representation
unless it has information that would cause a reasonable person to
question the accuracy of the representation.
---------------------------------------------------------------------------
\106\ See 17 CFR 23.402(d).
---------------------------------------------------------------------------
B. Applicability of Margin Requirements to Cross-Border Uncleared Swaps
The following sections discuss the cross-border application of the
margin requirements to swaps between CSEs and their counterparties,
including when substituted compliance and the Exclusion are applicable.
Section 1 provides a brief overview of the proposed rule; section 2
addresses the availability of substituted compliance; section 3
addresses the availability of the Exclusion; section 4 discusses a
special provision in the Final Rule for non-segregation jurisdictions;
and section 5 discusses a special provision in the Final Rule for non-
netting jurisdictions.
1. Proposed Rule
Under the proposed rule, the application of substituted compliance
and the scope of the Exclusion closely tracked the Prudential
Regulators' Proposed Margin Rule.\107\ Specifically:
---------------------------------------------------------------------------
\107\ See 79 FR at 57379-81.
---------------------------------------------------------------------------
A U.S. CSE would be required to comply with the
Commission's margin rules for all uncleared swaps but would be eligible
for substituted compliance with respect to the requirement to post (but
not the requirement to collect) initial margin for swaps with certain
non-U.S. counterparties (referred to herein as ``partial substituted
compliance'').\108\
---------------------------------------------------------------------------
\108\ U.S. CSEs would not be eligible for substituted compliance
with respect to the requirement that they collect initial margin or
the requirement to post or collect variation margin.
---------------------------------------------------------------------------
A U.S. Guaranteed CSE would receive the same treatment as
a U.S. CSE.
A non-U.S. CSE whose obligations under the relevant swap
are not guaranteed by a U.S. person would be eligible for substituted
compliance unless the counterparty to the swap is a U.S. CSE or U.S.
Guaranteed CSE, in which case substituted compliance would be available
with respect to the requirement to collect (but not the requirement to
post) initial margin (also referred to as ``partial substituted
compliance'').
A non-U.S. CSE would be eligible for an exclusion from the
Final Margin Rule when trading with a non-U.S. person counterparty
provided that (a) neither party's obligations under the relevant swap
are guaranteed by a U.S.
[[Page 34828]]
person; (b) neither party is an FCS; and (c) the swap is not conducted
by or through a U.S. branch of a non-U.S. CSE.
The Commission requested comment on all aspects of the proposed
rule, including how the rule should treat FCSs (e.g., whether they
should be offered the same treatment as U.S. Guaranteed CSEs or
conversely be offered the Exclusion), whether U.S. branches should be
eligible for the Exclusion, and whether the Commission should provide
exceptions related to certain ``emerging markets'' or non-netting
jurisdictions.\109\
---------------------------------------------------------------------------
\109\ See Proposal, 80 FR at 41387, 88-91.
---------------------------------------------------------------------------
2. Substituted Compliance
a. Comments
Most commenters argued for the greater availability of substituted
compliance. Some requested that all CSEs, whether a U.S. persons or a
non-U.S. person, be eligible for full substituted compliance with
respect to all comparable foreign margin requirements, including any
swap dealer in a BCBS-IOSCO framework-compliant jurisdiction.\110\
Others phrased their requests in narrower terms, arguing for the
broader availability of substituted compliance for U.S. CSEs and/or
U.S. Guaranteed CSEs when trading with non-U.S. persons.\111\
Commenters generally argued that requiring CSEs to comply with the
Commission's margin requirements in the face of comparable foreign
margin requirements would undermine international efforts to develop a
consistent global swaps regime and impose unnecessary and costly
compliance burdens, resulting in competitive disparities and market
inefficiencies.\112\ Several commenters also argued that the proposed
rule would involve substantial operational costs, including
categorizing market participants and developing appropriate
documentation.\113\
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\110\ See, e.g., AIMA/IA at 4-5 (substituted compliance should
be ``all encompassing, and applicable to all parties to a
transaction''); ICI Global at 2, 9 (substituted compliance should be
made available ``without qualification'' wherever foreign
jurisdiction's margin requirements are comparable); ISDA at 2, 7-8
(substituted compliance should be available for any transaction
subject to foreign requirements comparable to BCBS-IOSCO framework);
SIFMA AMG 4, 6-8 (market participants should be allowed ``to comply
with a single set of substantive margin requirements for all
uncleared swaps''). See also ABA/ABASA at 3 (market participants
should be allowed to rely on substituted compliance ``to the
greatest possible degree across the markets in and structures
through which they operate'').
\111\ See, e.g., FSR at 7 (U.S. CSEs should be able to rely on
substituted compliance for both posting and collecting of initial
margin when trading with non-U.S. CSEs and their foreign branches be
extended full substituted compliance); IIB/SIFMA at 4-9 (substituted
compliance should be available for U.S. CSEs and U.S. Guaranteed
CSEs with respect to all margin requirements, including posting and
collecting both initial and variation margin); JBA at 8-9
(availability of substituted compliance for U.S. Guaranteed CSEs is
too limited); PensionsEurope at 2 (``full substituted compliance,''
including collection of initial margin and variation margin, should
be available for transactions between U.S. Guaranteed CSEs and
``financial institutions without a U.S. nexus'').
\112\ See, e.g., AIMA/IA at 1; FSR at 3-7; ICI Global at 8-9.
See also Vanguard at 2 (applying substituted compliance on a
``transaction-by-transaction basis'' would undermine ``the
fundamental risk mitigation tool of cross-transactional close-out
netting'').
\113\ See, e.g., AIMA/IA at 1 (proposed rule would require a
``significant amount of replacement and additional documentation to
account for different counterparty combinations''); ISDA at 5
(operational complexity of proposed substituted compliance regime
would further increase operating costs); IIB/SIFMA at 7 (CSEs would
not know sufficient information about businesses of their
counterparties to categorize them, and non-U.S. counterparties would
not be familiar with, and would be reluctant to hire counsel to
determine, all U.S. laws relevant to making the determination);
SIFMA AMG at 6 (highlighting complications in determining
availability of substituted compliance on basis of counterparty
status in context of block trades).
---------------------------------------------------------------------------
With respect to U.S. CSEs and U.S. Guaranteed CSEs, IIB/SIFMA and
ISDA argued that compliance with the Commission's margin requirements
was not necessary to prevent the transmission of risk to the U.S.
financial system because the risk would be adequately addressed by
comparable foreign margin requirements.\114\ IIB/SIFMA argued that the
proposed substituted compliance regime could actually increase
liquidity risk by discouraging non-U.S. counterparties from trading
with U.S. CSEs and U.S. Guaranteed CSEs in order to avoid costs
associated with understanding and complying with the Commission's
margin requirements, and that the resulting increased concentration of
bilateral credit exposures among U.S. CSEs and U.S. Guaranteed CSEs
would increase the risk of contagion in U.S. markets.\115\ ISDA further
argued that ``[c]omity and respect for the supervisory interests of
non-U.S. regulators'' argue in favor of full substituted compliance or
exclusion for swaps involving non-U.S. person counterparties.\116\ FSR
argued that substituted compliance is at least necessary for foreign
branches because they are likely to be subject to foreign margin
requirements and pose the same concerns to foreign regulators as the
U.S. branches of non-U.S. CSEs pose to U.S. regulators.\117\
---------------------------------------------------------------------------
\114\ See IIB/SIFMA at 5; ISDA at 6-7. See also ICI Global at 9
(by not permitting substituted compliance in certain instances,
Commission would effectively be determining that foreign margin
requirements are not ``good enough'' despite being found
comparable).
\115\ See IIB/SIFMA at 6-7.
\116\ See ISDA at 6.
\117\ See FSR at 7-8. See also AIMA/IA at 3 (absence of
substituted compliance for foreign branches of U.S. CSEs is an
``apparent gap[ ]'').
---------------------------------------------------------------------------
Several commenters raised concerns with regard to the proposal to
allow partial substituted compliance.\118\ SIMFA AMG argued that
partial substituted compliance would be ``inconsistent with the
importance of bilateral margining,'' add unnecessary costs and
complexity, and increase the potential for margin disputes.\119\ AIMA/
IA argued that developing a legal agreement allowing for the transfer
of margin amounts according to more than one margin regime would be
``commercially and legally problematic.'' \120\ As a result, market
participants would default to complying with the Commission's margin
requirements, negating the value of substituted compliance.\121\ ISDA
similarly argued that developing a standardized model for initial
margin that could account for different margin rules in one netting set
would be ``impractical'' in the available timeframe for
compliance.\122\ FSR argued that partial substituted compliance was not
``in the spirit of the International Standards'' \123\ and pointed out
that its usefulness may be questionable, given that no other foreign
jurisdiction has proposed a similar approach.\124\
---------------------------------------------------------------------------
\118\ See, e.g., AIMA/IA at 4; FSR at 7; ISDA at 3, 5; SIFMA AMG
at 10.
\119\ See SIFMA AMG at 10 (highlighting additional complexities
in calculating margin for clients using multiple asset managers).
\120\ See AIMA/IA at 4.
\121\ See id.
\122\ See ISDA at 9 (counterparties wanting to use a single
custodian could face additional challenges, as the custodial
arrangement would have to be drafted to accommodate overlapping and
potentially inconsistent requirements for segregation).
\123\ See proposed 17 CFR 23.160(a)(3) (defining ``International
Standards'' as based on the BCBS-IOSCO framework).
\124\ See FSR at 7.
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IATP, on the other hand, supported the proposed substituted
compliance regime.\125\ IATP agreed that FCSs should be granted
substituted compliance but not U.S. Guaranteed Affiliates because
losses from the swaps of an FCS may have a negative impact on the
foreign jurisdiction's economy.\126\ IATP also agreed that U.S.
Guaranteed Affiliates should not be eligible for substituted compliance
with respect to the requirement to collect
[[Page 34829]]
initial margin from a non-U.S. counterparty.\127\ AFR described the
proposed rule as creating a ``very significant scope for substituted
compliance'' with respect to non-U.S. CSEs, but suggested that the
scope would not be a concern provided the substituted compliance were
limited to foreign rules that are ``very similar'' to U.S. margin
requirements.\128\
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\125\ See IATP at 3-4 (proposed rule would provide ``the
greatest opportunity for effective risk mitigation against swaps
counterparty default'' and would be a ``critical step'' to ensuring
that ``de-guaranteed'' swaps ``will not continue to elude effective
regulation'').
\126\ See IATP at 7.
\127\ See id.
\128\ See AFR at 7. See also id. at 4 (scope of substituted
compliance could become ``overbroad'' given that proposed rule
included narrow definition of ``guarantee'' and limited Foreign
Consolidated Subsidiaries to subsidiaries of registered CSEs).
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b. Final Rule
The Commission has determined to adopt a cross-border framework
largely as proposed, but with certain modifications to address concerns
raised by commenters and to further align the rule with the cross-
border approach adopted by the Prudential Regulators. Generally
speaking, the cross-border margin framework in the Final Rule reflects
the Commission's efforts to carefully tailor the application of the
Commission's margin requirements to address comity considerations and
mitigate potential adverse impact on market efficiency and competition
without compromising the safety and soundness of CSEs. The availability
of substituted compliance under the Final Rule therefore depends on the
degree of nexus the CSEs and their counterparties have to the U.S.
financial system, as indicated by their status (e.g., whether they are
U.S. persons or non-U.S. persons whose obligations under the relevant
swap are guaranteed by a U.S. person).
i. Uncleared Swaps of U.S. CSEs and U.S. Guaranteed CSEs
As a general rule, the Commission believes that, in light of their
position in the U.S. financial system, U.S. persons and U.S. Guaranteed
CSEs should be required to comply with the Commission's margin
requirements. Under the Final Rule, however, U.S. CSEs and U.S.
Guaranteed CSEs would be eligible for substituted compliance with
respect to the requirement to post (but not the requirement to collect)
initial margin provided that the counterparty is a non-U.S. person
whose obligations under the relevant swap are not guaranteed by a U.S.
person. By virtue of their being domiciled or organized in the United
States, U.S. CSEs give rise to greater supervisory interests relative
to other CSEs. U.S. Guaranteed CSEs create a similar supervisory
interest because, as discussed in the proposed rule, the swap of a non-
U.S. CSE whose obligations under the swap are guaranteed by a U.S.
person is identical, in relevant aspects, to a swap entered into
directly by a U.S. person.
Nevertheless, the Commission believes that, in the interest of
comity, permitting substituted compliance for the limited requirement
of posting initial margin would be reasonable. While requiring a CSE to
post initial margin protects the counterparty in the event of default
by the CSE, it also serves as a risk management tool because it limits
the amount of leverage a CSE can incur by requiring that it have
adequate eligible collateral to enter into an uncleared swap.
Accordingly, when the counterparty is a non-U.S. person (whose
obligations under the swap are not guaranteed by a U.S. person), the
Commission believes that substituting the foreign margin requirements
with regard to the initial margin posted would be reasonable. The
Commission further believes that allowing substituted compliance in
this limited instance may reduce transaction costs for U.S. CSEs when
trading with non-U.S. counterparties \129\ and thereby mitigate
potential competitive disparities (relative to other CSEs and non-CFTC
registered dealers operating in the foreign jurisdiction), while
ensuring that the U.S. CSE is adequately protected in the event of
default of the non-U.S. counterparty. The availability of substituted
compliance is limited to circumstances where the non-U.S.
counterparty's obligations under the relevant swap are not guaranteed
by a U.S. person in order to avoid incentivizing market participants to
structure their swaps solely for purposes of avoiding application of
the Commission's margin requirements.\130\
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\129\ That is, if the initial margin amount required to be
posted under the foreign rule is lower than the amount required
under the Commission's Final Margin Rule, and the parties elect for
the CSE to post margin pursuant to the foreign margin requirements,
the lower margin may reduce the U.S. CSE's funding costs.
\130\ For example, if partial substituted compliance were
available for non-U.S. counterparties that are guaranteed by a U.S.
person, a swap between a U.S. CSE and a U.S. counterparty could be
restructured as a swap between a U.S. CSE and a non-U.S.
counterparty that is guaranteed by a U.S. person in order to avoid
application of the Commission's margin requirements.
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The Commission does not believe that partial substituted compliance
would prohibit the use of a single netting set for calculating initial
margin. Under the Final Rule, a U.S. CSE can comply with the
Commission's initial margin requirements by posting pursuant to
comparable foreign margin requirements. Accordingly, from the
Commission's perspective, one netting set could encompass swaps that
comply with both foreign and CFTC initial margin requirements.\131\
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\131\ The Commission similarly does not expect that reliance on
partial substituted compliance will hinder the development or use of
a standardized model for initial margin, as the Commission believes
that a single model could be developed to satisfy the initial margin
requirements of multiple jurisdictions.
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The Commission understands that CSEs relying on partial substituted
compliance may face certain costs or challenges not experienced by non-
U.S. CSEs that are eligible for full substituted compliance.
Nevertheless, as discussed above, the Commission believes that granting
substituted compliance more broadly (e.g., permitting both collection
and posting of initial margin pursuant to the foreign requirements)
would not be appropriate for a swap transaction involving a U.S. CSE or
a U.S. Guaranteed CSE. Moreover, U.S. CSEs and U.S. Guaranteed CSEs
that elect to rely on partial substituted compliance may realize
savings in the form of reduced funding costs (to the extent that
foreign jurisdiction requires less initial margin to be posted), and
their non-U.S. counterparties may experience lower operational costs as
a result of only having to comply with their home jurisdiction's
requirements.
Finally, the Commission does not believe it would be appropriate to
broaden the scope of substituted compliance available to swaps
conducted through foreign branches of U.S. CSEs. A foreign branch is
legally indistinguishable from the U.S. CSE itself, such that the whole
U.S. CSE, and not merely the foreign branch, holds itself out to the
market and assumes the risks of any uncleared swap transactions
conducted by or through the foreign branch. Accordingly, swaps
conducted through a foreign branch of a U.S. CSE are appropriately
treated the same as swaps of the U.S. CSE as a whole. Moreover, if the
Commission were to allow broader substituted compliance for swaps
conducted through foreign branches than swaps conducted domestically,
U.S. CSEs could be incentivized to conduct swap activity through
foreign branches to avoid direct compliance with Commission's margin
requirements.
ii. Uncleared Swaps of Non-U.S. CSEs (Including FCSs) Whose Obligations
Under the Relevant Swap Are Not Guaranteed by a U.S. Person
Under the Final Rule, consistent with the Proposed Rule, non-U.S.
CSEs (including FCSs) whose obligations under the relevant uncleared
swap are
[[Page 34830]]
not guaranteed by a U.S. person may avail themselves of substituted
compliance to a greater extent than U.S. CSEs and U.S. Guaranteed CSEs.
Specifically, where the obligations of a non-U.S. CSE (including an
FCS) under the relevant swap are not guaranteed by a U.S. person,
substituted compliance is available with respect to its uncleared swaps
with any counterparty, other than a U.S. CSE or a U.S. Guaranteed
CSE.\132\
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\132\ With respect to uncleared swaps of a non-U.S. CSE whose
obligations under the swap are not guaranteed by a U.S. person, on
the one hand, with a U.S. CSE or a U.S. Guaranteed CSE, on the other
hand, substituted compliance would only be available for initial
margin collected by the non-U.S. CSE whose obligations under the
relevant swap are not guaranteed by a U.S. person, as discussed
above.
---------------------------------------------------------------------------
The broad substituted compliance framework available to this
category of non-U.S. CSEs reflects the Commission's recognition of
foreign jurisdictions' supervisory interest in CSEs that are domiciled
and operating in their jurisdictions. In addition, the Commission
understands that compliance with two sets of margin regulations may
lead to costs and burdens for non-U.S. CSEs not faced by their
competitors in the local jurisdiction and may provide disincentives for
foreign clients to transact with a non-U.S. CSE. The Commission
believes that making substituted compliance broadly available to non-
U.S. CSEs that are not guaranteed by a U.S. person may help to reduce
the potential adverse impact on market efficiency and competition,
without compromising the protections for the non-U.S. CSE and the U.S.
financial markets.
As discussed in the next section, a non-U.S. CSE that is not an FCS
will be eligible for the Exclusion from the Commission's margin rules
under certain circumstances. However, uncleared swaps entered into by
an FCS will not be eligible for any exclusion because of its
relationship with its U.S. ultimate parent entity, and because of the
possible negative impact of its swap activities on its U.S. ultimate
parent entity and the U.S. financial system. As explained in section
II.A.3.c. above, the financial position, operating results, and
statement of cash flows of an FCS are included in the financial
statements of the U.S. ultimate parent entity and therefore have a
direct impact on the consolidated entity's financial position, risk
profile, and market value. The Commission is also concerned that
extending the Exclusion to FCSs would incentivize U.S. entities to
conduct their swap activities with non-U.S. counterparties through non-
U.S. subsidiaries solely in order to avoid application of the Dodd-
Frank Act margin requirements, leading to further bifurcation between
U.S. and non-U.S. swap business.
The Commission recognizes that its decision not to extend the
Exclusion to FCSs could put them at a disadvantage relative to other
non-U.S. market participants/swap dealers (including those that are
CSEs).\133\ However, given the supervisory concerns raised by the nexus
between FCSs and their U.S. ultimate parent entity, the Commission
believes that extending the Exclusion to an FCS would not further the
paramount statutory objective of ensuring the safety and soundness of a
CSE and the stability of U.S. financial markets. The Commission notes
that potential competitive disparities may be mitigated to the extent
that the relevant foreign jurisdiction implements comparable margin
requirements.
---------------------------------------------------------------------------
\133\ For example, a non-U.S. CSE relying on the Exclusion or
non-CFTC registered swap dealers may be able to realize cost savings
and offer better pricing terms to foreign clients.
---------------------------------------------------------------------------
3. Exclusion
a. Comments
Several commenters supported the Exclusion because they believed
that it recognized the absence of a U.S. jurisdictional nexus.\134\
Nevertheless, these commenters requested that the Exclusion be expanded
to include U.S. branches of non-U.S. CSEs and FCSs.\135\
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\134\ See ICI Global at 2, 5; IIB/SIFMA at 10.
\135\ See id. See also ISDA at 3 (Exclusion should be expanded
to include any swap between a non-U.S. CSE, whether or not
guaranteed, and any non-U.S. person counterparty that is not
guaranteed by a U.S. person).
---------------------------------------------------------------------------
With respect to U.S. branches, IIB/SIFMA argued that distinguishing
them would not be necessary from a risk-mitigation perspective because
the risk remains with the non-U.S. CSE outside the United States
regardless of whether the non-U.S. CSE involves U.S. personnel.\136\
ISDA and ICI Global further argued that treating U.S. branches
differently from the rest of the CSE could create ``significant
operational issues and credit risks.'' \137\ ICI Global stated that the
same ISDA Master Agreement typically governs all transactions involving
both the U.S. and non-U.S. branches of a non-U.S. CSE, and that not
granting the Exclusion to swaps between a non-U.S. person and a U.S.
branch of a non-U.S. CSE (whose obligations are not guaranteed by a
U.S. person) may require parties to document transactions with the U.S.
branch under a separate master agreement, which could create
operational difficulties.\138\ ICI Global also expressed concern that
disparate treatment of U.S. branches could lead to additional credit
risk because counterparties might lose netting benefits under
bankruptcy laws.\139\
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\136\ See IIB/SIFMA at 16.
\137\ See IIB/SIFMA at 16; ICI Global at 10-11.
\138\ See ICI Global at 10-11.
\139\ See also ISDA at 11 (fragmenting netting sets could
increase risk and discourage use and employment of U.S. personnel).
---------------------------------------------------------------------------
With respect to FCSs, ICI Global argued that consolidation is
insufficient to create a ``direct'' U.S. nexus because the U.S.
ultimate parent is not under a legal obligation to support the
FCS.\140\ IIB/SIFMA added that foreign jurisdictions have not proposed
to apply margin rules to foreign, non-guaranteed subsidiaries and that
the Commission should extend the Exclusion to avoid overlapping
requirements that could lead market participants to avoid trading with
an FCS.\141\ Although substituted compliance would potentially be
available in place of the Exclusion, ISDA asserted that the difference
between the Exclusion and substituted compliance is not costless, as
affected swap dealers would incur costs of complying with any
conditions imposed with respect to substituted compliance and with the
Commission's exercise of its related examination authority, in addition
to lost business that could result if substituted compliance is not
``seamless'' and counterparties are ``inconvenienced'' by its
application.\142\
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\140\ See ICI Global at 11. See also IIB/SIFMA at 14 (CEA
section 2(i) does not authorize the Commission to regulate a foreign
subsidiary solely due to potential for support from and risk to a
U.S. parent entity because, absent a legal obligation to provide
support, the ``chain of intervening factors and events'' that might
lead to such support would not satisfy ``direct'' requirement in CEA
section 2(i)).
