Federal Register, Volume 81 Issue 179 (Thursday, September 15, 2016)
[Federal Register Volume 81, Number 179 (Thursday, September 15, 2016)]
[Rules and Regulations]
[Pages 63376-63395]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-22045]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Comparability Determination for Japan: Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of comparability determination for margin requirements
for uncleared swaps under the laws of Japan.
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SUMMARY: The following is the analysis and determination of the
Commodity Futures Trading Commission (``Commission'') regarding a
request by the Japan Financial Services Agency (``JFSA'') that the
Commission determine that laws and regulations applicable in Japan
provide a sufficient basis for an affirmative finding of comparability
with respect to margin requirements for uncleared swaps applicable to
certain swap dealers (``SDs'') and major swap participants (``MSPs'')
registered with the Commission. As discussed in detail herein, with one
exception, the Commission has found the margin requirements for
uncleared swaps under the laws and regulations of Japan comparable to
those under the Commodity Exchange Act (``CEA'') and Commission
regulations.
DATES: This determination is effective September 15, 2016.
FOR FURTHER INFORMATION CONTACT: Eileen T. Flaherty, Director, 202-418-
5326, [email protected], or Frank N. Fisanich, Chief Counsel, 202-418-
5949, [email protected], Division of Swap Dealer and Intermediary
Oversight, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Introduction
Pursuant to section 4s(e) of the CEA,\1\ the Commission is required
to promulgate margin requirements for uncleared swaps applicable to
each SD and MSP for which there is no Prudential Regulator
(collectively, ``Covered Swap Entities'' or ``CSEs'').\2\ The
Commission published final margin requirements for such CSEs in January
2016 (the ``Final Margin Rule'').\3\
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\1\ 7 U.S.C. 1 et. seq.
\2\ See 7 U.S.C. 6s(e)(1)(B). SDs and MSPs for which there is a
Prudential Regulator must meet the margin requirements for uncleared
swaps established by the applicable Prudential Regulator. 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'').
\3\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016). The Margin
Rule, which became effective April 1, 2016, is codified in part 23
of the Commission's regulations. See 17 CFR 23.150 through 23.159,
and 23.161. The Commission's regulations are found in chapter I of
Title 17 of the Code of Federal Regulations, 17 CFR 1 et. seq.
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Subsequently, on May 31, 2016, the Commission published in the
Federal Register its final rule with respect to the cross-border
application of the Commission's margin requirements for uncleared swaps
applicable to CSEs (hereinafter, the ``Cross-Border Margin Rule'').\4\
The Cross-Border Margin Rule sets out the circumstances under which a
CSE is allowed to satisfy the requirements under the Margin Rule by
complying with comparable foreign margin requirements (``substituted
compliance''); offers certain CSEs a limited exclusion from the
Commission's margin requirements; and outlined a framework for
assessing whether a foreign jurisdiction's margin requirements are
comparable to the Final Margin Rule (``comparability determinations'').
The Commission promulgated the Cross-Border Margin Rule after close
consultation with the Prudential Regulators and in light of comments
from and discussions with market participants and foreign
regulators.\5\
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\4\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Cross-Border Application of the Margin
Requirements, 81 FR 34818 (May 31, 2016). The Cross-Border Margin
Rule, which became effective August 1, 2016, is codified in part 23
of the Commission's regulations. See 17 CFR 23.160.
\5\ In 2014, in conjunction with re-proposing 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) (the ``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); 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). 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.
See GMAC Meeting (May 14, 2015), transcript and webcast available at
http://www.cftc.gov/PressRoom/Events/opaevent_gmac051415.
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On June 17, 2016, the JFSA (the ``applicant'') submitted a request
that the Commission determine that laws and regulations applicable in
Japan provide a sufficient basis for an affirmative finding of
comparability with respect to the Final Margin Rule. The applicant
provided Commission staff with an updated submission on July 26, 2016.
On August 18, 2016, the application was further supplemented with
corrections and additional materials. The Commission's analysis and
comparability determination for Japan regarding the Final Margin Rule
is detailed below.
[[Page 63377]]
II. Cross-Border Margin Rule
A. Regulatory Objective of Margin Requirements
The regulatory objective of the Final Margin Rule 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.\6\ The primary
function of margin 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. 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.\7\
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\6\ See 7 U.S.C. 6s(e)(3)(A).
\7\ See Capital Requirements for Swap Dealers and Major Swap
Participants, 76 FR 27802 (May 12, 2011).
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However, 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 the Commission believes are vital to a well-
functioning global swap market.\8\ 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.
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\8\ 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
45300-45301 (referencing the Restatement (Third) of Foreign
Relations Law of the United States).
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B. Substituted Compliance
To address these concerns, the Cross-Border Margin Rule provides
that, subject to certain findings and conditions, a CSE is permitted to
satisfy the requirements of the Final Margin Rule by instead complying
with the margin requirements in the relevant foreign jurisdiction. This
substituted compliance regime is intended to address the concerns
discussed above without compromising the congressional mandate to
protect the safety and soundness of CSEs and the stability of the U.S.
financial system. 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 builds on international efforts to
develop a global margin framework.\9\
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\9\ 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 and the Committee on Global Financial
Systems, formed a Working Group on Margining Requirements 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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Pursuant to the Cross-Border Margin Rule, any CSE that is eligible
for substituted compliance under Sec. 23.160 \10\ 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 may apply to the Commission
for a comparability determination.\11\
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\10\ See 17 CFR 23.160(c)(1)(i).
\11\ See 17 CFR 23.160(c)(1)(ii).
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The Cross-Border Margin Rule requires that applicants for a
comparability determination provide copies of the relevant foreign
jurisdiction's margin requirements \12\ and descriptions of their
objectives,\13\ how they differ from the BCBS/IOSCO Framework,\14\ and
how they address the elements of the Commission's margin
requirements.\15\ The applicant must identify the specific legal and
regulatory provisions of the foreign jurisdiction's margin requirements
that correspond to each element and, if necessary, whether the relevant
foreign jurisdiction's margin requirements do not address a particular
element.\16\
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\12\ See 17 CFR 23.160(c)(2)(v).
\13\ See 17 CFR 23.160(c)(2)(i).
\14\ See 17 CFR 23.160(c)(2)(iii). See also 17 CFR 23.160(a)(3)
(defining ``international standards'' as based on the BCBS-ISOCO
Framework).
\15\ 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
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.
\16\ See id.
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C. Standard of Review for Comparability Determinations
The Cross-Border Margin 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; \17\ whether
the relevant foreign jurisdiction's margin requirements achieve
comparable outcomes to the Commission's corresponding margin
requirements; \18\ and the ability of the relevant regulatory authority
or authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's margin requirements.\19\
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\17\ See 17 CFR 23.160(c)(3)(i).
\18\ See 17 CFR 23.160(c)(3)(ii). As discussed above, the
Commission's Final Margin Rule is based on the BCBS/IOSCO Framework;
therefore, the Commission expects that the relevant foreign margin
requirements would conform to such Framework at minimum in order to
be deemed comparable to the Commission's corresponding margin
requirements.