\141\ See IIB/SIFMA at 15.
\142\ See id. at 7.
---------------------------------------------------------------------------
As an alternative to extending the Exclusion to FCSs, IIB/SIFMA
suggested that the Commission grant an exclusion to FCSs operating
without a U.S. guarantee when transacting with non-U.S. persons
operating without a U.S. guarantee, up to an aggregate 5 percent limit
on the notional trading volume in uncleared swaps entered into by
commonly controlled FCSs under the exclusion relative to the total
notional swap trading volume of entities within the common U.S.
ultimate parent entity's consolidated group.\143\ IIB/SIFMA argued that
such a limited exclusion would achieve the Commission's risk mitigation
objectives
[[Page 34831]]
without directly regulating wholly non-U.S. counterparties.\144\
---------------------------------------------------------------------------
\143\ See IIB/SIFMA at 16.
\144\ See id.
---------------------------------------------------------------------------
Both AFR and Better Markets expressed support for the proposal not
to extend the Exclusion to FCSs, describing it as a means of addressing
the issue of de-guaranteeing.\145\ AFR nevertheless expressed concern
that the Exclusion would apply to a non-U.S. CSE when entering into a
swap with a foreign subsidiary that is a financial end user that has a
U.S. ultimate parent, and suggested that the Commission also deny the
Exclusion in this case.\146\ AFR also suggested that the Commission
``supplement'' its approach by further denying the Exclusion to a non-
consolidated, non-U.S. subsidiary that could, based on the facts and
circumstances, have a ``major impact on the financial well-being of the
parent,'' including circumstances where the parent does not use U.S.
GAAP accounting.\147\
---------------------------------------------------------------------------
\145\ See AFR at 2 (proposed rule would go ``some distance''
toward limiting evasion of Commission's margin requirements); Better
Markets at 5 (proposed rule ``adequately captures'' many foreign
affiliates that may have escaped U.S. margin requirements through
de-guaranteeing).
\146\ See AFR at 8 (foreign subsidiary of a U.S. financial end
user that is not a CSE would not be defined as an FCS even if
consolidated).
\147\ See AFR at 3. See also Better Markets at 2 (Exclusion is
needlessly complicated and indirect and Commission should address
issue more completely by reverting to and updating approach in
Guidance).
---------------------------------------------------------------------------
b. Final Rule
The Commission has determined to adopt the Exclusion largely as
proposed, with a modification that preserves the Commission's intent
with respect to the treatment of inter-affiliate swaps under the Final
Margin Rule. Under the Final Rule, an uncleared swap entered into by a
non-U.S. CSE with a non-U.S. counterparty (including a non-U.S. CSE) is
excluded from the Commission's margin rules, provided that neither
counterparty's obligations under the relevant swap are guaranteed by a
U.S. person and neither counterparty is an FCS.\148\ This approach
reflects the Commission's recognition of foreign jurisdictions' strong
supervisory interest in the uncleared swaps of non-U.S. CSEs and their
non-U.S. counterparties, both of which are domiciled and operate
abroad. Under these circumstances, the Commission believes that it is
appropriate to make a limited exception to the principle of firm-wide
application of margin requirements, consistent with comity principles,
so as to exclude a narrow class of uncleared swaps involving a non-U.S.
CSE and a non-U.S. counterparty.\149\
---------------------------------------------------------------------------
\148\ The Exclusion also does not apply if the counterparty is a
U.S. branch of a non-U.S. CSE. See 17 CFR 23.160(b)(2)(ii).
\149\ The Commission disagrees that the Commission lacks a
jurisdictional nexus with respect to swaps subject to the Exclusion.
To the contrary, as discussed above, by the terms of the relevant
statutory provision, CEA section 4s(e), and the underlying purpose
of that provision, the Commission's authority to adopt margin rules
applies to all CSEs, U.S. and non-U.S., and extends to all of their
uncleared swaps, regardless of the counterparties' domicile or the
location of the swaps transaction.
---------------------------------------------------------------------------
The Commission notes that a non-U.S. CSE that can avail itself of
the Exclusion is still subject to the Commission's margin rules with
respect to all other uncleared swaps (i.e., those that do not qualify
for the Exclusion), with the possibility of substituted compliance. And
any excluded swaps may be covered by the margin requirements of another
jurisdiction that adheres to the BCBS-IOSCO framework.\150\
Additionally, the non-U.S. CSE would be subject to the Commission's
capital requirements, which, as proposed, would impose a capital charge
for uncollateralized exposures.\151\
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\150\ In this regard, the Commission notes that, as indicated in
supra note 23, representatives of 26 regulatory authorities
(comprising 17 nations) participated in the WGMR that developed the
BCBS-IOSCO framework. As of today, 24 of these 26 regulatory
authorities that participated in the WGMR have proposed a regulatory
framework for margin for uncleared swaps, all of which are
consistent with the BCBS-IOSCO framework. In addition, these 24
regulatory authorities have jurisdiction over more than 90% of the
swaps activities in the world by any measure.
\151\ See Proposed Capital Rule, 76 FR 27802.
---------------------------------------------------------------------------
The Commission considered comments urging a broader scope of the
Exclusion to include, for example, any FCSs so long as their swaps are
not guaranteed by a U.S. person or alternatively, do not exceed a ``de
minimis'' level of swap activity. However, the Commission does not
believe that extending the Exclusion to uncleared swaps of FCSs is
appropriate given the nature of their relationship to their U.S.
ultimate parent entity. The limited scope of the Exclusion reflects
that the benefits of the margin requirement are achieved when it is
applied to all CSEs and on a firm-wide basis and therefore, any
exception needs to be carefully tailored to avoid creating a
significant supervisory gap and inappropriate levels of risk to the CSE
and the U.S. financial system.
The Commission also disagrees with comments that the Exclusion is
overly broad because it would extend to a swap between a non-U.S. CSE
and a foreign subsidiary of a U.S. financial end user.\152\ The
Commission notes that such a foreign subsidiary would not be an FCS
even if it is consolidated with its U.S. parent because it is not a
CSE. The Commission believes that a swap between such a foreign
subsidiary and a non-U.S. CSE should be eligible for the Exclusion
because financial end users are not covered swap entities and are
likely to include many entities that do not conduct a significant level
of swap activities; as such, their swap activities would not have the
same effect on the U.S. ultimate parent entity as would a covered swap
entity's. Therefore, the Exclusion applies to qualifying non-U.S. CSEs
when transacting with foreign subsidiaries that are financial end users
that have a U.S. ultimate parent entity.
---------------------------------------------------------------------------
\152\ The term ``financial end user'' is defined in section
23.150 of the Final Margin Rule.
---------------------------------------------------------------------------
Under the Final Margin Rule, a CSE is not required to collect
initial margin from its affiliate, provided, among other things, that
affiliate collects initial margin on its market-facing swaps or is
subject to comparable initial margin collection requirements (in the
case of non-U.S. affiliates that are financial end users) on its own
market-facing swaps. In order to preserve the Commission's intent with
respect to the treatment of inter-affiliate swaps under the Final
Margin Rule, the Exclusion is not available if the market-facing swap
of the non-U.S. CSE (that is otherwise eligible for the Exclusion) is
not subject to comparable initial margin collection requirements in the
home jurisdiction and any of the risk associated with the uncleared
swap is transferred, directly or indirectly, through inter-affiliate
transactions, to a U.S. CSE or a U.S. Guaranteed CSE. This condition is
intended to ensure that inter-affiliate swaps are not used to avoid the
requirement to collect initial margin from third-parties.\153\ The
limitation on the Exclusion is consistent with that rationale.
---------------------------------------------------------------------------
\153\ See 17 CFR 23.159.
---------------------------------------------------------------------------
Under the Final Rule, uncleared swaps of a U.S. branch of a non-
U.S. CSE are not eligible for the Exclusion. The Commission does not
believe extending the Exclusion to U.S. Branches would be appropriate.
Generally speaking, U.S. branches of foreign banks \154\ have a
Prudential Regulator and must therefore comply with the Prudential
Regulators' margin rules. The Prudential Regulators' Final Margin Rule
does not grant an exclusion for the uncleared swaps of such U.S.
branches on the basis that U.S. branches of foreign banks clearly
operate within the United States and could pose risk to
[[Page 34832]]
the U.S. financial system.\155\ To the extent that a U.S. branch of a
non-U.S. CSE is subject to the Commission's requirements rather than a
Prudential Regulator, the Final Rule appropriately harmonizes with the
Prudential Regulators.\156\ Additionally, given that U.S. branches
operate within the United States, allowing their swaps to be excluded
from application of the Commission's margin requirements could
disadvantage U.S. CSEs when competing with U.S. branches for U.S.
clients \157\ and create incentives for CSEs to operate through U.S.
branches solely for purposes of avoiding the Dodd-Frank Act margin
requirements. Accordingly, the Commission believes that a non-U.S. CSE
should be subject to the Commission's margin requirements when
conducting swap activities from within the United States by or through
a U.S. branch.\158\
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\154\ See Prudential Regulators' Final Margin Rule, 80 FR at
74901 (setting forth the definition of ``foreign bank'' for purposes
of the Prudential Regulators' Final Margin Rule).
\155\ See Prudential Regulators' Final Margin Rule, 80 FR at
74883.
\156\ Under the International Banking Act of 1978, 12 U.S.C.
3101 et seq., U.S. branches are generally treated the same as
national banks operating in that same location and are subject to
the same laws, regulations, policies, and procedures that apply to
national banks.
\157\ That is, a U.S. branch of a non-U.S. CSE that is permitted
to operate outside of the Commission's margin requirements may, by
virtue of being subject to reduced or even no margin requirements,
be able to offer a more competitive price to U.S. clients than a
U.S. CSE.
\158\ As noted above in section II.B.3.a., some commenters
suggested that not extending the Exclusion to U.S. branches of non-
U.S. CSEs could require non-U.S. CSEs to document transactions with
the U.S. branch under a separate ISDA Master Agreement, creating
operational challenges. However, because such U.S. branches are
eligible for substituted compliance, use of a separate credit
support agreement to document transactions with a non-U.S. CSE's
U.S. branch should only be necessary where foreign margin
requirements are not comparable. Although the Commission
acknowledges that the non-U.S. CSE may need to use a separate credit
support agreement for U.S. branch transactions in this limited case,
the Commission nevertheless believes that it would not be
appropriate to extend the Exclusion to U.S. branches of non-U.S.
CSEs for the reasons discussed above.
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4. Special Provision for Non-Segregation Jurisdictions \159\
---------------------------------------------------------------------------
\159\ The term ``emerging market'' is not used in the Final Rule
because some jurisdictions covered by this provision of the Final
Rule are not aptly described by that term.
---------------------------------------------------------------------------
a. Comments
Several commenters supported the creation of a de minimis exception
similar to the emerging markets exemption set out in the Guidance.\160\
Specifically, commenters recommended that U.S. CSEs be exempt from the
margin requirements when trading with ``emerging market
counterparties'' provided that the aggregate notional volume of its
uncleared swaps with emerging market counterparties does not exceed 5
percent of the CSEs' total notional swap trading volume, both cleared
and uncleared.\161\ They further recommended defining ``emerging market
counterparty'' as a non-U.S. person that is (a) not a registered CSE,
(b) not guaranteed by a U.S. person, and (c) not located in a
jurisdiction covered by a comparability determination for uncleared
swaps margin rules issued by the Commission.\162\ Commenters generally
agreed that the exception should apply to foreign branches of U.S.
CSEs,\163\ but some commenters also recommended that it be extended to
U.S. Guaranteed CSEs \164\ and FCSs.\165\ For swaps between U.S.
Guaranteed CSEs and emerging market counterparties, ABA/ABASA and IIB/
SIFMA recommended that the de minimis threshold apply to the aggregate
volume of uncleared swaps guaranteed by a particular U.S. person,
rather than to the trading volume of the U.S. Guaranteed CSE
itself.\166\
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\160\ See, e.g., ABA/ABASA at 3-5; IIB/SIFMA at 3, 11-13; ISDA
at 2, 9-10; JBA at 10.
\161\ See ABA/ABASA at 5. See also ISDA at 9-10 (further
recommending that Commission impose recordkeeping requirement as
condition to exemption, as was included in Guidance).
\162\ See ABA/ABASA at 4-5; IIB/SIFMA at 13. See also ISDA at 9
(``emerging market counterparty'' should be defined as any non-U.S.
person that is not guaranteed by a U.S. person and that is not
located in one of six jurisdictions identified in Guidance as having
submitted requests for comparability determinations).
\163\ See ABA/ABASA at 1 n.5 (exemption should apply to ``U.S.-
based banking organizations, however they are operating in emerging
markets, including, but not limited to, through a foreign branch of
a prudentially-regulated CSE''); IIB/SIFMA; ISDA.
\164\ See ABA/ABASA at 1 n.5, 3; IIB/SIFMA at 12; ISDA at 9.
\165\ See ISDA at 10 (availability of the exemption should be
extended to FCSs if Commission does not otherwise make Exclusion
available to them).
\166\ See ABA/ABASA at 5; IIB/SIFMA at 13 (approach would be
appropriate given that risk to U.S. guarantor provides basis for
extraterritorial application of margin rules to U.S. Guaranteed
CSEs).
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In support of such an exception, commenters argued that legal and
operational constraints in emerging market jurisdictions could make
compliance with margin rules difficult, if not impossible.\167\ As a
result, broad application of the margin requirements to these swaps
could negatively impact the competitiveness of registered CSEs.\168\
Commenters argued that by limiting the exception to CSEs with a de
minimis level of swaps activity, the Commission could accomplish the
goal of ensuring a CSE's safety and soundness but with less disruption
to existing business relationships than the exchange of initial and
variation margin would impose.\169\ IIB/SIFMA also argued that the
exception would be consistent with CEA section 2(i), and encouraged the
Commission to coordinate with foreign regulators to develop a
consistent global approach to swaps with emerging market
counterparties.\170\
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\167\ See, e.g., ABA/ABASA at 4 (local banking sector may lack
operational infrastructure to support daily exchange of margin or
third-party custodial arrangements); IIB/SIFMA (local legal regime
may not recognize concept of netting); ISDA at 4 (emerging market
counterparties may be unable to comply with U.S. margin
requirements).
\168\ See ABA/ABASA at 4 (absent an exemption, U.S. CSEs could
lose not only derivatives business but associated commercial and
investment banking relationships); IIB/SIFMA at 12 (emerging market
counterparties are likely to move business away from U.S. CSEs and
U.S. Guaranteed CSEs in order to avoid being subject to margin
requirements); ISDA at 10 (dealing activities that would fall within
exemption may be an ``integral element'' of CSEs' global business).
\169\ See ABA/ABASA at 3; IIB/SIFMA at 12-13; ISDA at 10.
\170\ See IIB/SIFMA at 12 (arguing that de minimis nature of
exemption ensures that nexus of swap activity to the United States
is not ``significant'').
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b. Final Rule
The Commission is adopting a special provision for swaps with
counterparties in foreign jurisdictions where limitations in the legal
or operational infrastructure of the jurisdiction make it impracticable
for the CSE and its counterparty to comply with the custodial
arrangement requirements in the Final Margin Rule (``non-segregation
jurisdictions'').\171\ The Commission understands that CSEs may
transact swaps with counterparties located in foreign jurisdictions
that do not have legal or operational infrastructures to support
custodial arrangements required under the Final Margin Rule.\172\ In
the face of these legal and operational impediments, FCSs and foreign
branches of U.S. CSEs would be forced to discontinue their swaps
business with clients located in these jurisdictions. Taking these
factors into consideration, the Commission has determined to include a
special provision to accommodate this unique circumstance. The
Commission notes that the Prudential Regulators adopted a similar
provision in their final margin rules.
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\171\ For convenience, the term ``non-segregation jurisdiction''
is used in the preamble of this release.
\172\ The Final Margin Rule addresses the manner in which the
margin collected or posted by a CSE must be held and requires, among
other things, that the CSE must have a custodial agreement
prohibiting rehypothecation or otherwise transfer the initial margin
held by the custodian. See 17 CFR 23.157. The custodial requirements
are critical to ensuring the proper segregation and protection of
CSE funds.
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Under section 23.160(e) of the Final Rule, an FCS or a foreign
branch of a U.S. CSE would be eligible to engage in
[[Page 34833]]
uncleared swaps with certain non-U.S. counterparties in non-segregation
jurisdictions, without complying with either the requirement to post
initial margin \173\ or the custodial arrangement requirements that
pertain to initial margin collected by a CSE under the Final Margin
Rule,\174\ subject to certain conditions.\175\ This special provision
reflects the Commission's recognition that CSEs would otherwise be
precluded from engaging in any uncleared swaps in these foreign
jurisdictions as they cannot satisfy the custodial requirements of the
Final Margin Rule. The Commission clarifies that the special provision
for non-segregation jurisdictions only provides relief from the
specified requirements; all other margin rules in part 23 of the
Commission's regulations (with the exception of the special provision
for non-netting jurisdictions) would continue to apply.\176\
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\173\ See 17 CFR 23.152(b).
\174\ See 17 CFR 23.157(b). The Commission notes that with
respect to initial margin collected by a qualifying CSE in a non-
segregation jurisdiction in reliance on Sec. 23.160(e), Sec.
23.157(c) also would not apply to initial margin that is collected
by the CSE. Section 23.157(c) requires a CSE to enter a custodial
agreement meeting specified requirements with respect to any funds
that the CSE holds (i.e., initial margin posted or collected by the
CSE). Because CSEs that rely on Sec. 23.160(e) are not required to
hold collateral in accordance with Sec. 23.157(b) for initial
margin that they collect, they also would not be required to comply
with Sec. 23.157(c) with respect to initial margin that they
collect.
\175\ This provision only provides relief from the custodial
requirement for collection of initial margin in Sec. 23.157(b).
Accordingly, FCSs and foreign branches of U.S. CSEs remain subject
to the requirements of Sec. 23.157(a) and (c) of the Final Margin
Rule with respect to initial margin that is posted in a non-
segregation jurisdiction (which the CSE would be unable to comply
with in a non-segregation jurisdiction).
\176\ If the special provision for non-segregation jurisdictions
is available, then the special provision for non-netting
jurisdictions (discussed in the next section) would not be available
even if the relevant foreign jurisdiction is also a ``non-netting
jurisdiction.'' As explained in supra note 174, because CSEs that
rely on Sec. 23.160(e) are not required to hold collateral in
accordance with Sec. 23.157(b) for initial margin that they
collect, they would not be required to comply with Sec. 23.157(c)
with respect to initial margin that they collect.
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This provision is narrowly tailored to limit its availability to
FCSs (and foreign branches of U.S. CSEs) in foreign jurisdictions where
compliance with the Final Margin Rule's custodial requirements is
effectively precluded due to impediments inherent in the relevant
foreign jurisdiction.\177\ In addition, this provision is only
available in such jurisdictions if the following conditions are
satisfied. First, the CSE's counterparty must be a non-U.S. person that
is not a CSE, and the counterparty's obligations under the swap must
not be guaranteed by a U.S. person.\178\ Second, the CSE must collect
initial margin in cash on a gross basis, and post and collect variation
margin in cash, in accordance with the Final Margin Rule.\179\ The
collection of margin on a gross basis ensures that the CSE has adequate
collateral in the event of a counterparty or custodial default;
similarly, not requiring the CSE to post initial margin minimizes the
amount of collateral that may not be recovered if the CSE's
counterparty defaults. Third, for each broad risk category set out in
section 23.154(b)(2)(v) of the Final Margin Rule,\180\ the total
outstanding notional value of all uncleared swaps in that broad risk
category, as to which the CSE is relying on section 23.160(e), may not
exceed 5 percent of the CSE's total outstanding notional value for all
uncleared swaps in the same broad risk category. Accordingly, a 5
percent limit applies to each of the four broad risk categories set
forth in section 23.154(b)(2)(v): Credit, equity, foreign exchange and
interest rates (considered together as a single asset class), and
commodities. Fourth, the CSE must have policies and procedures ensuring
that it is in compliance with all of the requirements of this
exception. Fifth, the CSE must maintain books and records properly
documenting that all of the requirements of this exception are
satisfied.\181\
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\177\ The special provision applies where inherent limitations
in the legal or operational infrastructure in the applicable foreign
jurisdiction make it impracticable for the FCS (or foreign branch of
a U.S. CSE) and its counterparty to post initial margin in
compliance with the custodial requirements of Sec. 23.157 of the
Final Margin Rule. The special provision does not apply if the CSE
that is subject to the foreign regulatory restrictions is permitted
to post collateral for the uncleared swap in compliance with the
custodial arrangements of Sec. 23.157 in the United States or a
jurisdiction for which the Commission has issued a comparability
determination with respect to Sec. 23.157. See 17 CFR 23.160(e)(1)
and (2).
\178\ The Commission would expect the CSE's counterparty to be a
local financial end user that is required to comply with the foreign
jurisdiction's laws and that is prevented by regulatory restrictions
in the foreign jurisdiction from posting collateral for the
uncleared swap in compliance with the custodial arrangements of
Sec. 23.157 in the United States or a jurisdiction for which the
Commission has issued a comparability determination under the Final
Rule, even using an affiliate.
\179\ The CSE must collect initial margin in accordance with
Sec. 23.152(a) on a gross basis, in the form of cash pursuant to
Sec. 23.156(a)(1)(i) and post and collect variation margin in
accordance with Sec. 23.153(a) in the form of cash pursuant to
Sec. 23.156(a)(1)(i). See Sec. 23.160(e)(4) of the Final Rule.
\180\ Section 23.154(b)(2)(v) of the Final Margin Rule permits a
CSE to use an internal initial margin model that reflects offsetting
exposures, diversification, and other hedging benefits within four
broad risk categories: Credit, equity, foreign exchange and interest
rates (considered together as a single asset class), and commodities
when calculating initial margin for a particular counterparty if the
uncleared swaps are executed under the same ``eligible master
netting agreement.'' See 17 CFR 23.154(b)(2)(v).
\181\ See 17 CFR 23.160(e).