\19\ See 17 CFR 23.160(c)(3)(iii). See also 17 CFR
23.160(c)(3)(iv) (indicating the Commission would also consider any
other relevant facts and circumstances).
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This process reflects an outcome-based approach to assessing the
comparability of a foreign jurisdiction's margin requirements. Instead
of demanding strict uniformity with the Commission's margin
requirements, the Commission evaluates 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
[[Page 63378]]
every aspect or contain identical elements.
In keeping with the Commission's commitment to international
coordination on margin requirements for uncleared derivatives, the
Commission believes that the standards it has established are fully
consistent with the BCBS-IOSCO Framework.\20\ Accordingly, where
relevant to the Commission's comparability analysis, the BCBS/IOSCO
Framework is discussed to explain certain internationally agreed
concepts and, where appropriate, used as a baseline to compare
provisions of the Final Margin Rule with those of the foreign
jurisdiction.
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\20\ The Final Margin Rule was modified substantially from its
proposed form to further align the Commission's margin requirements
with the BCBS/IOSCO Framework and, as a result, the potential for
conflict with foreign margin requirements should be reduced. 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. The
Commission notes, however, that 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.'').
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The Cross-Border Margin Rule provided a detailed discussion
regarding the facts and circumstances under which substituted
compliance for the requirements under the Final Margin Rule would be
available and such discussion is not repeated here. CSEs seeking to
rely on substituted compliance based on the comparability
determinations contained herein are responsible for determining whether
substituted compliance is available under the Cross-Border Margin Rule
with respect to the CSE's particular status and circumstances.
D. Conditions to Comparability Determinations
The Cross-Border Margin Rule provides that the Commission may
impose terms and conditions it deems appropriate in issuing a
comparability determination.\21\ Specific terms and conditions with
respect to margin requirements are discussed in the Commission's
determinations detailed below.
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\21\ See 17 CFR 23.160(c)(5).
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As a general condition to all determinations, however, the
Commission requires notification of any material changes to information
submitted to the Commission by the applicant in support of a
comparability finding, 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 or similar arrangement with the Commission in connection
with a comparability determination.\22\
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\22\ Under Commission regulations 23.203 and 23.606, CSEs 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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Finally, the Commission will generally rely on an applicant's
description of the laws and regulations of the foreign jurisdiction in
making its comparability determination. The Commission considers an
application to be a representation by the applicant that the laws and
regulations submitted are in full force and effect, that the
description of such laws and regulations is accurate and complete, and
that, unless otherwise noted, the scope of such laws and regulations
encompasses the swaps activities \23\ of CSEs \24\ in the relevant
jurisdictions.\25\ Further, the Commission expects that an applicant
would notify the Commission of any material changes to information
submitted in support of a comparability determination (including, but
not limited to, changes in the relevant supervisory or regulatory
regime) as, depending on the nature of the change, the Commission's
comparability determination may no longer be valid.\26\
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\23\ ``Swaps activities'' is defined in Commission regulation
23.600(a)(7) to mean, with respect to a registrant, such
registrant's activities related to swaps and any product used to
hedge such swaps, including, but not limited to, futures, options,
other swaps or security-based swaps, debt or equity securities,
foreign currency, physical commodities, and other derivatives. The
Commission's regulations under 17 CFR part 23 are limited in scope
to the swaps activities of CSEs.
\24\ No CSE that is not legally required to comply with a law or
regulation determined to be comparable may voluntarily comply with
such law or regulation in lieu of compliance with the CEA and the
relevant Commission regulation. Each CSE that seeks to rely on a
comparability determination is responsible for determining whether
it is subject to the laws and regulations found comparable.
\25\ The Commission has provided the relevant foreign
regulator(s) with opportunities to review and correct the
applicant's description of such laws and regulations on which the
Commission will base its comparability determination. The Commission
relies on the accuracy and completeness of such review and any
corrections received in making its comparability determinations. A
comparability determination based on an inaccurate description of
foreign laws and regulations may not be valid.
\26\ 78 FR at 45345.
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III. Margin Requirements for Swaps Activities in Japan
As represented to the Commission by the applicant, margin
requirements for swap activities in Japan are governed by the Financial
Instruments and Exchange Act, No. 25 of 1948 (``FIEA''), covering
Financial Instrument Business Operators (``FIBOs'') and Registered
Financial Institutions (``RFIs''), which include regulated banks,
cooperatives, insurance companies, pension funds, and investment funds.
The Japanese Prime Minister delegated broad authority to implement
these laws to the JFSA. Pursuant to this authority, the JFSA has
promulgated the Cabinet Office Ordinance,\27\ Supervisory
Guidelines,\28\ and Public Notifications.\29\
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\27\ Cabinet Office Ordinance on Financial Instruments Business
(Cabinet Office Ordinance No. 52 of August 6, 2007), including
supplementary provisions (``FIB Ordinance'').
\28\ Comprehensive Guideline for Supervision of Major Banks,
etc., Comprehensive Guidelines for Supervision of Regional Financial
Institutions, Comprehensive Guideline for Supervision of Cooperative
Financial Institutions, Comprehensive Guideline for Supervision of
Financial Instruments Business Operators, etc., Comprehensive
Guidelines for Supervision of Insurance Companies, and Comprehensive
Guidelines for Supervision of Trust Companies, etc. (together,
``Supervisory Guideline'').
\29\ JFSA Public Notification No. 15 of March 31, 2016 (``JFSA
Public Notice No. 15''); JFSA Public Notification No. 16 of March
31, 2016 (``JFSA Public Notice No. 16''); and JFSA Public
Notification No. 17 of March 31, 2016 (``JFSA Public Notice No.
17'').
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These requirements supplement the requirements of FIEA with a more
proscriptive direction with respect to margin requirements.\30\
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\30\ Collectively, FIEA, FIB Ordinance, Supervisory Guideline,
and JFSA Public Notifications are referred to herein as the ``JFSA's
margin rules,'' ``JFSA's margin regime,'' ``JFSA's margin
requirements'' or the ``laws of Japan.''
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Pursuant to Article 29 of the FIEA, any person that engages in
trade activities that constitute ``Financial Instruments Business''--
which, among other things, includes over-the-counter transactions in
derivatives (``OTC derivatives'') or intermediary, brokerage (excluding
brokerage for clearing of securities) or agency services therefor
\31\--must register under the
[[Page 63379]]
FIEA as a FIBO. Banks that conduct specified activities in the course
of trade, including OTC derivatives must register under the FIEA as
RFIs pursuant to Article 33-2 of the FIEA. Banks registered as RFIs are
required to comply with relevant laws and regulations for FIBOs
regarding specified activities. Failure to comply with any relevant
laws and regulations, Supervisory Guidelines, or Public Notifications
would subject the applicant to potential sanctions or corrective
measures.
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\31\ See Article 2(8)(iv) of the FIEA.
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All current CSEs established under the laws of Japan are registered
in Japan as RFIs or FIBOs under the supervision of the JFSA.
IV. Comparability Analysis
The following section describes the regulatory objective of the
Commission's requirements with respect to margin for uncleared swaps
imposed by the CEA and the Final Margin Rule and a description of such
requirements. Immediately following a description of the requirement(s)
of the Final Margin Rule for which a comparability determination was
requested by the applicant, the Commission provides a description of
the foreign jurisdiction's comparable laws, regulations, or rules. The
Commission then provides a discussion of the comparability of, or
differences between, the Final Margin Rule and the foreign
jurisdiction's laws, regulations, or rules.
A. Objectives of Margin Requirements
1. Commission Statement of Regulatory Objectives
The regulatory objective of the Final Margin Rule is 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. The primary function of margin 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. 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.\32\
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\32\ See Cross-Border Margin Rule, 81 FR at 34819.
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2. JFSA Statement of Regulatory Objectives
The JFSA states that the objectives of margin requirements are the
reduction of systemic risk and promotion of central clearing, as the
BCBS/IOSCO Framework defines. To ensure that these objectives are
achieved, the laws and regulations of Japan prescribe that financial
institutions shall establish an appropriate framework for margin
requirements, in line with the BCBS/IOSCO Framework. In addition, the
JFSA intends to improve the risk management capabilities of financial
institutions through its margin requirements and accordingly, JFSA's
Supervisory Guidelines explicitly prescribe that financial institutions
are required to establish a framework for margin requirements in order
to manage counterparty credit risk.
B. Products Subject to Margin Requirements
The Commission's Final Margin Rule applies only to uncleared swaps.
Swaps are defined in section 1a(47) of the CEA \33\ and Commission
regulations.\34\ ``Uncleared swap'' is defined for purposes of the
Final Margin Rule in Commission regulation Sec. 23.151 to mean a swap
that is not cleared by a registered derivatives clearing organization,
or by a clearing organization that the Commission has exempted from
registration by rule or order pursuant to section 5b(h) of the Act.\35\
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\33\ 7 U.S.C. 1a(47).
\34\ See, e.g., Sec. 1.3(xxx), 17 CFR 1.3(xxx).
\35\ 17 CFR 23.151.
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In Japan, the JFSA's margin rules apply to ``non-cleared OTC
derivatives,'' which are defined to mean:
OTC derivatives except for those cases where Financial
Instruments Clearing Organizations (including an Interoperable
Clearing Organization in cases where the Financial Instruments
Clearing Organization conducts Interoperable Financial Instruments
Obligation Assumption Business; hereinafter the same shall apply in
paragraph (11), item (i)(c)1.) or a Foreign Financial Instruments
Clearing Organization meets the obligation pertaining to OTC
derivatives or cases designated by Commissioner of the Financial
Services Agency prescribed in Article 1-18-2 of the Order for
Enforcement of the [FIEA].\36\
\36\ See Cabinet Order No. 321 of 1965; See also Article
123(1)(xxi)-5 of the FIB Ordinance. ``OTC derivative'' is defined in
Article 2(22) of FIEA to mean:
[T]he following transactions which are conducted in neither a
Financial Instruments Market nor a Foreign Financial Instruments
Market (except those specified by a Cabinet Order as those for which
it is found not to hinder the public interest or protection of
investors when taking into account its content and other related
factors).
(i) Transactions wherein the parties thereto promise to deliver
or receive Financial Instruments (excluding those listed in Article
2(24)(v); hereinafter the same shall apply in this paragraph) or
consideration for them at a fixed time in the future, and, when the
resale or repurchase of the underlying Financial Instruments or
other acts specified by a Cabinet Order is made, settlement thereof
may be made by paying or receiving the differences;
(ii) transactions wherein the parties thereto promise to pay or
receive the amount of money calculated based on the Agreed Figure
and the Actual Figure or any other similar transactions; and
(iii) transactions wherein the parties thereto promise that one
of the parties grants the other party an option to effect a
transaction listed in the following items between the parties only
by unilateral manifestation of the other party's intention, and the
other party pays consideration for such option, or any other similar
transactions:
(a) Sales and purchase of Financial Instruments (excluding those
specified in item (i)); or
(b) any transaction listed in the preceding two items or items
(v) to (vii).
(iv) transactions wherein the parties thereto promise that one
of the parties grants the other party an option to, only by
unilateral manifestation of his/her intention, effect a transaction
wherein the parties promise to pay or receive the amount of money
calculated based on the difference between a figure which the
parties have agreed in advance to use as the Agreed Figure of the
Financial Indicator when such manifestation is made and the Actual
Figure of the Financial Indicator at the time of such manifestation,
and the other party pays the consideration for such option, or any
other similar transactions;
(v) transactions wherein the parties mutually promise that,
using the amount the parties have agreed to as the principal, one of
the parties will pay the amount of money calculated based on the
rate of change in the agreed period of the interest rate, etc. of
the Financial Instruments (excluding those listed in Article
2(24)(iii)) or of a Financial Indicator agreed with the other party,
and the other party will pay the amount of money calculated based on
the rate of change in the agreed period of the interest rate, etc.
of the Financial Instruments (excluding those listed in Article
2(24)(iii)) or of a Financial Indicator agreed with the former party
(including transactions wherein the parties promise that, in
addition to the payment of such amounts, they will also pay, deliver
or receive the amount of money or financial instruments that amounts
to the agreed principal), or any other similar transactions;
(vi) transactions wherein one of the parties pays money, and the
other party, as the consideration therefor, promises to pay money in
cases where a cause agreed by the parties in advance and listed in
the following items occurs (including those wherein one of the
parties promises to transfer the Financial Instruments, rights
pertaining to the Financial Instruments or monetary claim (excluding
claims that are Financial Instruments or rights pertaining to the
Financial Instruments), but excluding those listed in item (ii) to
the preceding item), or any other similar transactions; or
(a) a cause pertaining to credit status of a juridical person or
other similar cause as specified by a Cabinet Order; or
(b) a cause which it is impossible or extremely difficult for
either party to exert his/her influence on the occurrence of and
which may have serious influence on business activities of the
parties or other business operators as specified by a Cabinet Order
(excluding those specified in (a)).
(vii) in addition to transactions listed in the preceding items,
transactions which have an economic nature similar to these
transactions and are specified by a Cabinet Order as those for which
it is found necessary to secure the public interest or protection of
investors.
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[[Page 63380]]
As represented by the applicant, however, Japan has separate
definitions of ``OTC Derivatives'' and ``OTC Commodity Derivatives.''
\37\ Japan also has separate margin rules for OTC Commodity Derivatives
that are administered by the Japan Ministry of Economy, Trade, and
Industry (METI) and the Japan Ministry of Agriculture, Forestry, and
Fisheries (MAFF). METI/MAFF finalized their margin requirements for
non-cleared OTC Commodity Derivatives on August 1, 2016.\38\ While the
margin rules for non-cleared OTC Derivatives and OTC Commodity
Derivatives are separate, the METI/MAFF non-cleared OTC Commodity
Derivative rules incorporate by reference the corresponding JFSA margin
rules,\39\ and thus, for all purposes material to the determinations
below, the METI/MAFF rules and JFSA margin rules are identical.
Accordingly, for ease of reference, the discussion below refers only to
the JFSA and the JFSA margin rules, but such discussion is equally
applicable to METI/MAFF and the METI/MAFF non-cleared OTC Commodity
Derivative margin rules. Further, CSEs may rely on the determinations
set forth below regarding non-cleared OTC Derivatives subject to the
JFSA margin rules equally with respect to non-cleared OTC Commodity
Derivatives subject to the METI/MAFF margin rules.