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In adopting this provision, the Commission considered the various
alternatives endorsed by commenters, including the adoption of a
blanket exclusion, subject to a transactional volume limit (e.g., using
a 5 percent limit patterned after a limited exclusion for certain
jurisdictions in the Guidance, as discussed in section II.B.4.a.
above). However, given the importance of the Final Margin Rule's
requirements to the protection of CSEs and the broader financial
system, and the potential for a blanket exclusion to incentivize market
participants to structure their swap business solely to avoid
application of the Commission's margin requirements, the Commission
believes that a more targeted approach that provides relief from only
from the requirement to post initial margin and the custodial
arrangement requirements that pertain to initial margin collected by a
CSE, as described above, is appropriate. While the Commission believes
that the relief provided by the special provision is appropriate
because FCSs and foreign branches of U.S. CSEs would otherwise be
effectively precluded from entering swaps in non-segregation
jurisdictions, the Commission also believes that, in order to protect
the safety and soundness of FCSs and foreign branches of U.S. CSEs
relying on the special provision, the exception from the specified
requirements is appropriately limited, as these CSEs are integral to
the stability of the U.S. financial system.
Therefore, rather than provide an exception from all of the
Commission's margin requirements to CSEs that engage in swaps
activities in non-segregation jurisdictions up to a 5% limit, as
suggested by some commenters, the special provision only excepts
qualifying FCSs and foreign branches of U.S. CSEs from certain
specified requirements, subject to specified conditions (including a 5
percent limit in each of four broad risk categories set forth in Sec.
23.154(b)(2)(v)), as described above. The Commission believes that
imposing a 5 percent limit in each of the four broad risk categories
set out in Sec. 23.154(b)(2)(v) is necessary because the FCS (or
foreign branch of a U.S. CSE) may have a large notional amount
outstanding in the foreign exchange and interest rate category (which
is considered together as a single class) which would effectively
eviscerate any limit in other lower notional risk categories.
The Commission believes that the total outstanding notional value
of all
[[Page 34834]]
uncleared swaps as to which an FCS relies on Sec. 23.160(e) should not
exceed 5 percent of the FCS's total outstanding notional amount of
uncleared swaps (in each of the four broad risk categories), rather
than the total notional outstanding amount of uncleared swaps of its
ultimate parent entity. Using the ultimate parent entity's swap
activity as the basis for the formula could allow the FCS to engage in
significant levels of swap activity in non-segregation jurisdictions
based on swap activities of its affiliates, rendering the 5 percent
limit meaningless. In addition, as an FCS is a registered CSE, its swap
activities with U.S. persons were sufficient to require its
registration in the United States, and therefore its swap activity in
the non-segregation jurisdiction would never account for all of the
CSE's swap dealing activity.
5. Special Provision for Non-Netting Jurisdictions
a. Comments
Commenters generally agreed that, at a minimum, the Commission
should provide an exception for swaps with counterparties located in
jurisdictions in which netting, collateral or third party custodial
arrangements may not be legally effective, including in a
counterparty's insolvency.\182\ ISDA and JBA proposed that an exception
for non-netting jurisdictions should apply up to 5 percent of the
aggregate notional amount of a CSE's uncleared swaps.\183\ They argued
that, without enforceable netting and collateral arrangements, a
bankruptcy administrator could ``cherry pick'' when determining the
return of posted collateral in the event of insolvency.\184\ ISDA
further argued that imposing margin in such cases could severely limit
swaps activity in non-netting jurisdictions and cause significant
disruptions in financial markets.\185\
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\182\ See ABA/ABASA at 5 n.14; IIB/SIFMA at 13 n.44; ISDA at 10
(requesting an exemption for jurisdictions where getting a ``clean''
netting or collateral opinion is ``not possible''); JBA at 10.
\183\ See ISDA at 10; JBA at 10.
\184\ See ISDA at 10 (further arguing that a CSE may not be able
to effectively foreclose on margin in event of a counterparty
default); JBA at 10.
\185\ See ISDA at 10.
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ISDA and JBA further recommended that, absent an exception for non-
netting jurisdictions, CSEs should have at least some exception from
the requirement to collect or post margin.\186\ According to ISDA,
without such an exception, a CSE could be prevented from applying
collateral to the obligations of the counterparty and face difficulties
in recovering it.\187\ ISDA argued that posting margin could therefore
increase risk to the CSE, while an exception could bypass segregation
problems in the non-netting jurisdiction.\188\
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\186\ See ISDA at 10-11 (requesting exemption from requirement
to post initial margin); JBA at 10 (requesting exemption from both
initial and variation margin requirements because, under such
conditions, amount of variation margin to be posted or collected
cannot be fixed).
\187\ See ISDA at 11.
\188\ See id.
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b. Final Rule
The Commission is adopting a special provision, also included in
the Prudential Regulators' Final Margin Rule, for non-netting
jurisdictions.\189\ Under the Final Rule, a CSE that cannot conclude,
with a well-founded basis, that the netting agreement with a
counterparty in a foreign jurisdiction meets the definition of an
``eligible master netting agreement'' set forth in the Final Margin
Rule may nevertheless net uncleared swaps in determining the amount of
margin that it posts, provided that certain conditions are met.\190\ In
order to avail itself of this special provision, the CSE must treat the
uncleared swaps covered by the agreement on a gross basis in
determining the amount of initial and variation margin that it must
collect, but may net those uncleared swaps in determining the amount of
initial and variation margin it must post to the counterparty, in
accordance with the netting provisions of the Final Margin Rule.\191\
Requiring CSEs to calculate and collect initial margin on a gross basis
is intended to ensure that the CSE can obtain the collateral posted
with the counterparty in the event of counterparty default. As with the
special provision for non-segregation jurisdictions in section
23.160(e) of the Final Rule, this provision is carefully tailored to
allow CSEs to enter into uncleared swaps in ``non-netting''
jurisdictions but without abandoning the key protections behind the
netting requirement under the Final Margin Rule. A CSE that enters into
uncleared swaps in ``non-netting'' jurisdictions in reliance on this
provision must have policies and procedures ensuring that it is in
compliance with the special provision's requirements, and maintain
books and records properly documenting that all of the requirements of
this exception are satisfied.\192\
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\189\ As used in this release, a ``non-netting jurisdiction'' is
a jurisdiction in which a CSE cannot conclude, with a well-founded
basis, that the netting agreement with a counterparty in that
foreign jurisdiction meets the definition of an ``eligible master
netting agreement'' set forth in the Final Margin Rule. See 17 CFR
23.151.
\190\ The Final Margin Rule permits offsets in relation to
either initial margin or variation margin calculation when (among
other things), the offsets related to swaps are subject to the same
eligible master netting agreement. This ensures that CSEs can
effectively foreclose on the margin in the event of a counterparty
default, and avoids the risk that the administrator of an insolvent
counterparty will ``cherry-pick'' from posted collateral to be
returned.
\191\ As noted above, in the event that the special provision
for non-segregation jurisdictions applies to a CSE, then the special
provision for non-netting jurisdictions would not apply to the CSE
even if the relevant jurisdiction is also a ``non-netting
jurisdiction.'' In this circumstance, the CSE must collect the gross
amount of initial margin in cash (but would not be required to post
initial margin), and post and collect variation margin in cash in
accordance with the requirements of the special provision for non-
segregation jurisdictions, as discussed in section II.B.4.b.
\192\ See Sec. 23.160(d) of the Final Rule.
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The Commission considered ISDA's request that it adopt a blanket
exclusion, subject to a percentage limitation based on the level of
swap activity. However, the Commission believes that a blanket
exclusion, even with a transactional limit, presents a significant risk
that the safety and soundness of a CSE engaged in swaps in non-netting
jurisdictions would be insufficiently protected because, without the
collection of sufficient margin, the CSE could be unduly exposed to
counterparty default. The Commission also considered, but determined to
not adopt, ISDA's request that posting to counterparties in non-netting
jurisdictions not be required.\193\ Because the posting requirement
serves to limit the ability of a CSE to assume excessive risk, the
Commission believes that CSEs should be required to post margin in
order to advance the objectives of the margin mandate.
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\193\ The Commission agrees with commenters that without
enforceable netting and collateral arrangements, there is a risk
that the administrator of an insolvent counterparty will ``cherry-
pick'' from posted collateral to be returned in the event of
insolvency. This would result in an increase in the risk in posting
collateral, because a CSE may not be able to effectively foreclose
on the margin in the event its counterparty defaults.
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C. Comparability Determinations
As discussed above, consistent with CEA section 2(i) and comity
principles, the Final Rule permits eligible CSEs to rely on substituted
compliance to the extent that the Commission determines the relevant
foreign jurisdiction's margin requirements are comparable to the
Commission's. Specifically, the Final Rule outlines a framework for the
Commission's comparability determinations, including eligibility and
submission requirements for requesters and the Commission's standard of
review for making comparability determinations.\194\
---------------------------------------------------------------------------
\194\ See 17 CFR 23.160(c).
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[[Page 34835]]
1. Proposed Rule
As proposed, section 23.160(c) established a process for requesting
comparability determinations. Specifically, the proposed rule
identified persons eligible to request a comparability determination
(CSEs eligible to rely on substituted compliance and any relevant
foreign regulatory authorities) and the information and documentation
they should provide the Commission, including how the relevant foreign
jurisdiction's margin requirements address the various elements of the
Commission's margin regime (e.g., the products and entities subject to
margin requirements).
The proposed rule also identified several factors the Commission
would consider in making a comparability determination, such as how the
relevant foreign margin requirements compare to International Standards
\195\ and whether they achieve comparable outcomes to the Commission's
requirements. The Commission explained that its analysis would follow
an outcome-based approach, one that would focus on evaluating the
outcomes and objectives of the foreign margin requirements and not
require them to be identical to the Commission's margin
requirements.\196\ The Commission further explained that it would
review a foreign margin regime's comparability on an element-by-element
basis, such that a foreign jurisdiction's margin requirements could be
deemed comparable with respect to some elements of the Commission's
margin requirements and not others.\197\ The Commission made clear,
however, that consistent with its outcome-based approach, a
comparability determination could be appropriate even if the foreign
jurisdiction approaches an element differently.\198\
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\195\ See proposed 17 CFR 23.160(a)(3) (defining ``International
Standards'' as based on the BCBS-IOSCO framework).
\196\ See Proposal, 80 FR at 41389.
\197\ See id.
\198\ See id. (``[T]he Commission would evaluate whether a
foreign jurisdiction has rules and regulations that achieve
comparable outcomes. If it does, the Commission believes that a
comparability determination may be appropriate, even if there may be
differences in the specific elements of a particular regulatory
provision.'').
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The proposed rule concluded by explaining the regulatory effect of
complying with a foreign jurisdiction's margin requirements in reliance
on a comparability determination, such that a violation of a foreign
margin requirement could constitute a violation of the Commission's
corresponding requirement. It also codified the Commission's authority
to condition or otherwise modify any comparability determination it
issues.
The Commission requested comment on all aspects of proposed Sec.
23.160(c).\199\
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\199\ The Commission also requested comment on the scope of the
Commission's proposed substituted compliance regime, whether the
Commission should develop an interim process for comparability
determinations that would take into account differing implementation
timeliness for margin rules by other foreign jurisdictions, and the
need for an emerging markets exception. Comments received in
response to these questions were addressed above.
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2. Comments
Commenters generally focused on the Commission's proposed approach
to evaluating the comparability of a foreign jurisdiction's margin
regime.\200\ Commenters supported an approach that would focus on the
regulatory objectives and outcomes of the relevant margin regimes and
not require uniformity with the Commission's rule provisions.\201\ JBA,
for instance, urged the Commission not to deny a comparability
determination because a Commission rule is ``stricter,'' but to focus
on whether the substance of the foreign jurisdiction's rules
effectively achieves the objective of mitigating risk.\202\
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\200\ See proposed 17 CFR 23.160(c)(2)-(3); Proposal, 80 FR at
41389-90.
\201\ See, e.g., AIMA/IA at 3-4 (absent ``automatic substituted
compliance'' for any transaction involving an entity from a
jurisdiction that participated in the WGMR, Commission should make
comparability determinations based ``on broad comparability of
requirements rather than detailed correspondence of rules''); ICI
Global at 9-10; IIB/SIFMA at 3; ISDA at 7; JBA at 9; Vanguard at 3.
\202\ See JBA at 9 (for example, while Commission's proposed
margin rule with respect to eligible collateral for variation margin
was narrower in scope than rule proposed by European or Japanese
authorities, foreign regulations are not necessarily less effective
from a risk mitigation perspective).
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Commenters expressed concern, however, that the Commission's
proposed approach was overly complicated and would undermine an
outcome-based approach.\203\ IIB/SIFMA described the Commission's
proposed approach as too ``granular,'' requiring ``consistency at a
level of detail that ignores the overall risk mitigating impact'' of a
foreign jurisdiction's margin regime.\204\ IIB/SIFMA suggested that the
``test for comparability'' should be ``whether differences between the
regimes would, in the aggregate, create a significant and unacceptable
level of risk to CSEs or the U.S. financial system.'' \205\
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\203\ See, e.g., ICI Global at 10 (proposed approach to
determining comparability is ``unnecessarily complicated'' and
effectively requires comparability with respect to ``each particular
aspect'' of the foreign jurisdiction's margin regime); ISDA at 7
(``complexity and specificity'' of Commission's proposed approach is
``not consistent with a general outcome-based approach'').
\204\ See IIB/SIFMA at 9 (element-by-element approach would
result in ``stricter-rule-applies'' approach).
\205\ See id. at 10 (margin regimes that comply with
International Standards would likely satisfy such a test).
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Commenters also expressed concern that issuing comparability
determinations with respect to some but not all of a foreign
jurisdiction's margin requirements would be challenging and costly to
implement.\206\ As a result, market participants would either default
to the Commission's margin requirements, undercutting the benefits of
substituted compliance,\207\ or modify their cross-border activities to
avoid Commission regulation, increasing market fragmentation.\208\ ISDA
further argued that an element-by-element approach would be
inconsistent with the goals of the BCBS-IOSCO framework to avoid
``duplicative or conflicting margin requirements'' and ensuring
``substantial certainty'' as to which country's margin rules
apply.\209\ Commenters urged the Commission to evaluate and issue a
comparability determination for a foreign jurisdiction's margin regime
as a whole.\210\
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\206\ See, e.g., PensionsEurope at 2 (there are ``some
benefits'' to an element-by-element approach but, by creating
potential for partial comparability determinations, proposed rule
would add ``a significant amount of complexity'' and ``likely create
more problems than it solves''); SIFMA AMG at 8 (``the potential for
piecemeal comparability determinations'' would lead to
``uncertainty, compliance difficulties and the potential for margin
disputes''); Vanguard at 4-5 (market participants would be required
to develop and implement a new system designed to apply the
Commission's comparability determinations and ensure simultaneous
compliance with two sets of rules).
\207\ See, e.g., ICI Global at 10; IIB/SIFMA at 9; SIFMA at 8
(Commission's prior issuance of partial comparability determinations
with respect to swap trading relationship documentation led to
confusion and disagreements regarding which rule sections may be
complied with via substituted compliance).
\208\ See IIB/SIFMA at 9; SIFMA AMG at 7.
\209\ See ISDA at 8 (highlighting background discussion of
element 7 of the BCBS-IOSCO framework (interaction of national
regimes in cross-border transactions), which encourages cooperation
among regulatory regimes to produce ``sufficiently consistent and
non-duplicative'' margin requirements).
\210\ See, e.g., ICI Global at 2, 10 (Commission should
``consider [] the margin rules of a jurisdiction in their entirety''
and not ``mak[e] determinations for each element of the margin
rules''); IIB/SIFMA at 9-10; SIFMA AMG at 8; Vanguard at 4-5.
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A majority of commenters also encouraged the Commission to make
consistency with the BCBS-IOSCO framework the primary focus of its
comparability determinations.\211\ FSR
[[Page 34836]]
suggested that the Commission ignore whether the foreign margin
requirements achieve comparable outcomes to the Commission's margin
requirements \212\ and make consistency with International Standards
the sole basis of its analysis.\213\ FSR argued that the ``purpose and
driving force'' of the BCBS-IOSCO framework was to create a ``uniform
global standard'' and that the Commission would undermine that goal if
it were to deny a comparability determination when the foreign margin
regime conforms to International Standards.\214\ Thus, FSR recommended
that the Commission issue a comparability determination to any regime
that complies with the International Standards despite any divergence
from the Commission's rules.\215\ IIB/SIFMA argued that margin regimes
that adhere to the BCBS-IOSCO framework are ``highly unlikely'' to
demonstrate ``material differences'' in the degree to which they reduce
aggregate risk,\216\ adding that issuing comparability determinations
based on consistency with the BCBS-IOSCO framework would further the
goal of international harmonization promoted by BCBS-IOSCO and
Congress.\217\
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\211\ See, e.g., AIMA/IA at 3; FSR at 2-5; ISDA at 7; SIFMA AMG
at 8; Vanguard at 5.
\212\ See proposed 17 CFR 23.160(c)(3)(iii).
\213\ See FSR at 5-6.
\214\ See id. at 3-4 (pointing to differences in the approaches
proposed by the European Market Infrastructure Regulation and the
Commission with regard to certain topics (e.g., eligible collateral
for variation margin) and expressing concern that, under the
Proposal, the Commission would reject comparability even though both
proposed approaches are consistent with BCBS-IOSCO framework).
\215\ See id. at 3. See also Vanguard at 5 (``unique local legal
or market structure issues'' may render certain individual elements
of a foreign jurisdiction's margin regime not comparable to
Commission's margin rules but foreign regime's ``overall outcome''
may nevertheless be consistent with BCBS-IOSCO framework).
\216\ See id. at 2 (BCBS-IOSCO framework-compliant regimes would
impose ``full, daily variation margin requirements and stringent
initial margin requirements'').
\217\ See id. at 3 (citing Dodd-Frank section 752(a)). See also
SIFMA AMG 7.
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AFR, on the other hand, argued that foreign margin rules should not
qualify for substituted compliance on the basis that they follow
International Standards alone.\218\ AFR stated that the Commission's
proposed margin rules evidenced ``a number of important differences''
from the BCBS-IOSCO framework and that, given the broad availability of
substituted compliance in the proposed rule, issuing comparability
determinations solely on the basis of consistency with International
Standards could lead to ``excessive opportunities for substituted
compliance.'' \219\
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\218\ See AFR at 7.
\219\ See id. See also IATP at 4 (provide appendix illustrating
``comparable and quantitative outcomes of swaps margining in other
jurisdictions with those under Commission authority, once margining
requirements and margin calculation methodology are agreed in those
jurisdictions'').
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3. Final Rule
After a careful review of the comments, the Commission is adopting
Sec. 23.160(c) as proposed, but is providing some additional
clarifications in response to commenters. The rule begins by
identifying persons eligible to request a comparability determination
with respect to the Commission's margin requirements, including any CSE
that is eligible for substituted compliance under rule Sec. 23.160
\220\ and any foreign regulatory authority that has direct supervisory
authority over one or more CSEs and that is responsible for
administering the relevant foreign jurisdiction's margin
requirements.\221\ Eligible persons may request a comparability
determination individually or collectively and with respect to some or
all of the Commission's margin requirements. Eligible CSEs may wish to
coordinate with their home regulators and other CSEs in order to
simplify and streamline the process. The Commission will make
comparability determinations on a jurisdiction-by-jurisdiction basis.
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\220\ See 17 CFR 23.160(c)(1)(i).
\221\ See 17 CFR 23.160(c)(1)(ii).
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Persons requesting comparability determinations should provide the
Commission with certain documents and information in support of their
request. Notably, the Final Rule provides that requesters should
provide copies of the relevant foreign jurisdiction's margin
requirements \222\ and descriptions of their objectives,\223\ how they
differ from the International Standards,\224\ and how they address the
elements of the Commission's margin requirements.\225\ With regard to
how the foreign margin requirements address the elements of the
Commission's margin requirements, the description should identify the
specific legal and regulatory provisions that correspond to each
element and, if necessary, whether the relevant foreign jurisdiction's
margin requirements do not address a particular element.\226\
Requesters should also 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 margin
requirements \227\ and any other information and documentation the
Commission deems appropriate.\228\
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\222\ See 17 CFR 23.160(c)(2)(v).
\223\ See 17 CFR 23.160(c)(2)(i).
\224\ See 17 CFR 23.160(c)(2)(iii). See also 17 CFR 23.160(a)(3)
(defining ``International Standards'' as based on the BCBS-IOSCO
framework).
\225\ See 17 CFR 23.160(c)(2)(ii) (identifying the elements as:
(A) The products subject to the foreign jurisdiction's margin
requirements; (B) the entities subject to the foreign jurisdiction's
margin requirements; (C) the treatment of inter-affiliate derivative
transactions; (D) the methodologies for calculating the amounts of
initial and variation margin; (E) the process and standards for
approving models for calculating initial and variation margin
models; (F) the timing and manner in which initial and variation
margin must be collected and/or paid; (G) any threshold levels or
amounts; (H) risk management controls for the calculation of initial
and variation margin; (I) eligible collateral for initial and
variation margin; (J) the requirements of custodial arrangements,
including segregation of margin and rehypothecation; (K) margin
documentation requirements; and (L) the cross-border application of
the foreign jurisdiction's margin regime). Section 23.160(c)(2)(ii)
largely tracks the elements of the BCBS-IOSCO framework, but breaks
them down into their components as appropriate to ensure ease of
application.
\226\ See id.
\227\ See 17 CFR 23.160(c)(2)(iv) (requesting that such
description discuss the powers of the foreign regulatory authority
or authorities to supervise, investigate, and discipline entities
for compliance with the margin requirements and the ongoing efforts
of the regulatory authority or authorities to detect and deter
violations of the margin requirements).
\228\ See 17 CFR 23.160(c)(2)(vi). See also 17 CFR 23.160(c)(7)
(delegating authority to request additional information and/or
documentation 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).
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The Final Rule identifies certain key factors that the Commission
will consider in making a comparability determination. Specifically,
the Commission will consider the scope and objectives of the relevant
foreign jurisdiction's margin requirements; \229\ whether the relevant
foreign jurisdiction's margin requirements achieve comparable outcomes
to the Commission's corresponding margin requirements; \230\ and the
ability of the relevant regulatory authority or authorities to
supervise and enforce compliance with the relevant foreign
jurisdiction's margin requirements.\231\
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\229\ See 17 CFR 23.160(c)(3)(i). See also 17 CFR 23.160(a)(3)
(defining ``International Standards'' as based on the BCBS-IOSCO
framework).