---------------------------------------------------------------------------
\37\ ``OTC Commodity Derivative'' is defined in Article 2,
Paragraph 14 of the Commodity Derivatives Act (Act No. 239 of August
5, 1950) to mean any of the following transactions not executed on
any Commodity Market, Foreign Commodity Market, or Financial
Instruments Exchange Market (i.e., Financial Instruments Exchange
Markets prescribed in Article 2, paragraph (17) of the FIEA
(excluding transactions carried out through the facilities listed in
each of the items of Article 331 of the Commodity Derivatives Act):
(i) Buying and selling transactions where parties agree to
transfer between them a Commodity and the consideration therefor at
a certain time in the future and where a resale or repurchase of the
Commodity subject to said buying and selling can be settled by
exchanging the difference;
(ii) Transactions where parties agree to transfer between them
money calculated on the basis of the difference between the Contract
Price and the Actual Price or other transactions similar thereto;
(iii) Transactions where parties agree to transfer between them
money calculated on the basis of the difference between the Agreed
Figure and the Actual Figure or other transactions similar thereto;
(iv) Transactions where parties agree that, on the manifestation
of intention by one of the parties, the counterparty grants said
party a right to establish any of the following transactions between
the parties and said party pays the consideration therefor or other
transactions similar thereto:
(a) Transactions set forth in item (i);
(b) Transactions set forth in item (ii);
(c) Transactions set forth in the previous item;
(d) Transactions set forth in item (vi);
(v) Transactions where parties agree that the counterparty
grants said party a right to establish between the parties a
transaction where parties transfer between them money calculated on
the basis of the difference between the price agreed between the
parties in advance as a price of a Commodity pertaining to the
manifestation of intention by one of the parties (including a
numerical value that expresses the price level of a Commodity and a
numerical value calculated otherwise on the basis of the price of a
Commodity; hereinafter the same shall apply in this item) or the
numerical value agreed between the parties in advance as a Commodity
Index and the actual price of said Commodity or the actual numerical
value of said Commodity Index prevailing at the time of said
manifestation of intention and said party pays the consideration
therefor, or other transactions similar thereto;
(vi) Transactions where parties mutually agree, with respect to
a Commodity for which the volume is determined by the parties, that
one party will pay to the counterparty money calculated on the basis
of the rate of change in the price of said Commodity or a Commodity
Index for a period agreed between the parties in advance and that
the latter will pay to the former money calculated on the basis of
the rate of change in the price of said Commodity or a Commodity
Index for a period agreed between the parties in advance, or other
transactions similar thereto;
(vii) In addition to transactions listed in the preceding items,
transactions with an economic nature similar thereto that are
specified by Cabinet Order as those for which it is considered
necessary to secure the public interests or protection of parties
thereto.
\38\ See Ministry of Agriculture, Forestry and Fisheries/
Ministry of Economy, Trade and Industry Public Notification No. 2 of
August 1, 2016; Ordinance for Enforcement of the Commodity
Derivatives Act (Ordinance of the Ministry of Agriculture, Forestry
and Fisheries and the Ministry of Economy, Trade and Industry No. 3
of February 22, 2005); Supplementary Provisions of Ordinance for
Enforcement of the Commodity Derivatives Act No. 3 of February 22,
2005; and Basic Supervision Guidelines of Commodity Derivatives
Business Operators, etc.
\39\ See id.
---------------------------------------------------------------------------
While it is beyond the scope of this comparability determination to
definitively map any differences between the definitions of ``swap''
and ``uncleared swap'' under the CEA and Commission regulations and
Japan's definitions of ``OTC Derivative,'' ``OTC Commodity
Derivative,'' ``non-cleared OTC Derivative,'' and ``non-cleared OTC
Commodity Derivative,'' the Commission believes that such definitions
largely cover the same products and instruments.
However, because the definitions are not identical, the Commission
recognizes the possibility that a CSE may enter into a transaction that
is an uncleared swap as defined in the CEA and Commission regulations,
but that is not a non-cleared OTC Derivative as defined under the laws
of Japan. In such cases, the Final Margin Rule would apply to the
transaction but the JFSA's margin rules would not apply and thus,
substituted compliance would not be available. The CSE could not choose
to comply with the JFSA's margin rules \40\ in place of the Final
Margin Rule.
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\40\ Or the METI/MAFF margin rules, as discussed above.
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Likewise, if a transaction is a non-cleared OTC derivative as
defined under the laws of Japan but not an uncleared swap subject to
the Final Margin Rule, a CSE could not choose to comply with the Final
Margin Rule pursuant to this determination. CSEs are solely responsible
for determining whether a particular transaction is both an uncleared
swap and a non-cleared OTC derivative before relying on substituted
compliance under the comparability determinations set forth below.
C. Entities Subject to Margin Requirements
As stated previously, the Commission's Final Margin Rule and Cross-
Border Margin Rule apply only to CSEs, i.e., SDs and MSPs registered
with the Commission for which there is not a Prudential Regulator.\41\
Thus, only such CSEs may rely on the determinations herein for
substituted compliance, while CSEs for which there is a Prudential
Regulator must look to the determinations of the Prudential Regulators.
The Commission has consulted with the Prudential Regulators in making
these determinations.
---------------------------------------------------------------------------
\41\ See 7 U.S.C. 6s(e)(1)(B). SDs and MSPs for which there is a
Prudential Regulator must meet the margin requirements for uncleared
swaps established by the applicable Prudential Regulator. 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 Prudential Regulators' Final Margin Rule, 80 FR
74840 (Nov. 30, 2015).
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CSEs are not required to collect and/or post margin with every
uncleared swap counterparty. Under the Final Margin Rule, the initial
margin obligations of CSEs apply only to uncleared swaps with
counterparties that meet the definition of ``covered counterparty'' in
Sec. 23.151.\42\ Such definition provides that a ``covered
counterparty'' is a counterparty that is a financial end user \43\ with
material
[[Page 63381]]
swaps exposure \44\ or a swap entity \45\ that enters into a swap with
a CSE. The variation margin obligations of CSEs under the Final Margin
Rule apply more broadly. Such obligations apply to counterparties that
are swap entities and all financial end users, not just those with
``material swaps exposure.'' \46\
---------------------------------------------------------------------------
\42\ See 17 CFR 23.152.
\43\ See definition of ``Financial end user'' in 17 CFR 23.150.
\44\ See 17 CFR 23.150, which states that ``material swaps
exposure'' for an entity means that the entity and its margin
affiliates have an average daily aggregate notional amount of
uncleared swaps, uncleared security-based swaps, foreign exchange
forwards, and foreign exchange swaps with all counterparties for
June, July and August of the previous calendar year that exceeds $8
billion, where such amount is calculated only for business days. An
entity shall count the average daily aggregate notional amount of an
uncleared swap, an uncleared security-based swap, a foreign exchange
forward, or a foreign exchange swap between the entity and a margin
affiliate only one time. For purposes of this calculation, an entity
shall not count a swap that is exempt pursuant to 17 CFR 23.150(b)
or a security-based swap that qualifies for an exemption under
section 3C(g)(10) of the Securities Exchange Act of 1934 (15 U.S.C.