\230\ See proposed 17 CFR 23.160(c)(3)(ii). As discussed above,
the Commission's Final Margin Rule is based on the International
Standards; therefore, the Commission expects that the relevant
foreign margin requirements would conform to the International
Standards at minimum in order to be deemed comparable to the
Commission's corresponding margin requirements.
\231\ See 17 CFR 23.160(c)(3)(iii). See also supra note 227; 17
CFR 23.160(c)(3)(iv) (indicating the Commission would also consider
any other relevant facts and circumstances).
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As indicated in the proposed rule, the Final Rule reflects an
outcome-based approach to assessing the comparability of a foreign
jurisdiction's margin
[[Page 34837]]
requirements. Instead of demanding strict uniformity with the
Commission's margin requirements, the Commission will evaluate the
objectives and outcomes of the foreign margin requirements in light of
foreign regulator(s)' supervisory and enforcement authority.
Recognizing that jurisdictions may adopt different approaches to
achieving the same outcome, the Commission will focus on whether the
foreign jurisdiction's margin requirements are comparable to the
Commission's in purpose and effect, not whether they are comparable in
every aspect or contain identical elements.
As commenters noted, the Commission was actively involved in
developing the BCBS-IOSCO framework, and the Commission believes that
the minimum standards it establishes are consistent with the objectives
of the Commission's own margin requirements. However, while the BCBS-
IOSCO framework establishes minimum standards that are consistent with
the objectives of the Commission's own margin requirements, the
Commission notes that just because a foreign jurisdiction's margin
requirements are consistent with International Standards does not
necessarily mean that they will be comparable to the Commission's
requirements.\232\ Consequently, in the Commission's view, consistency
with International Standards is necessary but may not be sufficient to
finding comparability.\233\
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\232\ The BCBS-IOSCO framework leaves certain elements open to
interpretation (e.g., the definition of ``derivative'') and
expressly invites regulators to build on certain principles as
appropriate. See, e.g., Element 4 (eligible collateral) (national
regulators should ``develop their own list of eligible collateral
assets based on the key principle, taking into account the
conditions of their own markets''); Element 5 (initial margin) (the
degree to which margin should be protected would be affected by
``the local bankruptcy regime, and would vary across
jurisdictions''); Element 6 (transactions with affiliates)
(``Transactions between a firm and its affiliates should be subject
to appropriate regulation in a manner consistent with each
jurisdiction's legal and regulatory framework.'').
\233\ As the Commission noted above, the Final Margin Rule
included substantial modifications from the Proposed Margin Rule
that further aligned the Commission's margin requirements with
International Standards and, as a result, the potential for conflict
with foreign margin requirements should be reduced. See supra note
29. The Commission further notes that whether a particular margin
requirement in a foreign jurisdiction is comparable to the
Commission's corresponding requirement entails a fact-specific
analysis.
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As stated in the proposed rule, the Commission will review the
foreign margin requirements on an element-by-element basis.\234\ Margin
regimes are complex structures made up of a number of interrelated
components, and differences in how jurisdictions approach and assemble
those components are inevitable, even among jurisdictions that base
their margin requirements on the principles and requirements set forth
in the BCBS-IOSCO framework. In order to arrive at a meaningful and
complete comparability determination, the Commission must therefore
engage in a fact-specific analysis to develop a clear understanding of
the elements of the foreign margin regime and how they interact. The
Commission believes this level of review will support its outcome-based
approach by aiding its assessment of whether such differences affect
comparability.
---------------------------------------------------------------------------
\234\ See 17 CFR 23.160(c)(2) (specifying that persons
requesting comparability determinations should provide the
Commission with documentation and information relating to each
element of the Commission's margin requirements).
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As indicated in the proposed rule, the Commission is allowing for
the possibility that a comparability determination may not include all
elements of a foreign jurisdiction's margin regime.\235\ The Commission
believes that this position is preferable to an all-or-nothing
approach, in which the Commission would be unable to make a
comparability determination for an entire jurisdiction if one or more
aspects of the foreign jurisdiction's margin regime results in an
outcome that is critically different from that of the Commission's.
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\235\ For example, the Commission may determine that a foreign
jurisdiction's margin regime is comparable with respect to its
variation margin requirements but not with respect to custodial
arrangements, including segregation and rehypothecation
requirements.
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The Final Rule provides that any CSE that, in accordance with a
comparability determination, complies with a foreign jurisdiction's
margin requirements will be deemed in compliance with the Commission's
corresponding margin requirements.\236\ Accordingly, if the Commission
determines that a CSE has failed to comply with the relevant foreign
margin requirements, it could initiate an action for a violation of the
Commission's margin requirements. In addition, all CSEs remain subject
to the Commission's examination and enforcement authority regardless of
whether they rely on a comparability determination. Although the Final
Rule does not obligate the Commission to consult with or rely on the
advice of the foreign regulatory authority in making its determination
regarding whether a violation of foreign margin requirements has
occurred, the Commission notes that Commission staff may consult with
the relevant foreign regulatory authority to assist the Commission in
making its determination.
---------------------------------------------------------------------------
\236\ See 17 CFR 23.160(c)(4).
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The Final Rule concludes by codifying the Commission's authority to
impose any terms and conditions it deems appropriate in issuing a
comparability determination,\237\ and to further condition, modify,
suspend, terminate or otherwise restrict any comparability
determination it has issued in its discretion.\238\
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\237\ See 17 CFR 23.160(c)(5).
\238\ See 17 CFR 23.160(c)(6). For instance, a comparability
determination may require modification or termination if a key basis
for the determination ceases to be true.
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Comparability determinations issued by the Commission will 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 also expects that the
relevant foreign regulator will enter into, or will have entered into,
an appropriate memorandum of understanding (``MOU'') or similar
arrangement with the Commission in connection with a comparability
determination.\239\
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\239\ Under Commission regulations 23.203 and 23.606, registered
swap dealers and major swap participants must maintain all records
required by the CEA and the Commission's regulations in accordance
with Commission regulation 1.31 and keep them open for inspection by
representatives of the Commission, the United States Department of
Justice, or any applicable prudential regulator. See 17 CFR 23.203,
23.606. The Commission further expects that prompt access to books
and records and the ability to inspect and examine a non-U.S. CSE
will be a condition to any comparability determination.
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As stated above, the Commission recognizes that systemic risks
arising from the global and interconnected swap market must be
addressed through coordinated regulatory requirements for margin across
international jurisdictions. Accordingly, the Commission will continue
its practice of actively engaging market participants and consulting
closely with foreign regulators to encourage the international
harmonization and coordination of margin requirements for uncleared
swaps and to minimize market disruptions.
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
[[Page 34838]]
entities.\240\ The Commission previously has established certain
definitions of ``small entities'' to be used in evaluating the impact
of its regulations on small entities in accordance with the RFA.\241\
The final regulation establishes a mechanism for CSEs \242\ to satisfy
margin requirements by complying with comparable margin requirements in
the relevant foreign jurisdiction as described in paragraph (c) of the
Final Rule,\243\ but only to the extent that the Commission makes a
determination that complying with the laws of such foreign jurisdiction
is comparable to complying with the corresponding margin requirement(s)
for which the determination is sought.
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\240\ 5 U.S.C. 601 et seq.
\241\ See 47 FR 18618 (Apr. 30, 1982) (finding that designated
contract markets, future commission merchants, commodity pool
operators and large traders are not small entities for RFA
purposes).
\242\ See 17 CFR 23.151 (defining ``CSE'' as a swap dealer or
major swap participant for which there is no Prudential Regulator).
\243\ See 17 CFR 23.160(c).
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The Commission previously has determined that swap dealers and
major swap participants are not small entities for purposes of the
RFA.\244\ Thus, the Commission is of the view that there will not be
any small entities directly impacted by this rule.
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\244\ See 77 FR 30596, 30701 (May 23, 2012); 77 FR 2613, 2620
(Jan. 19, 2012) (noting that like future commission merchants, swap
dealers will be subject to minimum capital requirements, and are
expected to be comprised of large firms, and that major swap
participants should not be considered to be small entities for
essentially the same reasons that it previously had determined large
traders not to be small entities).
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The Commission notes that under the Final Margin Rule, swap dealers
and major swap participants would only be required to collect and post
margin on uncleared swaps when the counterparties to the uncleared
swaps are either other swap dealers and major swap participants or
financial end users. As noted above, swap dealers and major swap
participants are not small entities for RFA purposes. Furthermore, any
financial end users that may be indirectly \245\ impacted by the Final
Rule would be similar to eligible contract participants (``ECPs''),
and, as such, they would not be small entities.\246\ Further, to the
extent that there are any foreign financial entities that would not be
considered ECPs, the Commission expects that there would not be a
substantial number of these entities significantly impacted by the
Final Rule. As noted above, most foreign financial entities would
likely be ECPs to the extent they would transact in uncleared swaps.
The Commission expects that only a small number of foreign financial
entities that are not ECPs, if any, would transact in uncleared swaps.
In addition, the material swaps exposure threshold for financial end
users in the Final Margin Rule reinforces the Commission's expectation
that only a small number of entities would be affected by the Final
Rule.
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\245\ The RFA focuses on direct impact to small entities and not
on indirect impacts on these businesses, which may be tenuous and
difficult to discern. See Mid-Tex Elec. Coop., Inc. v. FERC, 773
F.2d 327, 340 (D.C. Cir. 1985); Am. Trucking Assns. v. EPA, 175 F.3d
1027, 1043 (D.C. Cir. 1985).
\246\ As noted in paragraph (1)(xii) of the definition of
``financial end user'' in Sec. 23.151 of the Final Margin Rule, a
financial end user includes a person that would be a financial
entity described in paragraphs (1)(i)-(xi) of that definition, if it
were organized under the laws of the United States or any State
thereof. See 17 CFR 23.151. The Commission believes that this prong
of the definition of financial end user captures the same type of
U.S. financial end users that are ECPs, but for them being foreign
financial entities. Therefore, for purposes of the Commission's RFA
analysis, these foreign financial end users will be considered ECPs
and therefore, like ECPs in the U.S., not small entities.
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Accordingly, the Commission finds that there will not be a
substantial number of small entities impacted by the Final Rule.
Therefore, the Chairman, on behalf of the Commission, hereby certifies
pursuant to 5 U.S.C. 605(b) that the proposed regulations will not have
a significant economic impact on a substantial number of small
entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \247\ 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 final rulemaking will result
in the collection of information requirements within the meaning of the
PRA, as discussed below. Responses to these collections of information
will be required to obtain or retain benefits. 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. One of the collections of information required by this final
rulemaking, which is described below under the heading ``Information
Collection--Comparability Determinations,'' was previously included in
the proposed rule and discussed in the Proposal. Accordingly, the
Commission requested from the Office of Management and Budget (``OMB'')
a control number for that information collection. OMB assigned OMB
control number 3038-0111. The title for this collection of information
is ``Margin Requirements for Uncleared Swaps for Swap Dealers and Major
Swap Participants; Comparability Determinations with Margin
Requirements.'' No comments were received on the paperwork burden
associated with this information collection request. In addition, this
final rulemaking includes two additional collections of information
that were not previously proposed, which are described below under the
headings ``Information Collection--Non-Segregation Jurisdictions'' and
``Information Collection--Non-Netting Jurisdictions,'' respectively.
Accordingly, the Commission, by separate notice published in the
Federal Register concurrently with this Final Rule, will request
approval by OMB of this new information collection under OMB Control
Number 3038-0111.
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\247\ 44 U.S.C. 3501 et seq.
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1. Information Collection--Comparability Determinations
Section 731 of the Dodd-Frank Act amended the CEA to add, as
section 4s(e) thereof, provisions concerning the setting of initial and
variation margin requirements for swap dealers and major swap
participants. Each swap dealer and major swap participant for which
there is a Prudential Regulator, as defined in section 1a(39) of the
CEA, must meet margin requirements established by the applicable
Prudential Regulator, and each CSE must comply with the Commission's
regulations governing margin. With regard to the cross-border
application of the swap provisions enacted by Title VII of the Dodd-
Frank Act, section 2(i) of the CEA provides the Commission with express
authority over activities outside the United States relating to swaps
when certain conditions are met. Section 2(i) of the CEA provides that
the CEA's provisions relating to swaps enacted by Title VII of the
Dodd-Frank Act (including Commission rules and regulations promulgated
thereunder) shall not apply to activities outside the United States
unless those activities (1) have a direct and significant connection
with activities in, or effect on, commerce of the United States or (2)
contravene such rules or regulations as the Commission may prescribe or
promulgate as are necessary or appropriate to prevent the evasion of
any provision of Title VII.\248\ Because margin requirements are
critical to ensuring the safety and soundness of a CSE and supporting
the stability of the U.S. financial markets, the Commission believes
that its margin rules should
[[Page 34839]]
apply on a cross-border basis in a manner that effectively addresses
risks to the registered CSE and the U.S. financial system.
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\248\ 7 U.S.C. 2(i).
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As noted above, the Final Rule establishes margin requirements for
uncleared swaps of CSEs, with substituted compliance available in
certain circumstances, except as to a narrow class of uncleared swaps
between a non-U.S. CSE and a non-U.S. counterparty that fall within the
Exclusion. The Final Rule also establishes a procedural framework in
which the Commission will consider permitting compliance with
comparable margin requirements in a foreign jurisdiction to substitute
for compliance with the Commission's margin requirements in certain
circumstances. The Commission will consider whether the requirements of
such foreign jurisdiction with respect to margin of uncleared swaps are
comparable to the Commission's margin requirements.
Specifically, the Final Rule provides that a CSE that is eligible
for substituted compliance may submit a request, individually or
collectively, for a comparability determination.\249\ Persons
requesting a comparability determination may coordinate their
application with other market participants and their home regulators to
simplify and streamline the process. Once a comparability determination
is made for a jurisdiction, it will apply for all entities or
transactions in that jurisdiction to the extent provided in the
determination, as approved by the Commission. In providing information
to the Commission for a comparability determination, applicants must
include, at a minimum, information describing any differences between
the relevant foreign jurisdiction's margin requirements and
International Standards,\250\ and the specific provisions of the
foreign jurisdiction that govern: (A) The products subject to the
foreign jurisdiction's margin requirements; (B) the entities subject to
the foreign jurisdiction's margin requirements; (C) the treatment of
inter-affiliate derivative transactions; (D) the methodologies for
calculating the amounts of initial and variation margin; (E) the
process and standards for approving models for calculating initial and
variation margin models; (F) the timing and manner in which initial and
variation margin must be collected and/or paid; (G) any threshold
levels or amounts; (H) risk management controls for the calculation of
initial and variation margin; (I) eligible collateral for initial and
variation margin; (J) the requirements of custodial arrangements,
including segregation of margin and rehypothecation; (K) margin
documentation requirements; and (L) the cross-border application of the
foreign jurisdiction's margin regime.\251\
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\249\ A CSE may apply for a comparability determination only if
the uncleared swap activities of the CSE are directly supervised by
the authorities administering the foreign regulatory framework for
uncleared swaps. Also, a foreign regulatory agency may make a
request for a comparability determination only if that agency has
direct supervisory authority to administer the foreign regulatory
framework for uncleared swaps in the requested foreign jurisdiction.
\250\ See 17 CFR 23.160(a)(3) (defining ``International
Standards'' as based on the BCBS-IOSCO framework).
\251\ See 17 CFR 23.160(c)(2)(ii).
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In addition, the Commission expects the applicant, at a minimum, to
describe how the foreign jurisdiction's margin requirements address
each of the above-referenced elements, and identify the specific legal
and regulatory provisions that correspond to each element (and, if
necessary, whether the relevant foreign jurisdiction's margin
requirements do not address a particular element). Further, the
applicant must describe the objectives of the foreign jurisdiction's
margin requirements, the ability of the relevant regulatory authority
or authorities to supervise and enforce compliance with the foreign
jurisdiction's margin requirements, including the powers of the foreign
regulatory authority or authorities to supervise, investigate, and
discipline entities for noncompliance with the margin requirements and
the ongoing efforts of the regulatory authority or authorities to
detect and deter violations of the margin requirements. Finally, the
applicant must furnish copies of the foreign jurisdiction's margin
requirements (including an English translation of any foreign language
document) and any other information and documentation that the
Commission deems appropriate.\252\
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\252\ See 17 CFR 23.160(c)(2)(v) and (vi).
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In issuing a comparability determination, the Commission may impose
any terms and conditions it deems appropriate. In addition, the Final
Rule will provide that the Commission may, on its own initiative,
further condition, modify, suspend, terminate, or otherwise restrict a
comparability determination in the Commission's 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, the Commission will require an
applicant to notify the Commission of any material changes to
information submitted in support of a comparability determination
(including, but not limited to, changes in the foreign jurisdiction's
supervisory or regulatory regime) as the Commission's comparability
determination may no longer be valid.\253\
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\253\ The Commission expects to impose this obligation as one of
the conditions to the issuance of a comparability determination.
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The collection of information that is proposed by this rulemaking
is necessary to implement section 4s(e) of the CEA, which mandates that
the Commission adopt rules establishing minimum initial and variation
margin requirements for CSEs on all swaps that are not cleared by a
registered derivatives clearing organization, and section 2(i) of the
CEA, which provides that the provisions of the CEA relating to swaps
that were enacted by Title VII of the Dodd-Frank Act (including any
rule prescribed or regulation promulgated thereunder) apply to
activities outside the United States that have a direct and significant
connection with activities in, or effect on, commerce of the United
States. Further, the information collection is necessary for the
Commission to determine whether the requirements of the foreign rules
are comparable to the Commission's rules.
As noted above, any CSE who is eligible for substituted compliance
may make a request for a comparability determination. Currently, there
are approximately 106 swap entities provisionally registered with the
Commission. The Commission further estimates that of the approximately
106 swap entities that are provisionally registered, approximately 54
are CSEs that are subject to the Commission's margin rules as they are
not subject to a Prudential Regulator. The Commission notes that any
foreign regulatory agency that has direct supervisory authority over
one or more CSEs and that is responsible to administer the relevant
foreign jurisdiction's margin requirements may also apply for a
comparability determination. Further, once a comparability
determination is made for a jurisdiction, it will apply for all
entities or transactions in that jurisdiction to the extent provided in
the determination, as approved by the Commission. The Commission
estimates that it will receive requests for a comparability
determination from 17 jurisdictions, consisting of the 16 jurisdictions
within the G20, plus Switzerland, and that each request will impose an
average of 10 burden hours.
Based upon the above, the estimated hour burden for collection is
calculated as follows:
[[Page 34840]]
Number of respondents: 17.
Frequency of collection: Once.
Estimated annual responses per registrant: 1.
Estimated aggregate number of annual responses: 17.
Estimated annual hour burden per registrant: 10 hours.
Estimated aggregate annual hour burden: 170 hours (17 registrants x
10 hours per registrant).
2. Information Collection--Non-Segregation Jurisdictions
Section 23.160(e) of the Final Rule provides that, in certain
foreign jurisdictions where inherent limitations in the legal or
operational infrastructure of the jurisdiction make it impracticable
for the CSE and its counterparty to post initial margin for the
uncleared swap pursuant to custodial arrangements that comply with the
Commission's margin rules, an FCS or a foreign branch of a U.S. CSE may
be eligible to engage in uncleared swaps with certain non-U.S.
counterparties without complying with the requirement to post initial
margin, and without complying with the requirement to hold initial
margin collected by the CSE with one or more custodians that are not
the CSE, its counterparty, or an affiliate of the CSE or its
counterparty, pursuant to section 23.157(b) of the Final Margin
Rule,\254\ but only if certain conditions are satisfied.\255\ In order
to rely on this provision, an FCS or foreign branch of a U.S. CSE will
need to satisfy all of the conditions of the rule, including that (1)
inherent limitations in the legal or operational infrastructure of the
foreign jurisdiction make it impracticable for the CSE and its
counterparty to post any form of eligible initial margin collateral for
the uncleared swap pursuant to custodial arrangements that comply with
the Commission's margin rules; (2) foreign regulatory restrictions
require the CSE to transact in uncleared swaps with the counterparty
through an establishment within the foreign jurisdiction and do not
permit the posting of collateral for the swap in compliance with the
custodial arrangements of section 23.157 of the Final Margin Rule in
the United States or a jurisdiction for which the Commission has issued
a comparability determination under the Final Rule with respect to
section 23.157; (3) the CSE's counterparty is not a U.S. person and is
not a CSE, and the counterparty's obligations under the uncleared swap
are not guaranteed by a U.S. person; \256\ (4) the CSE collects initial
margin in cash on a gross basis, in cash, and posts and collects
variation margin in cash, for the uncleared swap in accordance with the
Final Margin Rule; \257\ (5) for each broad risk category, as set out
in section 23.154(b)(2)(v) of the Final Margin Rule, the total
outstanding notional value of all uncleared swaps in that broad risk
category, as to which the CSE is relying on section 23.160 (e), may not
exceed 5 percent of the CSE's total outstanding notional value for all
uncleared swaps in the same broad risk category; (6) the CSE has
policies and procedures ensuring that it is in compliance with the
requirements of this provision; and (7) the CSE maintains books and
records properly documenting that all of the requirements of this
provision are satisfied.\258\
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\254\ As explained further in note 174, because CSEs that rely
on section 23.160(e) are not required to hold collateral in
accordance with section 23.157(b) for initial margin that they
collect, they also would not be required to comply with 23.157(c)
with respect to initial margin that they collect.
\255\ CSEs that are not FCSs or foreign branches of U.S. CSEs
and are not otherwise excluded from the Final Margin Rule could not
engage in swap transactions in these jurisdictions.
\256\ As noted above, the Commission would expect the CSE's
counterparty to be a local financial end user that is required to
comply with the foreign jurisdiction's laws and that is prevented by
regulatory restrictions in the foreign jurisdiction from posting
collateral for the uncleared swap in the United States or a
jurisdiction for which the Commission has issued a comparability
determination under the Final Rule, even using an affiliate.
\257\ As noted above, the CSE must collect initial margin in
accordance with Sec. 23.152(a) on a gross basis, in the form of
cash pursuant to Sec. 23.156(a)(1)(i) and post and collect
variation margin in accordance with section 23.153(a) in the form of
cash pursuant to section 23.156(a)(1)(i). See Sec. 23.160(e)(4) of
the Final Rule.
\258\ See 17 CFR 23.160(e).
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3. Information Collection--Non-Netting Jurisdictions
Section 23.160(d) of the Final Rule includes a special provision
for non-netting jurisdictions. This provision allows CSEs that cannot
conclude after sufficient legal review with a well-founded basis that
the netting agreement with a counterparty in a foreign jurisdiction
meets the definition of an ``eligible master netting agreement'' set
forth in the Final Margin Rule to nevertheless net uncleared swaps in
determining the amount of margin that they post, provided that certain
conditions are met. In order to avail itself of this special provision,
the CSE must treat the uncleared swaps covered by the agreement on a
gross basis in determining the amount of initial and variation margin
that it must collect, but may net those uncleared swaps in determining
the amount of initial and variation margin it must post to the
counterparty, in accordance with the netting provisions of the Final
Margin Rule. A CSE that enters into uncleared swaps in ``non-netting''
jurisdictions in reliance on this provision must have policies and
procedures ensuring that it is in compliance with the special
provision's requirements, and maintain books and records properly
documenting that all of the requirements of this exception are
satisfied.\259\
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\259\ See Sec. 23.160(d) of the Final Rule.
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As noted above, the Commission is publishing a separate notice in
the Federal Register concurrently with this final rule requesting
comments on the burden estimates of both new information collections to
amend OMB Control Number 3038-0111.
C. Cost-Benefit Considerations
1. Introduction
As discussed above, the Final Rule addresses the cross-border
application of the Commission's margin requirements. Specifically, the
Final Rule establishes certain key definitions (``U.S. person,''
``guarantee,'' and ``Foreign Consolidated Subsidiary''); allows CSEs to
rely on substituted compliance where appropriate; provides a limited
Exclusion for certain transactions between non-U.S. persons; includes
special provisions for ``non-segregation jurisdictions'' \260\ and
``non-netting jurisdictions;'' \261\ and establishes a framework for
making comparability determinations.
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\260\ As used in this release, a ``non-segregation
jurisdiction'' is a jurisdiction where inherent limitations in the
legal or operational infrastructure of the foreign jurisdiction make
it impracticable for the CSE and its counterparty to post initial
margin pursuant to custodial arrangements that comply with the Final
Margin Rule, as further described in section II.B.4.b.
\261\ As used in this release, a ``non-netting jurisdiction'' is
a jurisdiction in which a CSE cannot conclude, with a well-founded
basis, that the netting agreement with a counterparty in that
foreign jurisdiction meets the definition of an ``eligible master
netting agreement'' set forth in the Final Margin Rule, as described
in section II.B.5.b.
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In the sections that follow, the Commission discusses the costs and
benefits associated with the Final Rule on CSEs and affected market
participants and any reasonable alternatives.\262\ Given a general lack
of useful data regarding the costs and benefits of the Final Rule, from
commenters or otherwise, and the considerable uncertainty given that
foreign jurisdictions are at different
[[Page 34841]]
stages in implementing their regimes, the costs and benefits of the
Final Rule are generally considered in qualitative terms.
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\262\ As stated above, the Commission estimates that the Final
Rule will affect approximately 54 registered swap dealers and major
swap participants. The Commission further estimates that it will
receive requests for a comparability determination from 17
jurisdictions.
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The baseline against which the costs and benefits of this Final
Rule are being compared is the status quo, i.e., the swap market as it
exists as if the Final Margin Rule is in full effect.\263\ The cost-
benefit considerations section of the Final Margin Rule made clear that
CEA section 4s(e), read together with CEA section 2(i), applies the
margin rules to a CSE's swap activities outside the United States,
regardless of the domicile of the CSE or its counterparties.\264\
Accordingly, in considering the costs and benefits of this Final Rule,
the Commission focused on the impact of permitting substituted
compliance and certain exclusions from the Final Margin Rule.\265\
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\263\ 81 FR 636 (Jan. 6, 2016) (codified at 17 CFR parts 23 and
140). As the Commission noted above, the Final Margin Rule included
substantial modifications from the Proposed Margin Rule that further
aligned the Commission's margin requirements with International
Standards and, as a result, the potential for conflict with foreign
margin requirements should be reduced. See supra note 29.
\264\ See Final Margin Rule, 81 FR at 682. The Commission notes
that to the extent there may be differences in the particulars of
costs to foreign CSEs or financial end users, the Commission had not
been provided with information that would permit the evaluation of
any such differences.
\265\ As noted in the Final Margin Rule, as foreign
jurisdictions adopt their own margin rules, the existence of those
rules may affect the costs and benefits of the Final Margin Rule.
See Final Margin Rule, 81 FR at 682, n.359. For example, if certain
transactions become subject to duplicative foreign regulation, that
could increase costs, or reduce benefits, of compliance with the
Final Margin Rule. Because of the still developing state of foreign
law in this area and the absence of specific information on the
subject in the record, it was not possible to evaluate such effects
in detail in the Final Margin Rule release. In this rulemaking, the
same limitations do not permit a detailed evaluation of such
possible effects in the present proceeding and therefore, the
Commission discusses these possible effects in general qualitative
terms.
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The Commission is mindful of the potentially significant tradeoffs
inherent in the Final Rule. As discussed above, given the highly-
interconnected, global swap market, overseas risk can quickly manifest
in the United States. The cross-border application of the Commission's
margin rules is therefore important to protecting the U.S. financial
system from this risk. At the same time, competitive distortions and
market inefficiencies can result--and the benefits of the Commission's
cross-border framework could be reduced--if due consideration is not
given to comity principles. The Commission considered these tradeoffs
and worked to carefully tailor the cross-border approach in the Final
Rule to address comity considerations, mitigate the potential for undue
market distortions, and promote global coordination without
compromising the safety and soundness of CSEs.
Although commenters generally did not comment on the cost-benefit
discussion in the proposed rule itself,\266\ they did discuss various
costs and benefits associated with the Commission's proposal. These
comments are further addressed in the context of the Commission's cost-
benefit considerations below.
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\266\ But see IATP at 7 (Commission's assumptions about costs
and benefits of the Proposal were accurate considering the current
``stage of foreign jurisdiction rulemaking'' relating to margin
requirements); ABA/ABASA at 3 (Proposal did not adequately take into
account the costs of the proposed approach); ISDA at 5 (Proposal did
not give ``due weight'' to its impact on price discovery, risk
management, increased compliance and liquidity costs, market
fragmentation, or comity).
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2. Key Definitions
The extent to which the Commission's margin requirements apply--and
the availability of substituted compliance and the Exclusion--depends
on whether the relevant swap involves a U.S. person, a guarantee by a
U.S. person, or a Foreign Consolidated subsidiary. As discussed above,
the Final Rule adopts definitions of ``U.S. person,'' ``guarantee,''
and ``Foreign Consolidated Subsidiary'' solely for purposes of the
margin rules. The costs and benefits associated with these definitions,
and any reasonable alternatives, are discussed below. In general, the
Commission believes that the clear, objective nature of these terms,
along with the ability to rely on related written counterparty
representations, will promote legal certainty and help minimize the
costs associated with applying the Final Rule.
a. U.S. Person
As discussed in section II.A.1., the term ``U.S. person''
identifies individuals or entities whose activities have a significant
nexus to the U.S. market by virtue of being organized or domiciled in
the United States or the depth of their connection to the U.S. market,
even if they are domiciled or organized outside the United States. The
Final Rule generally follows a traditional, territorial approach to
defining a U.S. person, and the Commission believes that this
definition provides an objective and clear basis for determining those
individuals or entities that should be identified as a U.S. person.
Accordingly, the Commission does not believe market participants will
face significant costs in assessing their own U.S. person status,
particularly given the broad similarities between how the Final Rule
defines ``U.S. person'' and how the term is defined in the SEC's rules.
The Final Rule also makes clear that market participants may reasonably
rely on counterparty representations regarding their U.S. person status
absent indications to the contrary, which should further reduce any
operational costs associated with assessing U.S. person status.
The Final Rule addresses many of the concerns commenters raised
regarding the costs and benefits of its proposed approach to defining
``U.S. person.'' As discussed above, the Final Rule does not include a
U.S. majority-owned prong, which commenters argued would create
operational burdens for assessing U.S. person status and result in
regulatory overlap. Nor does it include a catchall provision, limiting
the Rule's application to a list of enumerated persons.
The Commission recognizes that, as commenters pointed out, legal
entities that fall within the unlimited U.S. responsibility prong may
also be subject to regulation under a foreign margin regime, creating
the potential for overlapping requirements. However, as discussed in
section II.A.1.c., the Commission believes that the unique nature of
the relationship between the legal entity and its U.S. person owner(s)
facilitates the legal entity's swap business and creates a significant
nexus between the legal entity and U.S. financial markets. While the
Commission understands that limiting application of the prong to
circumstances where the U.S. persons are majority owners of the legal
entity could mitigate the potential for overlapping requirements, as
the Commission explained above, the U.S. person owner(s) responsibility
for the legal entity's obligations and liabilities is unlimited
regardless of the amount of equity it owns in the legal entity.
Furthermore, excluding such legal entities from the scope of the U.S.
person definition could create incentives for U.S. persons to establish
such legal entities and use them as a pass-through for their own swap
activities solely for purposes of avoiding the margin requirements of
the Dodd-Frank Act.
The Commission also recognizes that further narrowing the
differences between the Final Rule's U.S. person definition and either
the SEC's definition or the ``U.S. person'' interpretation in the
Guidance could provide certain benefits. Namely, market participants
could enjoy reduced operational costs by relying on existing systems
and U.S. person status
[[Page 34842]]
determinations and not having to support multiple meanings of the term
``U.S. person.'' As discussed above, however, the Commission believes
that the Final Rule's ``U.S. person'' definition is appropriate in the
context of the margin rule. The Commission further believes that the
objective and clear definition set out in the Final Rule will result in
a lower overall cost for assessing U.S. person status going forward.
b. Guarantees
As explained in section II.A.2.c., under the Final Rule, the term
``guarantee'' is defined to include arrangements, pursuant to which one
party to an uncleared swap has rights of recourse against a guarantor,
with respect to its counterparty's obligations under the uncleared
swap. The Final Rule further defines what it means for a party to have
rights of recourse, and further encompasses any arrangement pursuant to
which the guarantor itself has a conditional or unconditional legally
enforceable right to receive or otherwise collect, in whole or in part,
payments from any other guarantor with respect to the counterparty's
obligations under the uncleared swap.\267\ As further explained in
section II.B.2.b.i, ``U.S. Guaranteed CSEs'' \268\ are eligible for
substituted compliance, but are ineligible for the Exclusion and the
special provision for non-segregation jurisdictions, to the same extent
as U.S. CSEs (except that foreign branches of U.S. CSEs may be eligible
for the special provision for non-segregation jurisdictions, as
described in section II.B.4.b.).\269\
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\267\ See 17 CFR 23.160(a)(2). As noted above, under the Final
Rule, the term ``guarantee'' applies whenever a party to the swap
has a legally enforceable right of recourse against a guarantor with
respect to its counterparty's obligations under the swap, regardless
of whether such right of recourse is conditioned upon the
counterparty's insolvency or failure to meet its obligations under
the relevant swap, or whether the counterparty seeking to enforce
the guarantee is required to make a demand for payment or
performance from its counterparty before proceeding against the U.S.
guarantor.
\268\ This release uses the term ``U.S. Guaranteed CSE'' for
convenience only. Whether a non-U.S. CSE falls within the meaning of
the term ``U.S. Guaranteed CSE'' varies on a swap-by-swap basis,
such that a non-U.S. CSE may be considered a U.S. Guaranteed CSE for
one swap and not another, depending on whether the non-U.S. CSE's
obligations under such swap are guaranteed by a U.S. person.
\269\ As further discussed above, the Final Rule generally
treats uncleared swaps of non-U.S. CSEs, where the non-U.S. CSE's
obligations under the uncleared swap are guaranteed by a U.S.
person, the same as uncleared swaps of a U.S. CSE. In addition,
guarantees may affect whether full or partial substituted compliance
is available. Further, under the Final Rule, the Exclusion is not
available if either party's obligations under the swap are
guaranteed by a U.S. person. In addition, in order for an FCS or
foreign branch of a U.S. CSE to engage in uncleared swaps in non-
segregation jurisdictions as provided in section 23.160(e) of the
Final Rule, one of the conditions that must be satisfied is that the
counterparty to the swap cannot be a U.S. person and its obligations
under the uncleared swap cannot be guaranteed by a U.S. person.
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As commenters noted, limiting the scope of guarantees in the
context of the margin requirements to arrangements that include a right
of recourse offers the benefit of legal certainty, making the
definition relatively easy to apply and helping keep down the cost of
determining whether a transaction involves a U.S. Guaranteed CSE.
Allowing market participants to rely on counterparty representations
with regard to the presence of guarantees should also help market
participants keep costs down. Although the Final Rule adopts a
definition of guarantee that is different than the existing
interpretation in the Guidance, which may result in market participants
incurring additional costs to update their current systems, those
operational challenges may be mitigated given that the definition is
straight-forward and similar to that previously adopted by the SEC. In
addition, while the inclusion of language that addresses indirect
guarantees may result in some added operational challenges or
assessment costs, the Commission believes the provision is necessary to
avoid creating incentives for market participants to structure
guarantee arrangements in order to avoid application of the Dodd-Frank
margin requirements. The Final Rule also achieves substantial benefits
in harmonizing with the guarantee definitions adopted by the Prudential
Regulators.
The Commission recognizes that, as discussed in section II.B.2 and
as pointed out by commenters, the definition of ``guarantee'' adopted
in the Final Rule does not encompass all forms of financial
arrangements or support that may result in a direct transfer of risk to
the U.S. financial markets, such as keepwells and liquidity puts. Nor
would it include instances in which a parent and a subsidiary entity
are closely related and the parent faces strong reputational incentives
to support the subsidiary. As discussed above, however, the Commission
believes that, in the context of the Final Rule, non-U.S. CSEs
benefitting from such other forms of U.S. financial support will likely
meet the definition of an FCS and thus be adequately covered by the
Commission's margin requirements. Given the further inclusion of
language that addresses indirect guarantees and the mandate to
coordinate with the Prudential Regulators, the Commission believes that
a more limited ``guarantee'' definition is appropriate in the context
of the cross-border application of the margin requirements and will not
undermine the safety and soundness of CSEs or the U.S. financial
markets.
c. Foreign Consolidated Subsidiary
As explained in section II.B.3, the Final Rule uses the term
``Foreign Consolidated Subsidiary'' to identify non-U.S. CSEs whose
uncleared swaps raise substantial supervisory concern in the United
States by virtue of their relationship with their U.S. ultimate parent
entity and because their financial position, operating results, and
statement of cash flows have a direct impact on the financial position,
risk profile and market value of their U.S. ultimate parent entity.
FCSs are not eligible for the Exclusion but are otherwise treated the
same as any other non-U.S. CSEs whose obligations under the relevant
swap are not guaranteed by a U.S. person.
As commenters noted, the Final Rule's use of a consolidation test
that relies on U.S. GAAP to define ``Foreign Consolidated Subsidiary''
promotes legal certainty by articulating a clear, familiar, bright-line
test. The Commission also took into account that the consolidation test
is already being used in preparing financial statements, and as a
result, should not result in more costs to market participants.\270\
The Commission further believes that allowing market participants to
rely on counterparty representations with respect to their status as an
FCS will reduce any operational costs that may be associated with
determining whether a counterparty is an FCS, especially given that the
Prudential Regulators adopted a similar definition for purposes of
their margin rules.
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\270\ As discussed in greater detail in section II.A.3, although
commenters suggested various modifications to the FCS definition,
such as relying on IFRS instead of U.S. GAAP or including non-U.S.
CSEs whose U.S. parent meets standards for consolidation, but is not
required to prepare consolidated financial statements under U.S.
GAAP, the Commission does not believe such modifications would offer
substantial benefits.
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3. Application
Section II.B describes the application of the Commission's margin
rules to cross-border uncleared swaps between CSEs and their
counterparties, including the availability of substituted compliance
and the Exclusion. The Final Rule also includes special provisions for
non-segregation
[[Page 34843]]
jurisdictions and non-netting jurisdictions.
a. Substituted Compliance
As described in section II.B.2.b and as set out in Table A, the
extent to which substituted compliance is available under the Final
Rule depends on whether the relevant swap involves a U.S. person, a
guarantee by a U.S. person, or an FCS. U.S. CSEs and U.S. Guaranteed
CSEs are eligible for substituted compliance only with respect to the
requirement to post (but not the requirement to collect) initial
margin, provided that their counterparty is a non-U.S. person
(including a non-U.S. CSE) whose obligations under the swap are not
guaranteed by a U.S. person.\271\ On the other hand, non-U.S. CSEs
whose obligations under the relevant swap are not guaranteed by a U.S.
person are broadly eligible for substituted compliance (including for
their swaps with U.S. persons that are not CSEs); however, only partial
substituted compliance would be available for such non-U.S. CSE's swaps
with U.S. CSEs or U.S. Guaranteed CSEs.\272\
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\271\ Similarly, a non-U.S. CSE (including an FCS) is eligible
for substituted compliance with respect to the requirement to
collect initial margin if its counterparty is a U.S. CSE or a U.S.
Guaranteed CSE.
\272\ A subset of these non-U.S. CSEs may qualify for the
Exclusion, as described in section II.B.3.b above.
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The Commission recognizes that the decision to offer any
substituted compliance in the first instance carries certain trade-
offs. Given the global and highly-interconnected nature of the swap
market, where risk does not respect national borders, market
participants are likely to be subject to the regulatory interest of
more than one jurisdiction. As commenters have pointed out, allowing
compliance with foreign margin requirements as an alternative to
domestic requirements can therefore reduce the application of
duplicative or conflicting requirements, resulting in lower compliance
costs and facilitating a more level playing field. Substituted
compliance also helps preserve the benefits of an integrated, global
swap market by fostering and advancing efforts among U.S. and foreign
regulators to collaborate in establishing robust regulatory standards,
as envisioned by the BCBS-IOSCO framework. If not properly implemented,
however, the Commission's margin regime could lose some of its
effectiveness. Accordingly, as commenters have recognized, the ultimate
costs and benefits of substituted compliance are affected by the
standard under which it is granted and the extent to which it is
applied. The Commission was mindful of this dynamic in structuring a
substituted compliance regime for the margin requirements and believes
the Final Rule strikes an appropriate balance, enhancing market
efficiency and fostering global coordination of margin requirements
without compromising the safety and soundness of CSEs and the U.S.
financial system.
The Commission also understands that, as commenters pointed out, by
not offering substituted compliance equally to all CSEs, the Final Rule
may lead to certain competitive disparities between CSEs and between
CSEs and non-CFTC registered dealers. For example, to the extent that
non-U.S. CSEs whose obligations are not guaranteed by a U.S. person can
rely on substituted compliance that is not available to U.S. CSEs or
U.S. Guaranteed CSEs, they may enjoy certain cost advantages (e.g.,
avoiding the costs of potentially duplicative or inconsistent
regulation, which could allow them to develop one enterprise-wide set
of compliance and operational infrastructures). The non-U.S. CSEs may
then be able to pass on these cost savings to their counterparties in
the form of better pricing or some other benefit. U.S. CSEs and U.S.
Guaranteed CSEs, on the other hand, could, depending on the extent to
which foreign margin requirements apply, be subject to both U.S. and
foreign margin requirements, and therefore be at a competitive
disadvantage. Counterparties may also be incentivized to transact with
CSEs that are offered substituted compliance in order to avoid being
subject to duplicative or conflicting margin requirements, which could
lead to increased market inefficiencies.\273\
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\273\ The Commission recognizes that its framework may impose
certain initial operational costs, as CSEs will be required to
determine the status of their counterparties in order to determine
the extent to which substituted compliance is available. The
Commission however believes the ability to obtain and rely on
counterparty representations should help mitigate such costs.
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Nevertheless, the Commission does not believe it is appropriate to
make substituted compliance broadly available to all CSEs. As discussed
above, the Commission has a strong supervisory interest in the
uncleared swaps activity of all CSEs, including non-U.S. CSEs, by
virtue of their registration with the Commission. Furthermore, U.S.
CSEs and U.S. Guaranteed CSEs are particularly key swap market
participants and their safety and soundness is critical to a well-
functioning U.S. swap market and the stability of the U.S. financial
system. Accordingly, in light of the Commission's supervisory interest
in the activities of U.S. persons and its statutory obligation to
ensure the safety and soundness of CSEs and the U.S. financial markets
in the context of uncleared swaps, the Commission believes that
substituted compliance is generally not appropriate for U.S. CSEs and
U.S. Guaranteed CSEs given their importance to the U.S. financial
markets.\274\ With respect to other non-U.S. CSEs (including FCSs) that
are not subject to a U.S. guarantee, however, the Commission believes
that, in the interest of international comity, making substituted
compliance broadly available is appropriate.
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\274\ As discussed in section II.B.2.b.i above, because
uncleared swaps of U.S. Guaranteed CSEs are identical in relevant
respects to a swap entered directly by a U.S. person, the Final Rule
treats these uncleared swaps the same as uncleared swaps of U.S.
CSEs.
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As further discussed in section II.B.2.b.i., the Commission
determined that partial substituted compliance is appropriate for U.S.
CSEs and U.S. Guaranteed CSEs in the limited case of posting (but not
collecting) initial margin. Contrary to commenters' assertions, the
Commission does not believe that partial substituted compliance is
impractical or will hinder the development of a standardized model for
initial margin. As discussed above, the Commission does not expect a
CSE to have two netting sets as a result of partial substituted
compliance, given that the U.S. CSE is always required to collect
initial margin according to the Commission's margin requirements while
it has the option to post according to the Commission's or its
counterparty's foreign margin requirements. If substituted compliance
is elected, the U.S. CSE will be deemed to satisfy the Commission's
margin requirements by meeting the foreign jurisdiction's margin
requirements, which will result in one netting set. Furthermore, the
Commission believes that permitting partial substituted compliance
allows market participants to avoid some costs associated with
complying with duplicative or conflicting requirements.
The Commission acknowledges that foreign branches may, for the
reasons raised by commenters and discussed above, be at a competitive
disadvantage compared to non-U.S. CSEs, with whom they may compete in
the countries in which they are established, by virtue of not being
eligible for substituted compliance. However, as discussed in section
II.B.2.b.i., the swap activities of a foreign branch of a U.S. CSE are
[[Page 34844]]
legally indistinguishable from the swap activities of the U.S. CSE.