78c-3(g)(4)) and implementing regulations or that satisfies the
criteria in section 3C(g)(1) of the Securities Exchange Act of 1934
(15 U.S.C. 78-c3(g)(4)) and implementing regulations.
\45\ ``Swap entity'' is defined in 17 CFR 23.150 as a person
that is registered with the Commission as a swap dealer or major
swap participant pursuant to the Act.
\46\ See 17 CFR 23.153.
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As represented by the JFSA, the JFSA's margin rules cover all types
of financial institutions, such as prudentially regulated banks,
cooperatives, securities companies, insurance companies, pension funds,
and investment funds.\47\ However, similar to the Final Margin Rule's
definitions of ``covered counterparty'' and ``financial end-user,'' the
JFSA's margin regime does not apply to non-financial institutions nor
to financial institutions below certain thresholds of activity in OTC
derivatives.\48\ As discussed above, CSEs are financial institutions
for purposes of the JFSA's margin rules.
---------------------------------------------------------------------------
\47\ See FIB Ordinance Article 123(10) and (11). Specifically,
``covered entities'' under the JFSA's margin rules include Type 1
FIBOs, RFIs, insurance companies that are RFIs and trust accounts
that are RFIs. Covered entities also include Shoko Chukin Bank, the
Development Bank of Japan, Shinkin Central Bank, and the Norinchukin
Bank. Covered entities must post and collect initial and variation
margin to and from other covered entity counterparties.
\48\ See FIB Ordinance, Article 123(10)(iv) and (11)(iv). In
general, the threshold for variation margin is whether the average
total amount of the notional principal of OTC Derivatives for a
one[hyphen]year period from April two years before the year in which
calculation is required (or one year if calculated in December)
exceeds JPY 300 bn. In general, the threshold for initial margin is
whether the average month[hyphen]end aggregate notional amount of
non[hyphen]cleared OTC derivatives, non[hyphen]cleared OTC commodity
derivatives, and physically[hyphen]settled FX forwards and FX swaps
of a consolidated group (excluding inter-affiliate transactions) for
March, April, and May one year before the year in which calculation
is required exceeds JPY 1.1 trillion. No margin is required for OTC
Derivatives with non-covered entities (i.e., non-financial end-
users). However, FIBOs and RFIs that fall below the threshold for
variation margin are still required by the Supervisory Guidelines to
establish appropriate risk management policies and procedures that
require exchange of variation margin and appropriate documentation.
See Supervisory Guideline Section IV--2-4(4)(i).
---------------------------------------------------------------------------
Given the definitional differences and differences in activity
thresholds with respect to the scope of application of the Final Margin
Rule and the JFSA's margin requirements, the Commission notes the
possibility that the Final Margin Rule and the JFSA's margin rules may
not apply to every uncleared swap that a CSE may enter into with a
Japanese counterparty. For example, it appears possible that a
financial end user with ``material swaps exposure'' would meet the
definition of ``covered counterparty'' under the Final Margin Rule (and
thus the initial and variation margin requirements) while at the same
time fall under the JFSA's OTC Derivative activity threshold and be
subject only to variation margin requirements. It may also be possible
that the Final Margin Rule's definition of ``financial end-user'' could
capture an entity that is a non-financial end-user under the JFSA's
margin regime.
With these differences in scope in mind, the Commission reiterates
that no CSE may rely on substituted compliance unless it and its
transaction are subject to both the Final Margin Rule and the JFSA's
margin rules; \49\ a CSE may not voluntarily comply with the JFSA's
margin rules where such law does not otherwise apply. Likewise, a CSE
that is not seeking to rely on substituted compliance should understand
that the JFSA's margin rules may apply to its counterparty irrespective
of the CSE's decision to comply with the Final Margin Rule.
---------------------------------------------------------------------------
\49\ Or the METI/MAFF margin rules, as discussed above.
---------------------------------------------------------------------------
D. Treatment of Inter-Affiliate Derivative Transactions
The BCBS/IOSCO Framework recognizes that the treatment of inter-
affiliate derivative transactions will vary between jurisdictions.
Thus, the BCBS/IOSCO Framework does not set standards with respect to
the treatment of inter-affiliate transactions. Rather, it recommends
that regulators in each jurisdiction review their own legal frameworks
and market conditions and put in place margin requirements applicable
to inter-affiliate transactions as appropriate.\50\
---------------------------------------------------------------------------
\50\ See BCBS/IOSCO Framework, Element 6: Treatment of
transactions with affiliates.
---------------------------------------------------------------------------
1. Commission Requirements for Treatment of Inter-Affiliate
Transactions
The Commission determined through its Final Margin Rule to provide
rules for swaps between ``margin affiliates.'' The definition of margin
affiliates provides that a company is a margin affiliate of another
company if: (1) Either company consolidates the other on a financial
statement prepared in accordance with U.S. Generally Accepted
Accounting Principles, the International Financial Reporting Standards,
or other similar standards; (2) both companies are consolidated with a
third company on a financial statement prepared in accordance with such
principles or standards; or (3) for a company that is not subject to
such principles or standards, if consolidation as described in (1) or
(2) would have occurred if such principles or standards had
applied.\51\
---------------------------------------------------------------------------
\51\ See 17 CFR 23.151.
---------------------------------------------------------------------------
With respect to swaps between margin affiliates, the Final Margin
Rule, with one exception explained below, provides that a CSE is not
required to collect initial margin \52\ from a margin affiliate
provided that the CSE meets the following conditions: (i) The swaps are
subject to a centralized risk management program that is reasonably
designed to monitor and to manage the risks associated with the inter-
affiliate swaps; and (ii) the CSE exchanges variation margin with the
margin affiliate.\53\
---------------------------------------------------------------------------
\52\ ``Initial margin'' is margin exchanged to protect against a
potential future exposure and is defined in 17 CFR 23.151 to mean
the collateral, as calculated in accordance with 17 CFR 23.154 that
is collected or posted in connection with one or more uncleared
swaps.
\53\ See 17 CFR 23.159(a).
---------------------------------------------------------------------------
In an exception to the foregoing general rule, the Final Margin
Rule does require CSEs to collect initial margin from non-U.S.
affiliates that are financial end users that are not subject to
comparable initial margin collection requirements on their own outward-
facing swaps with financial end users.\54\ This provision is an
important anti-evasion measure. It is designed to prevent the potential
use of affiliates to avoid collecting initial margin from third
parties. For example, suppose that an unregistered non-U.S. affiliate
of a CSE enters into a swap with a financial end user and does not
collect initial margin. Suppose further that the affiliate then enters
into a swap with the CSE. Effectively, the risk of the swap with the
third party would have been passed to the CSE without any initial
margin. The rule would require this affiliate to post initial margin
with the CSE in such cases. The rule would
[[Page 63382]]
further require that the CSE collect initial margin even if the
affiliate routed the trade through one or more other affiliates.\55\
---------------------------------------------------------------------------
\54\ See 17 CFR 23.159(c).
\55\ See id.