Permitting more favorable treatment to foreign branches of U.S. CSEs
than the principal U.S. entity could create an easy way for U.S. CSEs
to circumvent the Commission's margin requirements, which could
undermine the safety and soundness of the U.S. CSE and the U.S.
financial system.\275\
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\275\ The Commission notes that the potential competitive
disparities could be minimized to the degree foreign margin
requirements are harmonized or otherwise comparable to the
Commission's.
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b. Exclusion
Under the Final Rule, the Commission excludes from its margin
requirements uncleared swaps entered into by a non-U.S. CSE with a non-
U.S. counterparty (including a non-U.S. CSE), provided that neither
counterparty's obligations under the relevant swap are guaranteed by a
U.S. person and neither counterparty is an FCS nor a U.S. branch of a
non-U.S. CSE. As discussed in section II.B.3.b above, the Commission
believes that it is appropriate to tailor the application of margin
requirements in the cross-border context, consistent with section 4s(e)
of the CEA and comity principles, so as to exclude this narrow class of
uncleared swaps involving a non-U.S. CSE and a non-U.S. counterparty.
The Commission believes that such non-U.S. CSEs may benefit from
the Exclusion because it allows them to avoid duplicative or
conflicting regulations where a transaction is subject to more than one
uncleared swap margin regime. On the other hand, to the extent the
Exclusion allows a non-U.S. CSE to rely on foreign margin requirements
that are not comparable to the Commission's, the Exclusion could result
in a less rigorous margin regime for such CSE or, in the extreme, the
absence of any margin requirements. This would not only increase the
risk posed by that CSE's swaps activities, but could create competitive
disparities between non-U.S. CSEs relying on the Exclusion and other
CSEs that are not eligible for the Exclusion. That is, the Exclusion
could allow these non-U.S. CSEs to offer better pricing or other terms
to their non-U.S. clients and put them in a better position (than CSEs
ineligible for the Exclusion) to compete with non-CFTC registered
dealers in the relevant foreign jurisdiction for foreign clients. The
degree of competitive disparity will depend on the degree of disparity
between the Commission's margin framework and that of the relevant
foreign jurisdiction.
The Commission does not generally expect that the Exclusion will
result in a significant diminution in the safety and soundness of the
non-U.S. CSE, as discussed in section II.B.3.b above. This is based on
several considerations. First, the Commission understands that most
swaps are currently transacted in jurisdictions that have agreed to
adhere to the BCBS-IOSCO framework, which covers financial
entities.\276\ Accordingly, the Commission anticipates that many
excluded swaps will nevertheless be subject to margin requirements in a
jurisdiction that adheres to the BCBS-IOSCO framework. Second, the
potential adverse effect on a non-U.S. CSE would be mitigated by the
Commission's capital requirements which, as proposed, would impose a
capital charge for uncollateralized exposures.\277\
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\276\ Element 2 of BCBS-IOSCO framework states: ``All covered
entities (i.e. financial firms and systemically important non-
financial entities) that engage in non-centrally cleared derivatives
must exchange initial and variation margin as appropriate to the
counterparty risks posed by such transactions.''
\277\ See Proposed Capital Rule, 76 FR 27802.
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Third, a non-U.S. CSE that can avail itself of the Exclusion will
still be subject to the Commission's margin rules with respect to all
uncleared swaps not meeting the criteria for the Exclusion, albeit with
the possibility of substituted compliance. That the non-U.S. CSE will
be subject to U.S. or comparable margin requirements when entering into
a swap with U.S. counterparties reduces the possibility of a cascading
event affecting U.S. counterparties and the U.S. financial markets more
broadly as a result of a default by the non-U.S. CSE.
The unavailability of the Exclusion to FCSs could disadvantage them
relative to other non-U.S. CSEs that are eligible for the Exclusion or
non-CFTC registered dealers within a foreign jurisdiction. As
commenters noted, non-U.S. CSEs that rely on the Exclusion or non-CFTC
registered dealers could realize a cost advantage over FCSs and thus
have the potential to offer better pricing terms to foreign clients.
The competitive disparity between non-U.S. CSEs that rely on the
Exclusion and FCSs, however, may be somewhat mitigated to the extent
that the relevant foreign jurisdiction implements the BCBS-IOSCO
framework.\278\
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\278\ As discussed above, a commenter's suggestion to exclude
transactions between an FCS and another non-guaranteed non-U.S.
person up to an aggregate 5 percent notional trading limit would be
difficult to monitor and could create incentives to ``cherry-pick''
and exclude uncleared swaps presenting the highest margin
requirement, which could thereby introduce undue risk into the
system.
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As noted above in section II.B.3.a., some commenters suggested that
treating U.S. branches of non-U.S. CSEs differently from the rest of
the CSE with respect to eligibility for the Exclusion could present
operational challenges, requiring non-U.S. CSEs to document
transactions with the U.S. branch under a separate ISDA Master
Agreement. However, as explained in section II.B.3.b., in most cases
the Commission does not believe a separate credit support agreement
will be necessary; \279\ furthermore, in those cases where it is
required, the Commission nevertheless believes that extending the
Exclusion to U.S. branches of non-U.S. CSEs would not be appropriate
for the reasons discussed in section II.B.3.b above.\280\ In addition,
allowing U.S. branches to rely on the Exclusion would enable them to
offer more competitive terms to non-U.S. clients than U.S. CSEs,
thereby gaining an advantage when dealing with non-U.S. clients
relative to other CSEs operating within the United States (i.e., U.S.
CSEs). On the other hand, for the same reason, the Final Rule could put
non-U.S. CSEs that conduct swaps business through their U.S. branches
at a disadvantage relative either to non-U.S. CSEs that are eligible
for the Exclusion or non-CFTC registered dealers that conduct swaps
business overseas. The Commission recognizes that while substituted
compliance will be broadly available to such U.S. branches of non-U.S.
CSEs, more compliance costs could be incurred by these entities than if
the Exclusion were made available if a foreign jurisdiction's margin
requirements are not comparable.\281\
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\279\ See supra note 158.
\280\ The Prudential Regulators' Final Margin Rule does not
grant an exclusion for the uncleared swaps of such U.S. branches on
the basis that U.S. branches of foreign banks clearly operate within
the United States and could pose risk to the U.S. financial system,
and the Commission believes that harmonization with the Prudential
Regulators' Final Margin Rule is appropriate. For further discussion
of the reasons that the Exclusion does not extend to U.S. branches
of non-U.S. CSEs, see section II.B.3.b above.
\281\ As noted above, U.S. branches of foreign banks (as
``foreign bank'' is defined in section __.2 of the Prudential
Regulators' Final Margin Rule (12 CFR part 237)) must comply with
the Prudential Regulators' margin rules, as these U.S. branches have
a Prudential Regulator, as defined in 1(a)(39) of the CEA.
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In order to effectuate the Commission's treatment of inter-
affiliate swaps under the Final Margin Rule, the Exclusion is not
available if the market-facing transaction of the non-U.S. CSE (that is
otherwise eligible for the Exclusion) is not subject to comparable
initial margin collection requirements in the home jurisdiction and any
of the
[[Page 34845]]
risk associated with the uncleared swap is transferred, directly or
indirectly, through inter-affiliate transactions, to a U.S. CSE. As a
consequence, the affected non-U.S. CSEs may be placed at a cost
disadvantage relative to non-U.S. CSEs that can rely on the Exclusion
as well as non-CFTC registered dealers operating in the foreign
jurisdiction that are not subject to similarly rigorous initial margin
collection requirements. The Commission, however, believes that this
limitation is necessary to ensure that the Exclusion does not
facilitate the transfer of risk to a U.S. CSE through the use of inter-
affiliate transactions that, per the Final Margin Rule, are generally
not subject to the collection of initial margin.
c. Non-Segregation Jurisdictions and Non-Netting Jurisdictions
The Final Rule includes a special provision for non-segregation
jurisdictions, where custodial arrangements that comply with the
Commission's requirements set out in Commission Regulation 23.157 \282\
are impracticable due to the legal or operational infrastructure of the
foreign jurisdiction.\283\ Specifically, an FCS or a foreign branch of
a U.S. CSE may, in certain circumstances, be excepted from the
requirement to post initial margin for the uncleared swap in compliance
with the custodial requirements of the Final Margin Rule in certain
foreign jurisdictions where inherent limitations in the legal or
operational infrastructure of the jurisdiction make it impracticable
for the CSE and its counterparty to comply with that requirement,
subject to certain conditions.
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\282\ See 17 CFR 23.157.
\283\ As used in this release, a ``non-segregation
jurisdiction'' is a jurisdiction where inherent limitations in the
legal or operational infrastructure of the foreign jurisdiction make
it impracticable for the CSE and its counterparty to post initial
margin pursuant to custodial arrangements that comply with the Final
Margin Rule, as further described in section II.B.4.b.
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The Commission understands from commenters that inherent legal and
operational constraints in certain jurisdictions could make compliance
with the custodial requirements of the Final Margin Rule impracticable.
Accordingly, absent the exception, FCSs and foreign branches of U.S.
CSEs would be unable to conduct uncleared swap business with clients
based in such jurisdictions, contributing to further market
inefficiencies. The Commission further agrees with commenters that an
exception from the requirement to post (but not from the requirement to
collect) initial margin when transacting with clients in non-
segregation jurisdictions will accomplish the goal of ensuring a CSE's
safety and soundness but with less disruption to existing business
relationships than the exchange of initial and variation margin would
impose.
After careful consideration, the Commission is adding a special
provision so that FCSs and foreign branches of U.S. CSEs will not be
foreclosed from engaging in uncleared swaps business in non-segregation
jurisdictions, with appropriate conditions, including a 5 percent
limitation, as discussed in section II.B.4.b above, to avoid
compromising the safety and soundness of CSEs. The Commission does not
believe a blanket de minimis exception from the Commission's margin
requirements, as suggested by commenters, is appropriate. Rather, the
Commission believes that carefully tailored relief from the Final
Margin Rule's requirement to post initial margin and the custodial
arrangement requirements that pertain to initial margin collected by a
CSE will accomplish the goal of allowing FCSs and foreign branches of
U.S. CSEs to carry on their swaps business in non-segregation
jurisdictions without creating the risks that would attend wholesale
exemption from margin requirements in these jurisdictions. In addition,
in light of the importance of FCSs and foreign branches of U.S. CSEs to
the U.S. financial system, the special provision includes certain
conditions that are designed to appropriately limit the swap activities
conducted by these CSEs in these jurisdictions in order to help ensure
their safety and soundness. Although these conditions may place
affected entities at a relative cost disadvantage when compared to non-
U.S. CSEs that can rely on the Exclusion and non-CFTC registered
dealers engaged in swaps activity in non-segregation jurisdictions, and
may limit the overall swap dealing activity of affected entities in
these jurisdictions, the Commission believes that the special provision
provides a substantial benefit to the affected entities by allowing
them to conduct a limited level of swaps business in non-segregation
jurisdictions where they would otherwise be foreclosed. While
permitting FCSs and foreign branches of U.S. CSEs to carry on their
swaps business in non-segregation jurisdictions in accordance with this
special provision is not without some risk, in that the initial margin
collected by FCSs and foreign branches of U.S. CSEs in reliance on this
provision is not subject to the custodial arrangement requirements of
the Final Margin Rule, the Commission believes that the conditions to
using this provision (including the 5 percent limit in each of four
broad risk categories set forth in Sec. 23.154(b)(2)(v)) should be
sufficient to prevent undue risk arising from uncleared swaps by FCSs
and foreign branches of U.S. CSEs relying on this provision.
The Final Rule also includes a special provision for ``non-
netting'' jurisdictions.\284\ In order to avail itself of this
provision, the CSE must treat the uncleared swaps covered by the
netting agreement on a gross basis in determining the amount of initial
and variation margin that it must collect, but may net those uncleared
swaps in determining the amount of initial and variation margin it must
post to the counterparty, in accordance with the netting provisions of
the Final Margin Rule. The Commission agrees that, as suggested by
commenters, without enforceable netting and collateral arrangements,
there is a risk that a CSE may not be able to effectively foreclose on
the margin in the event of a counterparty default, and a risk that the
administrator of an insolvent counterparty will ``cherry-pick'' from
posted collateral to be returned in the event of insolvency, which
could result in an increase in the risk in posting collateral. As with
the provision for non-segregation jurisdictions, this provision is
carefully tailored to allow CSEs to conduct swap transactions in ``non-
netting'' jurisdictions without abandoning the key protections behind
the netting requirement under the Final Margin Rule.\285\ If the
Commission were not to adopt this special provision, then a CSE would
have to collect and post margin on a gross basis, which would result in
greater costs to the CSE and result in additional credit risk, and put
them at a competitive disadvantage. It is possible that this would lead
to CSEs
[[Page 34846]]
being effectively precluded from doing business in these jurisdictions.
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\284\ As used in this release, a ``non-netting jurisdiction'' is
a jurisdiction in which a CSE cannot conclude, with a well-founded
basis, that the netting agreement with a counterparty in that
foreign jurisdiction meets the definition of an ``eligible master
netting agreement'' set forth in the Final Margin Rule, as described
in section II.B.5.b.
\285\ The Commission considered a broader provision, including,
as requested by commenters, excluding these transactions from its
margin rule. However, as netting provisions are critical to the
overall goal of margin requirements and the Commission is not
requiring CSEs to post margin on a gross basis, the Commission
believes that the regulatory gap that a broader provision would
create would be inconsistent with the Commission's mandate to
protect the safety and soundness of CSEs.
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4. Comparability Determinations
As noted in section II.C above, any CSE eligible for substituted
compliance may make a request for a comparability determination.
Currently, there are approximately 106 swap entities provisionally
registered with the Commission. The Commission further estimates that
of the 106 swap entities that are registered, approximately 54 are
subject to the Commission's margin rules, as they are not supervised by
a Prudential Regulator. However, the Commission notes that any foreign
regulatory agency that has direct supervisory authority to administer
the foreign regulatory framework for margin of uncleared swaps in the
requested foreign jurisdiction may apply for a comparability
determination. Further, once a comparability determination is made for
a jurisdiction, it will apply for all entities or transactions in that
jurisdiction to the extent provided in the determination, as approved
by the Commission.
Although there is uncertainty regarding the number of requests for
comparability determinations that will be made under the Final Rule,
the Commission estimates that it will receive applications for
comparability determinations from 17 jurisdictions representing 61
separate registrants, and that each request will impose an average of
10 burden hours per registrant.
Based on the above, the Commission estimates that the preparation
and filing of submission requests for comparability determinations
should take no more than 170 hours annually in the aggregate (17
registrants x 10 hours). The Commission further estimates that the
total aggregate cost of preparing such submission requests will be
$64,600, based on an estimated cost of $380 per hour for an in-house
attorney.\286\
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\286\ Although different registrants may choose to staff
preparation of the comparability determination request with
different personnel, Commission staff estimates that, on average, an
initial request could be prepared and submitted with 10 hours of an
in-house attorney's time. To estimate the hourly cost of an in-house
attorney's attorney time, Commission staff reviewed data in SIFMA's
Report on Management and Professional Earnings in the Securities
Industry 2013, modified by Commission staff to account for an 1800-
hour work-year and multiplied by a factor of 5.35 to account for
firm size, employee benefits and overhead. Commission staff believes
that use of a 5.35 multiplier here is appropriate because some
persons may retain outside advisors to assist in making the
determinations under the rules.
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As summarized in section II.C.2, several commenters complained that
the costs and burdens to market participants associated with the
Commission's proposed framework and standard for making comparability
determinations would be minimized if the Commission were to rely on the
BCBS-IOSCO framework as the sole basis for its comparability analysis
and take a ``holistic'' approach to determining comparability. As the
Commission explained above, however, while the BCBS-IOSCO framework
establishes minimum standards that are consistent with the objectives
of the Commission's own margin requirements, consistency with
International Standards is necessary but may not be sufficient to
finding comparability.\287\ Furthermore, allowing for a comparability
determination to be made based on comparable outcomes and objectives
notwithstanding differences in foreign jurisdictions' requirements
ensures that substituted compliance is made available to the fullest
extent possible. While the Commission recognizes that, to the extent
that a foreign margin regime is not deemed comparable in all respects,
CSEs eligible for substituted compliance may experience costs from
being required to comply with more than one set of specified margin
requirements, the Commission believes that this approach is preferable
to an all-or-nothing approach, in which market participants may be
forced to comply with both margin regimes in their entirety.
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\287\ See supra notes 232 and 233 and accompanying text. Also,
as the Commission noted above, the Final Margin Rule included
substantial modifications from the Proposed Margin Rule that further
aligned the Commission's margin requirements with International
Standards and, as a result, the potential for conflict with foreign
margin requirements should be reduced. See supra note 29.
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5. Section 15(a) Factors
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders. Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. The Commission considers the costs and benefits
resulting from its discretionary determinations with respect to the
section 15(a) factors.
a. Protection of Market Participants and the Public
As described above, CEA section 4s(e)(2)(A) requires the Commission
to develop rules designed to ensure the safety and soundness of CSEs
and the U.S. financial system. On the one hand, full application of the
Commission's margin requirements to all uncleared swaps of CSEs would
help to ensure the safety and soundness of CSEs and the U.S. financial
system by reducing counterparty credit risk and the threat of
contagion. On the other hand, extending substituted compliance to
certain cross-border swaps reduces the potential for conflicting or
duplicative requirements, which would, in turn, reduce market
distortions and promote global harmonization. In addition, where
exceptions have been permitted (i.e., under the Exclusion and the
special provisions for non-segregation and non-netting jurisdictions),
the Commission has limited their availability to strike a balance
between international comity and the continuation of important business
activity by qualifying CSEs, on the one hand, and limiting risk to CSEs
and the U.S. financial system, on the other hand. While the Final Rule
will allow CSEs to comply with foreign margin requirements as an
alternative to the Commission's requirements in certain circumstances,
such margin requirements must be comparable in outcome and objectives,
and the Commission retains the authority to modify or condition the
availability of substituted compliance as necessary. Furthermore,
substituted compliance is available on a more limited basis for U.S.
CSEs and U.S. Guaranteed CSEs. Additionally, while the Final Rule also
excludes certain uncleared swap transactions involving non-U.S. CSEs
whose obligations under the relevant swap are not subject to a U.S.
guarantee from the Final Margin Rule and excepts qualifying CSEs from
certain requirements in non-segregation jurisdictions and non-netting
jurisdictions, the Exclusion and special provisions are narrowly
tailored and include safeguards to protect market participants and the
public. Overall, the Commission believes that the Final Rule takes
proper account of significant, and sometimes competing, factors in
order to effectively address the risk posed to the safety and soundness
of CSEs while creating a workable cross-border framework that reduces
the potential for undue market disruptions and promoting global
harmonization, thereby benefiting market participants and the public.
[[Page 34847]]
b. Efficiency, Competitiveness, and Financial Integrity
As discussed above, the Final Rule may have both a positive and
negative effect on market efficiency and competitiveness. As an initial
matter, substituted compliance and the Exclusion should improve
resource allocation efficiency by allowing market participants to avoid
potentially duplicative or conflicting requirements, reducing the
aggregate cost to the market of dealing uncleared swaps. By granting
this relief to some CSEs and not others, however, the Final Rule may
afford such CSEs a cost advantage compared to other CSEs that may be
required to comply with potentially duplicative or conflicting
requirements. Non-U.S. counterparties may also be incentivized to
transact with CSEs that are eligible for substituted compliance in
order to avoid complying with more than one margin regime (or the
Commission's margin regime alone), which could contribute to market
inefficiencies. In addition, as the Exclusion is not provided to all
CSEs, those that are not permitted to use the Exclusion may be at a
competitive disadvantage when competing in foreign jurisdictions that
do not have comparable margin rules. The Commission notes, however,
that to the extent that non-U.S. CSEs are domiciled in jurisdictions
with comparable requirements, this may mitigate possible regulatory
arbitrage by these CSEs.
At the same time, however, the Commission understands that if it
did not provide special accommodations for certain CSEs to enter into
certain markets, such CSEs would be disadvantaged and even prohibited
from engaging in swaps in these jurisdictions.
Furthermore, the Commission believes that the Final Rule ensures
that substituted compliance and the Exclusion are extended in a
tailored fashion that is consistent with protecting the integrity of
the swaps market. Substituted compliance is only provided in the event
that the relevant foreign jurisdiction has a comparable margin rule; if
not, the CSE must comply with the Commission's margin rule. Even in
instances where the Exclusion is available, the Commission notes that:
(1) The Final Margin Rule will cover many of the swaps of the non-U.S.
CSEs (eligible for the Exclusion) with other counterparties, namely,
all U.S. counterparties; (2) the Exclusion is limited to a narrow set
of swaps by non-U.S. CSEs; and (3) the excluded swaps may be covered by
another foreign regulator's margin rule that is based on the BCBS-IOSCO
framework.
c. Price Discovery
The Commission generally believes that substituted compliance, by
reducing the potential for duplicative or conflicting regulations,
could reduce impediments to transact uncleared swaps on a cross-border
basis. This, in turn, may enhance liquidity as more market participants
may be willing to enter into uncleared swaps, thereby possibly
improving price discovery--and ultimately reducing market
fragmentation. Alternatively, if substituted compliance or the
Exclusion were not made available, CSEs could be incentivized to
consider setting up their swap operations outside the Commission's
jurisdiction, and as a result, increase the potential for market
fragmentation. Additionally, exceptions for non-segregation and non-
netting jurisdictions could increase price discovery in such
jurisdictions by opening such markets to CSEs where, by virtue of the
application of the Commission's margin requirements, such CSEs would
otherwise be unable to deal uncleared swaps.
d. Sound Risk Management Practices
The Commission believes that the Final Rule is consistent with
sound risk management practices. The Final Margin Rule promotes sound
risk management practices, and this Final Rule requires U.S. CSEs and
U.S. Guaranteed CSEs to apply that rule in its entirety for most cross-
border transactions. To the extent substituted compliance is available
in limited fashion to these entities and more broadly to non-U.S. CSEs,
the foreign margin requirements must be comparable to the Commission's
in outcome and objectives. That should ensure that margin's critical
risk management function is unaffected. Although the Exclusion could
potentially lead to weaker risk management for eligible non-U.S. CSEs
to the extent that they are not otherwise subject to comparable foreign
margin requirements, the Commission notes that in jurisdictions that
are BCBS-IOSCO compliant, such CSEs will be subject to margin
requirements that satisfy the minimum International Standards
established by the BCBS-IOSCO framework.\288\ Furthermore, while the
Commission recognizes that a special provision in the Final Rule will
excuse CSEs that are FCSs and foreign branches of U.S. CSEs from the
requirement to post initial margin pursuant to custodial arrangements
that comply with the Final Margin Rule, the Commission believes that
the impact to risk management will be mitigated by the relatively small
volume of such transactions, the conditions required to rely on this
special provision, including a limit on the overall swaps using the
special provision, and the continued applicability of other
requirements, including margin with respect to other uncleared swaps of
such FCSs and foreign branches and broader capital requirements.\289\
The Commission similarly believes that the risk management implications
of the special provision for non-netting jurisdictions will be limited.
As explained above, CSEs will still be required to calculate and
collect initial margin on a gross basis to ensure that the CSE can
obtain the collateral posted with the counterparty in the event of
counterparty default.
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\288\ As indicated in supra note 23, representatives of 26
regulatory authorities participated in the WGMR that developed the
BCBS-IOSCO framework.
\289\ See Proposed Capital Rule, 76 FR 27802.
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e. Other Public Interest Considerations
The Commission has not identified any additional public interest
considerations related to the costs and benefits of the Final Rule.
List of Subjects in 17 CFR Part 23
Swaps, Swap dealers, Major swap participants, Capital and margin
requirements.
For the reasons discussed in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 23 as set forth below:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
1. The authority citation for part 23 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b),
Pub. L. 111-203, 124 Stat. 1641 (2010).
0
2. Add Sec. 23.160 to read as follows:
Sec. 23.160 Cross-border application.
(a) Definitions. For purposes of this section only:
(1) Foreign Consolidated Subsidiary means a non-U.S. CSE in which
an ultimate parent entity that is a U.S. person has a controlling
financial interest, in accordance with U.S. GAAP, such that the U.S.
ultimate parent entity includes the non-U.S. CSE's operating results,
financial position and statement
[[Page 34848]]
of cash flows in the U.S. ultimate parent entity's consolidated
financial statements, in accordance with U.S. GAAP.
(2) Guarantee means an arrangement pursuant to which one party to
an uncleared swap has rights of recourse against a guarantor, with
respect to its counterparty's obligations under the uncleared swap. For
these purposes, a party to an uncleared swap has rights of recourse
against a guarantor if the party has a conditional or unconditional
legally enforceable right to receive or otherwise collect, in whole or
in part, payments from the guarantor with respect to its counterparty's
obligations under the uncleared swap. In addition, in the case of any
arrangement pursuant to which the guarantor has a conditional or
unconditional legally enforceable right to receive or otherwise
collect, in whole or in part, payments from any other guarantor with
respect to the counterparty's obligations under the uncleared swap,
such arrangement will be deemed a guarantee of the counterparty's
obligations under the uncleared swap by the other guarantor.
(3) International standards mean the margin policy framework for
non-cleared, bilateral derivatives issued by the Basel Committee on
Banking Supervision and the International Organization of Securities in
September 2013, as subsequently updated, revised, or otherwise amended,
or any other international standards, principles or guidance relating
to margin requirements for non-cleared, bilateral derivatives that the
Commission may in the future recognize, to the extent that they are
consistent with United States law (including the margin requirements in
the Commodity Exchange Act).
(4) Non-U.S. CSE means a covered swap entity that is not a U.S.
person. The term ``non-U.S. CSE'' includes a ``Foreign Consolidated
Subsidiary'' or a U.S. branch of a non-U.S. CSE.
(5) Non-U.S. person means any person that is not a U.S. person.
(6) Ultimate parent entity means the parent entity in a
consolidated group in which none of the other entities in the
consolidated group has a controlling interest, in accordance with U.S.
GAAP.
(7) United States means the United States of America, its
territories and possessions, any State of the United States, and the
District of Columbia.
(8) U.S. CSE means a covered swap entity that is a U.S. person.
(9) U.S. GAAP means U.S. generally accepted accounting principles.
(10) U.S. person means:
(i) A natural person who is a resident of the United States;
(ii) An estate of a decedent who was a resident of the United
States at the time of death;
(iii) A corporation, partnership, limited liability company,
business or other trust, association, joint-stock company, fund or any
form of entity similar to any of the foregoing (other than an entity
described in paragraph (a)(10)(iv) or (v) of this section) (a ``legal
entity''), in each case that is organized or incorporated under the
laws of the United States or that has its principal place of business
in the United States, including any branch of such legal entity;
(iv) A pension plan for the employees, officers or principals of a
legal entity described in paragraph (a)(10)(iii) of this section,
unless the pension plan is primarily for foreign employees of such
entity;
(v) A trust governed by the laws of a state or other jurisdiction
in the United States, if a court within the United States is able to
exercise primary supervision over the administration of the trust;
(vi) A legal entity (other than a limited liability company,
limited liability partnership or similar entity where all of the owners
of the entity have limited liability) that is owned by one or more
persons described in paragraphs (a)(10)(i) through (v) of this section
and for which such person(s) bears unlimited responsibility for the
obligations and liabilities of the legal entity, including any branch
of the legal entity; or
(vii) An individual account or joint account (discretionary or not)
where the beneficial owner (or one of the beneficial owners in the case
of a joint account) is a person described in paragraphs (a)(10)(i)
through (vi) of this section.
(b) Applicability of margin requirements. The requirements of
Sec. Sec. 23.150 through 23.161 apply as follows.
(1) Uncleared swaps of U.S. CSEs or Non-U.S. CSEs whose obligations
under the relevant swap are guaranteed by a U.S. person--(i)
Applicability of U.S. margin requirements; availability of substituted
compliance for requirement to post initial margin. With respect to each
uncleared swap entered into by a U.S. CSE or a non-U.S. CSE whose
obligations under the swap are guaranteed by a U.S. person, the U.S.
CSE or non-U.S. CSE whose obligations under the swap are guaranteed by
a U.S. person shall comply with the requirements of Sec. Sec. 23.150
through 23.161 of this part, provided that the U.S. CSE or non-U.S. CSE
whose obligations under the swap are guaranteed by a U.S. person may
satisfy its requirement to post initial margin to certain
counterparties to the extent provided in paragraph (b)(1)(ii) of this
section.
(ii) Compliance with foreign initial margin collection requirement.
A covered swap entity that is covered by paragraph (b)(1)(i) of this
section may satisfy its requirement to post initial margin under this
part by posting initial margin in the form and amount, and at such
times, that its counterparty is required to collect initial margin
pursuant to a foreign jurisdiction's margin requirements, but only to
the extent that:
(A) The counterparty is neither a U.S. person nor a non-U.S. person
whose obligations under the relevant swap are guaranteed by a U.S.
person;
(B) The counterparty is subject to such foreign jurisdiction's
margin requirements; and
(C) The Commission has issued a comparability determination under
paragraph (c) of this section (``Comparability Determination'') with
respect to such foreign jurisdiction's requirements regarding the
posting of initial margin by the covered swap entity (that is covered
in paragraph (b)(1) of this section).
(2) Uncleared swaps of Non-U.S. CSEs whose obligations under the
relevant swap are not guaranteed by a U.S. person--(i) Applicability of
U.S. Margin requirements except where an exclusion applies;
Availability of substituted compliance. With respect to each uncleared
swap entered into by a non-U.S. CSE whose obligations under the
relevant swap are not guaranteed by a U.S. person, the non-U.S. CSE
shall comply with the requirements of Sec. Sec. 23.150 through 23.161
except to the extent that an exclusion is available under paragraph
(b)(2)(ii) of this section, provided that a non-U.S. CSE whose
obligations under the relevant swap are not guaranteed by a U.S. person
may satisfy its margin requirements under this part to the extent
provided in paragraphs (b)(2)(iii) and (b)(2)(iv) of this section.
(ii) Exclusion. (A) Except as provided in paragraph (b)(2)(ii)(B)
of this section, a non-U.S. CSE shall not be required to comply with
the requirements of Sec. Sec. 23.150 through 23.161 with respect to
each uncleared swap it enters into to the extent that the following
conditions are met:
(1) The non-U.S. CSE's obligations under the relevant swap are not
guaranteed by a U.S. person;
(2) The non-U.S. CSE is not a U.S. branch of a non-U.S. CSE;
[[Page 34849]]
(3) The non-U.S. CSE is not a Foreign Consolidated Subsidiary; and
(4) The counterparty to the uncleared swap is a non-U.S. person
(excluding a Foreign Consolidated Subsidiary or the U.S. branch of a
non-U.S. CSE), whose obligations under the relevant swap are not
guaranteed by a U.S. person.
(B) Notwithstanding paragraph (b)(2)(ii)(A) of this section, any
uncleared swap of a non-U.S. CSE that meets the conditions for the
Exclusion set forth in paragraph (b)(2)(ii)(A) must nevertheless comply
with Sec. Sec. 23.150 through 23.161 if:
(1) The uncleared swap of the non-U.S. CSE is not covered by a
Comparability Determination with respect to the initial margin
collection requirements in the relevant foreign jurisdiction in
accordance with paragraph (c) of this section; and
(2) The non-U.S. CSE enters into an inter-affiliate swap(s),
transferring any risk arising out of the uncleared swap described in
paragraph (b)(2)(ii)(B)(1) of this section directly or indirectly, to a
margin affiliate (as the term ``margin affiliate'' is defined in Sec.
23.151 of this part) that is a U.S. CSE or a U.S. Guaranteed CSE.
(iii) Availability of substituted compliance where the counterparty
is not a U.S. CSE or a non-U.S. CSE whose obligations under the
relevant swap are guaranteed by a U.S. person. Except to the extent
that an exclusion is available under paragraph (b)(2)(ii) of this
section, with respect to each uncleared swap entered into by a non-U.S.
CSE whose obligations under the relevant swap are not guaranteed by a
U.S. person with a counterparty (except where the counterparty is
either a U.S. CSE or a non-U.S. CSE whose obligations under the
relevant swap are guaranteed by a U.S. person), the non-U.S. CSE whose
obligations under the relevant swap are not guaranteed by a U.S. person
may satisfy margin requirements under this part by complying with the
margin requirements of a foreign jurisdiction to which such non-U.S.
CSE (whose obligations under the relevant swap are not guaranteed by a
U.S. person) is subject, but only to the extent that the Commission has
issued a Comparability Determination under paragraph (c) of this
section for such foreign jurisdiction.
(iv) Availability of substituted compliance where the counterparty
is a U.S. CSE or a non-U.S. CSE whose obligations under the relevant
swap are guaranteed by a U.S. person. With respect to each uncleared
swap entered into by a non-U.S. CSE whose obligations under the
relevant swap are not guaranteed by a U.S. person with a counterparty
that is a U.S. CSE or a non-U.S. CSE whose obligations under the
relevant swap are guaranteed by a U.S. person, the non-U.S. CSE (whose
obligations under the relevant swap are not guaranteed by a U.S.
person) may satisfy its requirement to collect initial margin under
this part by collecting initial margin in the form and amount, and at
such times and under such arrangements, that the non-U.S. CSE (whose
obligations under the relevant swap are not guaranteed by a U.S.
Person) is required to collect initial margin pursuant to a foreign
jurisdiction's margin requirements, provided that:
(A) The non-U.S. CSE (whose obligations under the relevant swap are
not guaranteed by a U.S. person) is subject to the foreign
jurisdiction's regulatory requirements; and
(B) The Commission has issued a Comparability Determination with
respect to such foreign jurisdiction's margin requirements.
(c) Comparability determinations--(1) Eligibility requirements. The
following persons may, either individually or collectively, request a
Comparability Determination with respect to some or all of the
Commission's margin requirements:
(i) A covered swap entity that is eligible for substituted
compliance under this section; or
(ii) A foreign regulatory authority that has direct supervisory
authority over one or more covered swap entities and that is
responsible for administering the relevant foreign jurisdiction's
margin requirements.
(2) Submission requirements. Persons requesting a Comparability
Determination should provide the Commission (either by hard copy or
electronically):
(i) A description of the objectives of the relevant foreign
jurisdiction's margin requirements;
(ii) A description of how the relevant foreign jurisdiction's
margin requirements address, at minimum, each of the following elements
of the Commission's margin requirements. Such description should
identify the specific legal and regulatory provisions that correspond
to each element and, if necessary, whether the relevant foreign
jurisdiction's margin requirements do not address a particular element:
(A) The products subject to the foreign jurisdiction's margin
requirements;
(B) The entities subject to the foreign jurisdiction's margin
requirements;
(C) The treatment of inter-affiliate derivative transactions;
(D) The methodologies for calculating the amounts of initial and
variation margin;
(E) The process and standards for approving models for calculating
initial and variation margin models;
(F) The timing and manner in which initial and variation margin
must be collected and/or paid;
(G) Any threshold levels or amounts;
(H) Risk management controls for the calculation of initial and
variation margin;
(I) Eligible collateral for initial and variation margin;
(J) The requirements of custodial arrangements, including
segregation of margin and rehypothecation;
(K) Margin documentation requirements; and
(L) The cross-border application of the foreign jurisdiction's
margin regime.
(iii) A description of the differences between the relevant foreign
jurisdiction's margin requirements and the International Standards;
(iv) A description of the ability of the relevant foreign
regulatory authority or authorities to supervise and enforce compliance
with the relevant foreign jurisdiction's margin requirements. Such
description should discuss the powers of the foreign regulatory
authority or authorities to supervise, investigate, and discipline
entities for compliance with the margin requirements and the ongoing
efforts of the regulatory authority or authorities to detect and deter
violations of, and ensure compliance with, the margin requirements; and
(v) Copies of the foreign jurisdiction's margin requirements
(including an English translation of any foreign language document);
(vi) Any other information and documentation that the Commission
deems appropriate.
(3) Standard of review. The Commission will issue a Comparability
Determination to the extent that it determines that some or all of the
relevant foreign jurisdiction's margin requirements are comparable to
the Commission's corresponding margin requirements. In determining
whether the requirements are comparable, the Commission will consider
all relevant factors, including:
(i) The scope and objectives of the relevant foreign jurisdiction's
margin requirements;
(ii) Whether the relevant foreign jurisdiction's margin
requirements achieve comparable outcomes to the Commission's
corresponding margin requirements;
(iii) The ability of the relevant regulatory authority or
authorities to
[[Page 34850]]
supervise and enforce compliance with the relevant foreign
jurisdiction's margin requirements; and
(iv) Any other facts and circumstances the Commission deems
relevant.
(4) Reliance. Any covered swap entity that, in accordance with a
Comparability Determination, complies with a foreign jurisdiction's
margin requirements, would be deemed to be in compliance with the
Commission's corresponding margin requirements. Accordingly, if the
Commission determines that a covered swap entity has failed to comply
with the foreign jurisdiction's margin requirements, it could initiate
an action for a violation of the Commission's margin requirements. All
covered swap entities, regardless of whether they rely on a
Comparability Determination, remain subject to the Commission's
examination and enforcement authority.
(5) Conditions. In issuing a Comparability Determination, the
Commission may impose any terms and conditions it deems appropriate.
(6) Modifications. The Commission reserves the right to further
condition, modify, suspend, terminate or otherwise restrict a
Comparability Determination in the Commission's discretion.
(7) Delegation of authority. 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 request information and/or documentation
in connection with the Commission's issuance of a Comparability
Determination.
(d) Non-netting jurisdiction requirements. Except as provided in
paragraph (e) of this section, if a CSE cannot conclude after
sufficient legal review with a well-founded basis that the netting
agreement described in Sec. 23.152(c) meets the definition of
``eligible master netting agreement'' set forth in Sec. 23.151, the
CSE must treat the uncleared swaps covered by the agreement on a gross
basis for the purposes of calculating and complying with the
requirements of Sec. 23.152(a) and Sec. 23.153(a) to collect margin,
but the CSE may net those uncleared swaps in accordance with Sec.
23.152(c) and Sec. 23.153(d) for the purposes of calculating and
complying with the requirements of this part to post margin. A CSE that
relies on this paragraph (d) must have policies and procedures ensuring
that it is in compliance with the requirements of this paragraph, and
maintain books and records properly documenting that all of the
requirements of this paragraph (d) are satisfied.
(e) Jurisdictions Where Compliance with Custodial Arrangement
Requirements is Unavailable. Sections 23.152(b), 23.157(b), and
paragraph (d) of this section do not apply to an uncleared swap entered
into by a Foreign Consolidated Subsidiary or a foreign branch of a U.S.
CSE if:
(1) Inherent limitations in the legal or operational infrastructure
in the applicable foreign jurisdiction make it impracticable for the
CSE and its counterparty to post any form of eligible initial margin
collateral recognized pursuant to Sec. 23.156 in compliance with the
custodial arrangement requirements of Sec. 23.157;
(2) The CSE is subject to foreign regulatory restrictions that
require the CSE to transact in uncleared swaps with the counterparty
through an establishment within the foreign jurisdiction and do not
accommodate the posting of collateral for the uncleared swap in
compliance with the custodial arrangements of Sec. 23.157 in the
United States or a jurisdiction for which the Commission has issued a
comparability determination under paragraph (c) of this section with
respect to Sec. 23.157;
(3) The counterparty to the uncleared swap is a non-U.S. person
that is not a CSE, and the counterparty's obligations under the
uncleared swap are not guaranteed by a U.S. person;
(4) The CSE collects initial margin for the uncleared swap in
accordance with Sec. 23.152(a) in the form of cash pursuant to Sec.
23.156(a)(1)(i), and posts and collects variation margin in accordance
with Sec. 23.153(a) in the form of cash pursuant to Sec.
23.156(a)(1)(i);
(5) For each broad risk category, as set out in Sec.
23.154(b)(2)(v), the total outstanding notional value of all uncleared
swaps in that broad risk category, as to which the CSE is relying on
this paragraph (e), may not exceed 5% of the CSE's total outstanding
notional value for all uncleared swaps in the same broad risk category;
(6) The CSE has policies and procedures ensuring that it is in
compliance with the requirements of this paragraph (e); and
(7) The CSE maintains books and records properly documenting that
all of the requirements of this paragraph (e) are satisfied.
Issued in Washington, DC, on May 24, 2016, by the Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.
Note: The following table and appendices will not appear in the
Code of Federal Regulations.
Table A--Application of the Final Rule
The following table should be read in conjunction with the rest of
the preamble and the text of the Final Rule, as well as the footnotes
at the end of the table.
------------------------------------------------------------------------
Applicable margin
CSE Counterparty requirements
------------------------------------------------------------------------
U.S. CSE.................... U.S. person U.S. (All).
or.......................... (including U.S.
Non-U.S. CSE (including U.S. CSE).
branch of a non-U.S. CSE Non-U.S.
and a Foreign Consolidated person (including
Subsidiary (``FCS'')) whose non-U.S. CSE, FCS,
obligations under the and U.S. branch of
relevant swap are a non-U.S. CSE)
guaranteed by a U.S. person. whose obligations
under the relevant
swap are guaranteed
by a U.S. person.
Non-U.S. U.S. (Initial Margin
person (including collected by CSE in
non-U.S. CSE, FCS column 1).
and U.S. branch of Substituted
a non-U.S. CSE) Compliance (Initial
whose obligations Margin posted by
under the relevant CSE in column 1).
swap are not U.S. (Variation
guaranteed by a Margin).
U.S. person.
FCS whose obligations under U.S. CSE... U.S. (Initial Margin
the relevant swap are not Non-U.S. posted by CSE in
guaranteed by a U.S. person. CSE (including U.S. column 1).
or.......................... branch of a non- Substituted
U.S. branch of a non-U.S. U.S. CSE and FCS) Compliance (Initial
CSE whose obligations under whose obligations Margin collected by
the relevant swap are not under the relevant CSE in column 1).
guaranteed by a U.S. person. swap are guaranteed U.S. (Variation
by a U.S. person. Margin).
[[Page 34851]]
U.S. person Substituted
(except as noted Compliance (All).
above for a CSE).
Non-U.S.
person whose
obligations under
the swap are
guaranteed by a
U.S. person (except
a non-U.S. CSE,
U.S. branch of a
non-U.S. CSE, and
FCS whose
obligations are
guaranteed, as
noted above).
Non-U.S.
person (including
non-U.S. CSE, U.S.
branch of a non-
U.S. CSE, and a
FCS) whose
obligations under
the relevant swap
are not guaranteed
by a U.S. person.
Non-U.S. CSE (that is not an U.S. CSE... U.S. (Initial Margin
FCS or a U.S. branch of a Non-U.S. posted by CSE in
non-U.S. CSE) whose CSE (including U.S. column 1).
obligations under the branch of a non- Substituted
relevant swap are not U.S. CSE and FCS) Compliance (Initial
guaranteed by a U.S. person. whose obligations Margin collected by
under the swap are CSE in column 1).
guaranteed by a U.S. (Variation
U.S. person. Margin).
U.S. person Substituted
(except as noted Compliance (All).
above for a CSE).
Non-U.S.
person whose
obligations under
the swap are
guaranteed by a
U.S. person (except
a non-U.S. CSE
whose obligations
are guaranteed, as
noted above).
U.S. branch
of a non-U.S. CSE
or FCS, in each
case whose
obligations under
the relevant swap
are not guaranteed
by a U.S. person.
Non-U.S. Excluded (except in
person (including a connection with
non-U.S. CSE, but certain inter-
not an FCS or a affiliate swaps).
U.S. branch of a
non-U.S. CSE) whose
obligations under
the relevant swap
are not guaranteed
by a U.S. person.
------------------------------------------------------------------------
\1\ The term ``U.S. person'' is defined in Sec. 23.160(a)(10) of the
Final Rule. A ``non-U.S. person'' is any person that is not a ``U.S.
person.'' The term swap means an uncleared swap and is defined in Sec.
23.151 of the Final Margin Rule. See Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR
636 (Jan. 6, 2016).
\2\ As used in this table, the term ``Foreign Consolidated Subsidiary''
or ``FCS'' refers to a non-U.S. CSE in which an ultimate parent entity
that is a U.S. person has a controlling financial interest, in
accordance with U.S. GAAP, such that the U.S. ultimate parent entity
includes the non-U.S. CSE's operating results, financial position and
statement of cash flows in the U.S. ultimate parent entity's
consolidated financial statements, in accordance with U.S. GAAP. The
term ``ultimate parent entity'' means the parent entity in a
consolidated group in which none of the other entities in the
consolidated group has a controlling interest, in accordance with U.S.