---------------------------------------------------------------------------
The Commission has stated that its inter-affiliate initial margin
requirement is consistent with its goal of harmonizing its margin rules
as much as possible with the BCBS/IOSCO Framework. Such Framework, for
example, states that the exchange of initial and variation margin by
affiliated parties ``is not customary'' and that initial margin in
particular ``would likely create additional liquidity demands.'' \56\
With an understanding that many authorities, such as those in Europe
and Japan, are not expected to require initial margin for inter-
affiliate swaps, the Commission recognized that requiring the posting
and collection of initial margin for inter- affiliate swaps generally
would be likely to put CSEs at a competitive disadvantage to firms in
other jurisdictions.
---------------------------------------------------------------------------
\56\ See BCBS/IOSCO Framework, Element 6: Treatment of
transactions with affiliates.
---------------------------------------------------------------------------
The Final Margin Rule however, does require CSEs to exchange
variation margin with affiliates that are SDs, MSPs, or financial end
users (as is also required under the Prudential Regulators' rules).\57\
The Commission believes that marking open positions to market each day
and requiring the posting or collection of variation margin reduces the
risks of inter-affiliate swaps.
---------------------------------------------------------------------------
\57\ See 17 CFR 23.159(b), Prudential Regulators' Final Margin
Rule, 80 FR at 74909.
---------------------------------------------------------------------------
2. Requirement for Treatment of Inter-Affiliate Derivatives Under the
Laws of Japan
Under Article 123(10) and (11) of Japan's FIB Ordinance, the JFSA's
margin requirements do not apply to OTC derivative transactions between
counterparties that are ``Consolidated Companies'' as defined in the
Ministry of Finance of Japan's Ordinance on Terminology, Forms, and
Preparation Methods of Consolidated Financial Statements.\58\ Such
``Consolidated Companies'' are defined generally in keeping with the
Commission's definition of ``margin affiliate'' for purposes of the
Final Margin Rule, discussed above.
---------------------------------------------------------------------------
\58\ See Ordinance of the Ministry of Finance No. 28 of October
30, 1976.
---------------------------------------------------------------------------
However, in mitigation of not requiring margin between Consolidated
Companies, the JFSA has explained that its capital requirements for
FIBOs/RFIs apply not only on a consolidated basis but also on
individual, non-consolidated basis. Thus, a CSE that is a FIBO/RFI is
required to hold enough capital to cover exposures under non-cleared
OTC derivatives to individual entities in the same consolidated group.
Such capital requirement can be reduced if the CSE collects initial
and/or variation margin for such inter-affiliate transactions.
In addition to this, the JFSA has explained that its supervision of
FIBOs/RFIs is a principles-based approach, and, in accordance with this
approach, the JFSA's ``Guideline for Financial Conglomerates
Supervision'' requires financial holding companies and parent companies
to measure, monitor, and manage the risks caused by inter-affiliate
transactions. Further, the JFSA's ``Inspection manual for financial
holding companies'' requires financial holding companies to establish a
robust governance framework and risk management system at a centralized
group level, that would, in operation, require management of the risks
caused by inter-affiliate transactions. Based on the foregoing, the
JFSA has emphasized that it is not necessary for it to require the risk
management procedures of FIBOs/RFIs applicable to inter-affiliate
transactions to rely on margin requirements only. Rather, taking into
account capital requirements and the JFSA's supervision and inspection
programs, JFSA represents that it ensures the safety and soundness of
FIBOs/RFIs as a whole.
3. Commission Determination
Having compared the outcomes of the JFSA's margin requirements
applicable to inter-affiliate derivatives to the outcomes of the
Commission's corresponding margin requirements applicable to inter-
affiliate swaps, the Commission finds that the treatment of inter-
affiliate transactions under the Final Margin Rule and under the JFSA's
margin requirements are not comparable.
A CSE entering into a transaction with a consolidated affiliate
under the Final Margin Rule would be required to exchange variation
margin in accordance with Sec. Sec. 23.151 through 23.161, and in
certain circumstances, collect initial margin in accordance with Sec.
23.159(c). Where such CSE and its counterparty are also subject to the
JFSA's margin requirements, and qualify as ``Consolidated Companies,''
the JFSA's margin requirements would not require the CSE to post or
collect any form of margin.
While not disputing the JFSA's explanation that its general
oversight of the risk management practices of Consolidated Companies
adequately addresses the risk of inter-affiliate transactions, the
Commission reiterates its view that the inter-affiliate margin
requirements are an important anti-evasion measure designed to prevent
the potential use of affiliates to avoid collecting initial margin from
third parties.
For this reason, the Commission finds that the outcome under the
JFSA's margin rules is not comparable to the outcome under the Final
Margin Rule and accordingly CSEs must comply with the Final Margin Rule
with respect to inter-affiliate swaps.
E. Methodologies for Calculating the Amounts of Initial and Variation
Margin
As an overview, the methodologies for calculating initial and
variation margin as agreed under the BCBS/IOSCO Framework state that
the margin collected from a counterparty should (i) be consistent
across entities covered by the requirements and reflect the potential
future exposure (initial margin) and current exposure (variation
margin) associated with the particular portfolio of non-centrally
cleared derivatives, and (ii) ensure that all counterparty risk
exposures are covered fully with a high degree of confidence.
With respect to the calculation of initial margin, as a minimum the
BCBS/IOSCO Framework generally provides that:
Initial margin requirements will not apply to
counterparties that have less than EUR 8 billion of gross notional in
outstanding derivatives.
Initial margin may be subject to a EUR 50 million
threshold applicable to a consolidated group of affiliated
counterparties.
All margin transfers between parties may be subject to a
de-minimis minimum transfer amount not to exceed EUR 500,000.
The potential future exposure of a non-centrally cleared
derivative should reflect an extreme but plausible estimate of an
increase in the value of the instrument that is consistent with a one-
tailed 99% confidence interval over a 10-day horizon, based on
historical data that incorporates a period of significant financial
stress.
The required amount of initial margin may be calculated by
reference to either (i) a quantitative portfolio margin model or (ii) a
standardized margin schedule.
When initial margin is calculated by reference to an
initial margin model, the period of financial stress used for
calibration should be identified and applied separately for each broad
asset class for which portfolio margining is allowed.
Models may be either internally developed or sourced from
the
[[Page 63383]]
counterparties or third-party vendors but in all such cases, models
must be approved by the appropriate supervisory authority.
Quantitative initial margin models must be subject to an
internal governance process that continuously assesses the value of the
model's risk assessments, tests the model's assessments against
realized data and experience, and validates the applicability of the
model to the derivatives for which it is being used.
An initial margin model may consider all of the
derivatives that are approved for model use that are subject to a
single legally enforceable netting agreement.
Initial margin models may account for diversification,
hedging, and risk offsets within well-defined asset classes such as
currency/rates, equity, credit, or commodities, but not across such
asset classes and provided these instruments are covered by the same
legally enforceable netting agreement and are approved by the relevant
supervisory authority.
The total initial margin requirement for a portfolio
consisting of multiple asset classes would be the sum of the initial
margin amounts calculated for each asset class separately.
Derivatives for which a firm faces zero counterparty risk
require no initial margin to be collected and may be excluded from the
initial margin calculation.
Where a standardized initial margin schedule is
appropriate, it should be computed by multiplying the gross notional
size of a derivative by the standardized margin rates provided under
the BCBS/IOSCO Framework \59\ and adjusting such amount by the ratio of
the net current replacement cost to gross current replacement cost
(NGR) pertaining to all derivatives in a legally enforceable netting
set. The BCBS/IOSCO Framework provides the following standardized
margin rates:
---------------------------------------------------------------------------
\59\ The BCBS/IOSCO Framework provides standardized margin
rates, as set out in the table accompanying the text.
------------------------------------------------------------------------
Initial margin
requirement
Asset class (% of notional
exposure)
------------------------------------------------------------------------
Credit: 0-2 year duration............................... 2
Credit: 2-5 year duration............................... 5
Credit 5+ year duration................................. 10
Commodity............................................... 15
Equity.................................................. 15
Foreign exchange........................................ 6
Interest rate: 0-2 year duration........................ 1
Interest rate: 2-5 year duration........................ 2
Interest rate: 5+ year duration......................... 4
Other................................................... 15
------------------------------------------------------------------------
For a regulated entity that is already using a schedule-
based margin to satisfy requirements under its required capital regime,
the appropriate supervisory authority may permit the use of the same
schedule for initial margin purposes, provided that it is at least as
conservative.
The choice between model- and schedule-based initial
margin calculations should be made consistently over time for all
transactions within the same well defined asset class.
Initial margin should be collected at the outset of a
transaction, and collected thereafter on a routine and consistent basis
upon changes in measured potential future exposure, such as when trades
are added to or subtracted from the portfolio.
In the event that a margin dispute arises, both parties
should make all necessary and appropriate efforts, including timely
initiation of dispute resolution protocols, to resolve the dispute and
exchange the required amount of initial margin in a timely fashion.
With respect to the calculation of variation margin, as a minimum
the BCBS/IOSCO Framework generally provides that:
The full amount necessary to fully collateralize the mark-
to-market exposure of the non-centrally cleared derivatives must be
exchanged.
Variation margin should be calculated and exchanged for
derivatives subject to a single, legally enforceable netting agreement
with sufficient frequency (e.g., daily).
In the event that a margin dispute arises, both parties
should make all necessary and appropriate efforts, including timely
initiation of dispute resolution protocols, to resolve the dispute and
exchange the required amount of variation margin in a timely fashion.
1. Commission Requirement for Calculation of Initial Margin
In keeping with the BCBS/IOSCO Framework described above, with
respect to the calculation of initial margin, the Commission's Final
Margin Rule generally provides that:
Initial margin is intended to address potential future
exposure, i.e., in the event of a counterparty default, initial margin
protects the non-defaulting party from the loss that may result from a
swap or portfolio of swaps, during the period of time needed to close
out the swap(s).\60\
---------------------------------------------------------------------------
\60\ See Final Margin Rule, 81 FR at 683.
---------------------------------------------------------------------------
Potential future exposure is to be an estimate of the one-
tailed 99% confidence interval for an increase in the value of the
uncleared swap or netting portfolio of uncleared swaps due to an
instantaneous price shock that is equivalent to a movement in all
material underlying risk factors, including prices, rates, and spreads,
over a holding period equal to the shorter of 10 business days or the
maturity of the swap or netting portfolio.\61\
---------------------------------------------------------------------------
\61\ See 17 CFR 23.154(b)(2)(i).
---------------------------------------------------------------------------
The required amount of initial margin may be calculated by
reference to either (i) a risk-based margin model or (ii) a table-based
method.\62\
---------------------------------------------------------------------------
\62\ See 17 CFR 23.154(a)(1)(i) and (ii).
---------------------------------------------------------------------------
All data used to calibrate the initial margin model shall
incorporate a period of significant financial stress for each broad
asset class that is appropriate to the uncleared swaps to which the
initial margin model is applied.\63\
---------------------------------------------------------------------------
\63\ See 17 CFR 23.154(b)(2)(ii).
---------------------------------------------------------------------------
CSEs shall obtain the written approval of the Commission
or a registered futures association to use a model to calculate the
initial margin required.\64\
---------------------------------------------------------------------------
\64\ See 17 CFR 23.154(b)(1)(i).
---------------------------------------------------------------------------
An initial margin model may calculate initial margin for a
netting portfolio of uncleared swaps covered by the same eligible
master netting agreement.\65\
---------------------------------------------------------------------------
\65\ See 17 CFR 23.154(b)(2)(v).
---------------------------------------------------------------------------
An initial margin model may reflect offsetting exposures,
diversification, and other hedging benefits for uncleared swaps that
are governed by the same eligible master netting agreement by
incorporating empirical correlations within the following broad risk
categories, provided the CSE validates and demonstrates the
reasonableness of its process for modeling and measuring hedging
benefits: Commodity, credit, equity, and foreign exchange or interest
rate.\66\
---------------------------------------------------------------------------
\66\ See id.
---------------------------------------------------------------------------
Empirical correlations under an eligible master netting
agreement may be recognized by the model within each broad risk
category, but not across broad risk categories.\67\
---------------------------------------------------------------------------
\67\ See id.
---------------------------------------------------------------------------
If the initial margin model does not explicitly reflect
offsetting exposures, diversification, and hedging benefits between
subsets of uncleared swaps within a broad risk category, the CSE
[[Page 63384]]
shall calculate an amount of initial margin separately for each subset
of uncleared swaps for which such relationships are explicitly
recognized by the model and the sum of the initial margin amounts
calculated for each subset of uncleared swaps within a broad risk
category will be used to determine the aggregate initial margin due
from the counterparty for the portfolio of uncleared swaps within the
broad risk category.\68\
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\68\ See 17 CFR 23.154(b)(2)(vi).
---------------------------------------------------------------------------
Where a risk-based model is not used, initial margin must
be computed by multiplying the gross notional size of a derivative by
the standardized margin rates provided under Sec. 23.154(c)(i) \69\
and adjusting such amount by the ratio of the net current replacement
cost to gross current replacement cost (NGR) pertaining to all
derivatives under the same eligible master netting agreement.\70\
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\69\ The standardized margin rates provided in 17 CFR
23.154(c)(i) are, in all material respects, the same as those
provided under the BCBS/IOSCO Framework. See supra note 59.
\70\ See 17 CFR 23.154(c).
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A CSE shall not be deemed to have violated its obligation
to collect or post initial margin if, inter alia, it makes timely
initiation of dispute resolution mechanisms, including pursuant to
Sec. 23.504(b)(4).\71\
---------------------------------------------------------------------------
\71\ See 17 CFR 23.152(d)(2)(i).
---------------------------------------------------------------------------
2. Commission Requirements for Calculation of Variation Margin
In keeping with the BCBS/IOSCO Framework described above, with
respect to the calculation of variation margin, the Commission's Final
Margin Rule generally provides that:
Each business day, a CSE must calculate variation margin
amounts for itself and for each counterparty that is an SD, MSP, or
financial end-user. Such variation margin amounts must be equal to the
cumulative mark-to-market change in value to the CSE of each uncleared
swap, adjusted for any variation margin previously collected or posted
with respect to that uncleared swap.\72\
---------------------------------------------------------------------------
\72\ See 17 CFR 23.155(a).