GAAP.
\3\ Under Sec. 23.160(e) of the Final Rule, in certain foreign
jurisdictions where inherent limitations in the legal or operational
infrastructure of the jurisdiction make it impracticable for the CSE
and its counterparty to post initial margin for the uncleared swap in
compliance with the custodial arrangement requirements of the Final
Margin Rule, an FCS (or non-U.S. branch of a U.S. CSE) may be eligible
to engage in uncleared swaps with certain non-U.S. counterparties,
subject to a limit, but only if certain conditions are satisfied.
Under the limit, for each broad risk category set out in Sec.
23.154(b)(2)(v), the total outstanding notional value of all uncleared
swaps in that broad risk category, as to which the CSE is relying on
Sec. 23.160(e), may not exceed 5% of the CSE's total outstanding
notional value for all uncleared swaps in the same broad risk
category. The specified conditions include collecting the gross amount
of initial margin in cash, and posting and collecting variation margin
in cash, in accordance with the Final Margin Rule. The CSE's
counterparty must be a non-U.S. person that is not a CSE, and the
counterparty's obligations under the swap must not be guaranteed by a
U.S. person. This provision does not apply if the CSE that is subject
to the foreign regulatory restrictions is permitted to post collateral
for the uncleared swap in compliance with the custodial arrangements
of Sec. 23.157 in the United States or a jurisdiction for which the
Commission has issued a comparability determination with respect to
Sec. 23.157. An FCS (or non-U.S. branch of a U.S. CSE) that relies
on this special provision would not post initial margin in qualifying
foreign jurisdictions, and would not be required to hold initial
margin that they collect with one or more custodians that are not the
CSE, its counterparty, or an affiliate of the CSE or its counterparty
as would otherwise be required by Sec. 23.157(b) of the Final Margin
Rule. CSEs that rely on this special provision must have policies and
procedures to ensure compliance and maintain books and records
properly documenting that all of the requirements of this provision
are satisfied.
If a CSE cannot conclude after sufficient legal review with a well-
founded basis that the netting agreement with a counterparty in a
foreign jurisdiction meets the definition of an ``eligible master
netting agreement'' set forth in the Final Margin Rule, the CSE must
treat the uncleared swaps covered by the netting agreement on a gross
basis in determining the amount of initial and variation margin that
it must collect, but the CSE may net those uncleared swaps in
accordance with the netting provisions of the Final Margin Rule in
determining the amount of initial and variation margin that it must
post to the counterparty. The CSE must have policies and procedures to
ensure compliance and maintain books and records properly documenting
that all of the requirements of this provision are satisfied.
\4\ In order to preserve the Commission's intent with respect to the
treatment of inter-affiliate swaps under the Final Margin Rule, the
Exclusion is not available if the market-facing swap of the non-U.S.
CSE (that is otherwise eligible for the Exclusion) is not subject to
comparable initial margin collection requirements in the home
jurisdiction and any of the risk associated with the uncleared swap is
transferred, directly or indirectly, through inter-affiliate swaps, to
a U.S. CSE or a U.S. Guaranteed CSE. Under the Final Margin Rule, a
CSE is not required to collect initial margin from its affiliate,
provided, among other things, that affiliate collects initial margin
on its market-facing swaps or is subject to comparable initial margin
collection requirements (in the case of non-U.S. affiliates that are
financial end-users) on their own market-facing swaps.
[[Page 34852]]
Appendices to Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Cross-Border Application of the Margin
Requirements--Commission Voting Summary, Chairman's Statement, and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Massad and Commissioner Bowen voted in
the affirmative. Commissioner Giancarlo voted in the negative.
Appendix 2--Statement of Chairman Timothy G. Massad
I am pleased that today, the Commission has adopted a cross-
border approach to our rule setting margin for uncleared swaps.
Our margin rule is one of the most important elements of swaps
market regulation set forth in the Dodd-Frank Act. Margin
requirements help ensure that uncleared swaps, which will always
remain a sizable portion of the market, do not generate excessive
uncollateralized risk. Last December, the Commission adopted a
strong and sensible margin rule. It requires swap dealers and major
swap participants to post and collect margin in their transactions
with one another, and with financial entities with which they have
significant exposures.
The risks our margin rule seeks to prevent do not only originate
in the United States. The interconnected nature of the global swaps
market means that risks created across the globe have the potential
to flow back into the United States. We recognize that having a
global swaps market is beneficial to all users. Therefore, one of
the most important objectives we already accomplished was to ensure
our margin rule is substantially similar to comparable international
rules. Harmonization is critical to creating a sound international
framework for regulation.
We also recognize that not all jurisdictions will adopt strong
margin rules. And even where rules are substantially harmonized,
there will still be some differences. Because cross-border
transactions are commonplace, we must clarify which rules apply in
different situations. Today, the Commission has acted to provide
that clarification.
First, we have drawn a clear, reasonable line as to when the
CFTC should take offshore risk into account. Today's action ensures
that our rule, or a comparable international measure, applies to
swap dealers that are foreign consolidated subsidiaries of a U.S.
parent. This helps address the risk that can flow back into the
United States from that offshore activity, even when the subsidiary
is not explicitly guaranteed by the U.S. parent. This treatment of
foreign consolidated subsidiaries--and our general cross-border
approach--is also consistent with the approach taken by the U.S.
prudential regulators.
At the same time, to further our efforts toward harmonization,
and to avoid conflicts with the rules of other jurisdictions, we
have provided for a broad scope of substituted compliance. Not only
will non-U.S. swap dealers be eligible for substituted compliance,
so will U.S. swap dealers with respect to the margin they post to
non-U.S. persons. This approach is an appropriate response to the
complex world created by the swap industry, where global swap
dealers can book a swap in a variety of ways. Dealers may book swaps
through different subsidiaries, branches or affiliates all over the
world, and they may do so based on a number of considerations, such
as the most favorable legal treatment. Our approach is intended to
protect our markets against risk coming from these cross-border
transactions, while taking into account the interests of other
regulators.
The process for conducting a comparability assessment of another
jurisdiction's rules is similar to what we have done in other areas.
The rule specifies the various factors that should be considered,
and indeed there is no reasonable way one can make a determination
without evaluating those factors. One important consideration will
be compliance with the international framework developed by the
Basel Committee on Banking Supervision and the International
Organization of Securities Commissions. Our approach will look at
the elements of each jurisdiction's rule set with an eye towards a
flexible, outcome-based determination. The process of making
comparability assessments can take time. In light of the impending
September 1 compliance date, I have asked the CFTC staff to work
closely with other domestic and international regulators, as well as
industry participants, and endeavor to effect a smooth transition.
The approach we have finalized today helps ensure the safety and
soundness of registered swap dealers, and reduces the potential for
conflict with the rules of other international regulators. I thank
all those who provided us with important feedback on these issues. I
also thank CFTC staff for their work on this rule, and my fellow
Commissioners for their careful consideration of this measure.
Appendix 3--Concurring Statement of Commissioner Sharon Y. Bowen
Margin and Capital as the Pillars of Market Safety
Margin and capital are two of the most important tools for risk
mitigation for the derivatives markets. Thus it is very important
that we get our rules on margin and capital right in order to
accomplish the reform required under the Dodd-Frank Wall Street
Reform and Consumer Protection Act.\290\ As many of you know, last
December, I voted against the final margin for uncleared swaps rule
because I did not believe that it was strong enough to fully protect
our system. As I said in December, adequate margin is fundamental to
market safety as it is a ``critical shock absorber for the bumps and
potholes of our financial markets and for the risk of contagion and
spillovers.'' \291\ I am even more confident in that view today.
---------------------------------------------------------------------------
\290\ Public Law 111-203, 124 Stat. 1376 (2010).
\291\ http://www.cftc.gov/PressRoom/SpeechesTestimony/bowenstatement121615a.
---------------------------------------------------------------------------
Today we vote on a critical supplement to that margin rule.
Specifically, today's rule would allow registered dealers to
substitute the margin rules of comparable jurisdictions for our
rules, when dealing with non-US counterparties, under certain
conditions. Needless to say, cross-border regulation is central to
our margin rule functioning effectively since our markets are
global.
I intend to vote yes for this cross-border rule because I want
to give the market legal certainty, as the first compliance date for
our margin rules, as well as those of regulators across
jurisdictions--September 1, 2016--looms.\292\ It is important that
market participants have enough time to prepare in advance of this
date so as to minimize market instability. We also want to minimize
the risk of creating regulatory arbitrage across jurisdictions.
While my concerns about our margin regime remain, I recognize that
there is no opportunity in today's cross-border margin decision to
remedy those errors.
---------------------------------------------------------------------------
\292\ Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636, 675 (Jan. 6, 2016).
---------------------------------------------------------------------------
One of the major drawbacks of our margin rulemaking is that it
was not done in conjunction with our capital rulemaking. Margin and
capital are intertwined--if our margin rule is weak, our capital
rule needs to be stronger to compensate. If both are strong,
investors and consumers can be confident that we have learned the
lessons of the past, and have placed adequate protections in place
against future financial instability. But, if both are weak, we have
surrendered our best defenses against contagion. We put the
interests of our investors at risk when we view regulation in a
piecemeal and non-comprehensive fashion, because we are not seeing
the whole picture. So, as I vote today on cross-border margin, my
mind is on our upcoming capital rule proposal.
Any firm that aspires to be a swap dealer is aspiring to be a
significant player in our economy. They must have the capacity to
not only stand ready to be the buyer to each seller and the seller
to each buyer, but to maintain those positions over years. Their
creditworthiness must be above reproach. In that way, market
participants, including commercial end-users who need to hedge, can
be confident that their dealer will be there during times of
stability and crisis. It is therefore critical to the health of our
economy that the market trusts, and with good reason, that our
dealers are robust and steadfast--that they are able to withstand
the financial swings that are endemic to today's economy. Thus while
strong capital rules may prevent some entities from entering the
dealing business, they ultimately benefit the dealers, their
customers and the whole economy.
In order to create a capital rule that appropriately manages
risk for the American people and our critical economy, our capital
rule proposal must:
(1) Not Be Weaker Than Our Comparable Prudential Regulators'
Rule: The capital proposal, and subsequent final rule, must be as
strong as those of the Prudential Regulators. We are required under
law to establish minimum capital requirements that are
``comparable'' to our Prudential Regulator counterparts ``to the
maximum extent
[[Page 34853]]
practicable.'' \293\ Not only is this our legal obligation, but it
is a sensible one as it prevents entities from gaming the system,
and organizing their businesses in order to have the lowest capital
requirements possible. We do not want our regulatory framework to be
an escape hatch from strong risk management.
---------------------------------------------------------------------------
\293\ Commodity Exchange Act (CEA) 6s(e)(3)(D).
---------------------------------------------------------------------------
(2) Account for the Entire Risk to the Dealer: The capital
proposal should also require dealers to hold sufficient capital to
cover the entirety of the risk posed by the full gamut of
derivatives products that they hold--including those products,
which, for various reasons, we did not impose a margin requirement,
such as inter-affiliate swaps and swaps with financial
counterparties that are below the $8 billion threshold. This is
consistent with our mandate under law to ``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. . . .''
\294\ This is an important requirement. The Congressional authors
understood that just because a particular category of swaps that a
dealer holds are not subject to a regulatory requirement, does not
mean that the dealers, and therefore their customers, are not
vulnerable to the risk posed by them.
---------------------------------------------------------------------------
\294\ CEA 6s(e)(2)(C).
---------------------------------------------------------------------------
(3) Include Effective Elements of Strong Capital Models: Our
capital proposal should take into consideration respected, and
effective capital models from other regulators. As of now, we have
two well-regarded capital models: The Basel rules for banks, and the
Securities and Exchange Commission's (SEC's) rule for Broker-
Dealers. The Basel rule has many positive attributes--including the
fact that it not only has strong capital requirements but also a
liquidity, leverage and funding ratio.\295\ We need look no further
than financial companies before the 2008 crisis to understand the
need for leverage requirements. For instance, it was estimated that,
prior to the crisis, some firms had debt that was 30 to 40 times
their net capital.\296\ And we have very present examples of
commercial companies that evidence the need for funding
requirements.\297\ The SEC's broker dealer rule also has its
positives including that it does not allow for internal models,
which came under fire after the crisis for allowing excessive
leverage,\298\ and it is liquidity-based such that the dealer is
obligated to maintain highly liquid assets to cover its
liabilities.\299\ Our capital rule proposal should be as strong, if
not stronger, than these models.
---------------------------------------------------------------------------
\295\ With the exception of the capital charge to the segregated
customer funds that have been set aside to secure cleared products.
See ``Speech of Commissioner Sharon Y. Bowen at George Washington
Law, 2016 Manuel F. Cohen Lecture,'' Feb. 4, 2016, available at
http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-8.
\296\ E.g., Julie Satow, ``Ex-SEC Official Blames Agency for
Blow-Up of Broker-Dealers,'' The New York Sun (September 18, 2008)
(``[B]roker dealers . . . [had] debt-to-net-capital ratios,
sometimes, as in the case of Merrill Lynch, to as high as 40-to-
1.''), available at http://www.nysun.com/business/ex-sec-official-blames-agency-for-blow-up/86130/; Alan S. Blinder, ``Six Errors on
the Path to the Financial Crisis,'' New York Times (January 25,
2009) (stating that in 2008, securities firms had leverage ratios of
``33 to 1''), available at http://www.nytimes.com/2009/01/25/business/economy/25view.html?_r=0.
\297\ Jasmine Ng and David Yong, ``Noble Group Gets $3 Billion
in Credit Facilities,'' Bloomberg.com (May 12, 2016), available at
http://www.bloomberg.com/news/articles/2016-05-12/noble-group-agrees-3-billion-credit-facilities-with-lenders. See also Sarah
Kent, Scott Patterson, and Margot Patrick, ``Glencore Discloses More
Details on Financing,'' The Wall Street Journal (October 7, 2015),
available at http://www.wsj.com/articles/glencore-reveals-financing-deals-to-fend-off-critics-1444137982.
\298\ See supra note 7.
\299\ Securities Exchange Act (SEA) Rule 15c3-1.
---------------------------------------------------------------------------
(4) Address Risks Posed by Swap-Dealing of Non-Financial
Companies: Some commercial entities are also registered as swap
dealers, and others may decide to do so in the future. Having
commercial end-users that are engaging in more than a de minimis
amount of swap dealing may increase market risk. Thus it is
important that we are able to isolate their swap dealing business
from the regular business, so that we can properly track their
activities as a dealer.
(5) Be Based on Data-Driven Risk Assessment, Not Industry
Preference: As a regulator, anything that we propose needs to be
based on our data-driven risk assessment, not on the desire to
ensure that all entities that want to be dealers are able to
maintain their current business models without any changes. In
response to our proposal, market participants are then free to
provide data to explain why our risk assessment may be inappropriate
and to inform us of the pragmatic restraints. While encouraging more
entrants into the market maybe a regulatory goal, doing all we can
to prevent the next catastrophic financial crisis that wipes out
pensions, is our fundamental goal.
Experience has taught us that comprehensive, well-considered
review is critical when considering major regulations. Ten years
ago, too many people in industry did not engage in such well-
considered review when crafting complicated financial deals. In the
end, that lack of consideration came back to haunt us all when the
mortgage bubble burst and unexpectedly exposed many large financial
institutions to massive losses that threatened the entire financial
system. In the end, the American public had to save the system at
great expense, and the ensuing rescue left many angry, alienated,
and disaffected. Today, nearly eight years later, that anger still
exists. We all pay a great price when we move forward in finance
with insufficient analysis and review.
Thus, for the sake of market certainty, I am voting yes to this
rule. But I encourage my fellow Commissioners to work with me to
develop a strong, comprehensive capital rule so that the American
people can have the appropriate safeguards to secure our economy.
Thank you.
Appendix 4--Statement of Dissent by Commissioner J. Christopher
Giancarlo
I respectfully dissent from the final rule on the cross-border
application of margin requirements for uncleared swaps.
In September 2009, the leaders of the G-20 countries agreed to
launch a framework for ``strong, sustainable and balanced global
growth'' to generate ``a durable recovery that creates the good jobs
our people need.'' \1\ The agreement included a commitment ``to take
action at the national and international level to raise standards
together so that our national authorities implement global standards
consistently in a way that ensures a level playing field and avoids
fragmentation of markets, protectionism, and regulatory arbitrage.''
\2\
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\1\ G-20 Leaders' Statement, The Pittsburgh Summit, Preamble at
par. 13 (Sept. 24-25, 2009).
\2\ Id. at par. 12.
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In keeping with that agreement, representatives of more than 20
regulatory authorities, including the CFTC, participated in
consultations with the Basel Committee on Banking Supervision
(``BCBS'') and the Board of the International Organization of
Securities Commissions (``IOSCO'') to develop an international
framework setting margin standards for uncleared derivatives
(``BCBS-IOSCO framework'').\3\ That 2013 framework stresses the
importance of developing consistent requirements across
jurisdictions to avoid conflicting or duplicative standards.\4\
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\3\ Margin Requirements for Non-centrally Cleared Derivatives
(Sept. 2013), available at http://www.bis.org/publ/bcbs261.pdf,
revised Mar. 2015, available at http://www.bis.org/bcbs/publ/d317.pdf.
\4\ Id. at 23.
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Today, instead of recognizing and building upon the strong
foundation for mutual recognition of foreign regulatory regimes
created by the G-20 commitments and the BCBS-IOSCO framework, as
well as the CFTC's own history of using a principles-based, holistic
approach to comparability determinations,\5\ the Commission is
adopting a set of preconditions to substituted
[[Page 34854]]
compliance that is overly complex, unduly narrow and operationally
impractical.
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\5\ The CFTC has a long history of working collaboratively with
foreign regulators to facilitate cross-border business. For example,
under Commission Regulation 30.10, adopted in 1987, if the CFTC
determines that a foreign regulatory regime offers comparable
protections to U.S. customers transacting in foreign futures and
options, and there is an appropriate information-sharing arrangement
in place, the CFTC has allowed foreign brokers to comply with their
home-country regulations in lieu of Commission regulations.
Similarly, since 1996 the Commission has permitted direct access by
U.S. customers to foreign boards of trade (``FBOTs'') without
requiring the FBOT to register with the CFTC as a derivatives
contract market (``DCM''). In determining the comparability of the
foreign regulatory regime the Commission does not engage in a line-
by-line examination of the foreign regulator's approach to
supervising the FBOT it regulates. Rather, the Commission conducts a
principles-based review to determine whether the foreign regime
supports and enforces regulatory oversight of the FBOT and its
clearing organization in a substantially equivalent manner as that
used by the CFTC in its oversight of DCMs and clearing
organizations. See Registration of Foreign Boards of Trade, 76 FR
80674, 80680 (Dec. 23, 2011).
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First, the rule establishes a complicated matrix of potential
cross-border counterparties under which substituted compliance is
either not permitted, is partially permitted, or is fully permitted,
depending upon the category in which the particular transaction
fits. Next, where permitted, the CFTC will conduct an ``element-by-
element'' analysis of CFTC and foreign margin rules under which a
transaction may be subject to a patchwork of U.S. and foreign
regulation.\6\ The CFTC will follow this ``element-by-element''
approach instead of assessing a foreign authority's margin regime as
a whole.
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\6\ Such a result would be antithetical to element seven of the
BCBS-IOSCO framework, which requires that there be no application of
duplicative or conflicting margin requirements to the same
transaction or activity. The framework advises that ``[w]hen a
transaction is subject to two sets of rules (duplicative
requirements), the home and the host regulators should endeavor to
(1) harmonize the rules to the extent possible or (2) apply only one
set of rules, by recognizing the equivalence and comparability of
their respective rules.'' BCBS-IOSCO framework at 23.
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In response to commenters who observed that today's approach
will undermine the BCBS-IOSCO framework, the Commission acknowledges
that consistency with the framework is necessary, but argues that
the framework leaves certain elements open to interpretation by each
regulator, including the CFTC.\7\ For these elements, the Commission
undertakes to use an outcome-based analysis, but will also engage in
a fact-specific inquiry of each legal and regulatory provision that
corresponds to each element.
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\7\ In footnote 232 of the preamble the Commission cites, for
example, the definition of ``derivative,'' the list of assets
eligible to post as collateral, the degree to which margin would be
protected under the local bankruptcy regime, and how transactions
with affiliates are treated.
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In effect, the Commission's approach is somewhat principles-
based, except when it is rules-based and somewhat objective, except
when it is subjective.
Today's muddled methodology invites foreign regulators to
respond in kind. It may well set us off down the same protracted,
circuitous and uncertain path that the CFTC and the European Union
took in the context of U.S. central counterparty clearinghouse
equivalence. The approach is impractical, unnecessary and contrary
to the cooperative spirit of the 2009 G-20 Pittsburgh Accords.\8\
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\8\ I am also concerned about the Commission's unwillingness to
delay the cross-border application of its margin rules until after
it has made comparability determinations. This will bring into the
CFTC's regulatory ambit many cross-border transactions over which
U.S. jurisdiction is inappropriate and an undue drain on precious
regulatory resources.
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Rather than conducting a granular rule-by-rule comparison, the
CFTC should focus on whether a foreign regulator's margin regime, in
the aggregate, provides a sufficient level of risk mitigation in
connection with the execution of uncleared swaps. The BCBS-IOSCO
framework does just that. Compliance with it should be
straightforward and unconditional to prevent the ``fragmentation of
markets, protectionism, and regulatory arbitrage'' that global
regulators were charged to avoid.
As confusing as this rule is, what is important is not that hard
to understand. American workers need quality American jobs. They
need them in factories, farms and offices across the United States.
The businesses that employ them want to sell their goods and
services both here and abroad. To succeed globally, American
businesses need U.S.-based financial institutions to support them
around the world with competitively priced risk management services.
Unfortunately, this complicated rule will make it harder for
U.S. financial institutions to compete globally and serve American
businesses. When businesses are placed at a competitive
disadvantage, they hire fewer workers. With over 94 million
Americans now out of the workforce,\9\ that is unacceptable.
Therefore, I oppose this rule--it's that simple.
\9\ Bureau of Labor Statistics, The Employment Situation--April
2016, U.S. DEPARTMENT OF LABOR, May 6, 2016, http://www.bls.gov/news.release/empsit.nr0.htm.
[FR Doc. 2016-12612 Filed 5-27-16; 8:45 am]
BILLING CODE 6351-01-P