---------------------------------------------------------------------------
Variation margin must be calculated using methods,
procedures, rules, and inputs that to the maximum extent practicable
rely on recently-executed transactions, valuations provided by
independent third parties, or other objective criteria.\73\
---------------------------------------------------------------------------
\73\ See id.
---------------------------------------------------------------------------
CSEs may comply with variation margin requirements on an
aggregate basis with respect to uncleared swaps that are governed by
the same eligible master netting agreement.\74\
---------------------------------------------------------------------------
\74\ See 17 CFR 23.153(d)(1).
---------------------------------------------------------------------------
A CSE shall not be deemed to have violated its obligation
to collect or post variation margin if, inter alia, it makes timely
initiation of dispute resolution mechanisms, including pursuant to
Sec. 23.504(b)(4).\75\
---------------------------------------------------------------------------
\75\ See 17 CFR 23.153(e)(2)(i).
---------------------------------------------------------------------------
3. Japan Requirements for Calculation of Initial Margin
Potential future exposure is margin to be posted as
deposits corresponding to a reasonable estimate of the amount of
expenses or losses that may occur in the future with regard to non-
cleared OTC derivatives.\76\
---------------------------------------------------------------------------
\76\ FIB Ordinance Article 123(1)(xxi)-6.
---------------------------------------------------------------------------
In cases where potential future exposure cannot be
calculated by a method of using a quantitative calculation model,
FIBOs/RFIs are required to calculate potential future exposure for the
non-cleared OTC derivatives by a method of using a standardized margin
schedule.\77\
---------------------------------------------------------------------------
\77\ JFSA Public Notice No. 15, Article 1(3).
---------------------------------------------------------------------------
When calculating potential future exposure using a
quantitative calculation model, FIBOs/RFIs shall use a one-tailed 99%
confidence interval and set a margin period of risk for non-cleared OTC
derivatives of not less than 10 business days.\78\
---------------------------------------------------------------------------
\78\ JFSA Public Notice No. 15, Article 3(1).
---------------------------------------------------------------------------
Where calculating potential future exposure by a method of
using a quantitative calculation model, FIBOs/RFIs must use historical
data which satisfies the following requirements for each category of
non-cleared OTC derivatives for which any of commodity, credit, equity,
and foreign exchange or interest rate is the major cause of changes in
mark-to-market: (i) Based on an observation period of at least one year
and not exceeding five years; (ii) to contain a stress period; (iii) to
contain the latest market data; (iv) to be equally weighted; and (v) to
be updated at least once a year.\79\
---------------------------------------------------------------------------
\79\ JFSA Public Notice No. 15, Article 4.
---------------------------------------------------------------------------
The quantitative calculation models of FIBOs/RFIs must
capture non-linear risks, basis risks, and material risks that may have
impact on the value of the exposure.\80\
---------------------------------------------------------------------------
\80\ JFSA Public Notice No. 15, Article 5(1).
---------------------------------------------------------------------------
FIBOs/RFIs must file notice with the JFSA of an intention
to use a quantitative calculation model to estimate an amount of
potential future exposure, including a description of the model's
methodology and structure, the model's compliance with JFSA margin
rules, and the policies and procedures of a ``model control unit''.\81\
---------------------------------------------------------------------------
\81\ JFSA Public Notice No. 15, Article 1(2).
---------------------------------------------------------------------------
FIBOs/RFIs must conduct back testing of the quantitative
calculation model against changes in the mark-to-market value of non-
cleared OTC derivatives that occurred during a period equivalent to a
holding period of not less than 10 business days.\82\
---------------------------------------------------------------------------
\82\ JFSA Public Notice No. 15, Article 6(1)(iii).
---------------------------------------------------------------------------
When calculating potential future exposure for non-cleared
OTC derivatives only by a method of using a quantitative calculation
model, FIBOs/RFIs may conduct a calculation for each master netting
agreement meeting the definition of such as prescribed in Article 2,
paragraph (5) of the Act on Close-out Netting of Specified Financial
Transaction Conducted by Financial Institutions. (Act No. 108 of
1998).\83\
---------------------------------------------------------------------------
\83\ JFSA Public Notice No. 15, Article 2(1).
---------------------------------------------------------------------------
Potential future exposure calculated by FIBOs/RFIs by a
method of using a quantitative calculation model shall be the sum of
amounts calculated for each category of transaction for which any of
the following is the major cause of changes in mark-to-market value,
with regard to all non-cleared OTC derivatives conducted by the FIBOs:
Commodity, credit, equity, and foreign exchange or interest rate.\84\
---------------------------------------------------------------------------
\84\ JFSA Public Notice No. 15, Article 3(2).
---------------------------------------------------------------------------
FIBOs/RFIs may account for the effects of risk offsets,
diversification, and hedging within each broad category of transactions
for which commodity, credit, equity, and foreign exchange or interest
rates is the major cause of changes in mark-to-market, but not across
such risk categories.\85\
---------------------------------------------------------------------------
\85\ JFSA Public Notice No. 15, Article 3(3).
---------------------------------------------------------------------------
Where a quantitative calculation model is not used, FIBOs/
RFIs must compute potential future exposure by multiplying the gross
notional size of a non-cleared OTC derivative by the standardized
margin schedule set forth in JFSA's Public Notification No. 15 \86\ and
adjusting such amount by the ratio of the net current replacement cost
to gross current replacement cost (NGR) pertaining to all derivatives
under the same master netting agreement.
---------------------------------------------------------------------------
\86\ The standardized margin rates provide in JFSA Public
Notification No. 15 of March 31, 2016, Article 9(2) are, in all
material respects, the same as those provided under the BCBS/IOSCO
Framework. See supra note 59.
---------------------------------------------------------------------------
FIBOs/RFIs are required to have documentation with each
uncleared OTC derivative counterparty that, among other things,
identifies dispute resolution measures applicable to margin disputes
for uncleared OTC derivatives.\87\
---------------------------------------------------------------------------
\87\ See Article 37-3 of the FIEA and Article 99 of the FIB
Ordinance.
---------------------------------------------------------------------------
[[Page 63385]]
4. Japan Requirements for Calculation of Variation Margin
FIBOs/RFIs must calculate on each business day for each
counterparty the total amount of the mark-to-market for non-cleared OTC
Derivatives and the total amount of the mark-to-market of collateral
collected or posted as variation margin with respect to the
counterparty.\88\
---------------------------------------------------------------------------
\88\ FIB Ordinance Article 123(1)(xxi)-5(a).
---------------------------------------------------------------------------
FIBOs/RFIs may comply with variation margin requirements
on an aggregate basis with respect to uncleared OTC derivatives that
are governed by the same master netting agreement.\89\
---------------------------------------------------------------------------
\89\ See FIB Ordinance Article 123(1)(xxi)-5(a).
---------------------------------------------------------------------------
FIBOs/RFIs are required to have documentation with each
uncleared OTC derivative counterparty that, among other things,
identifies dispute resolution measures applicable to margin disputes
for uncleared OTC derivatives.\90\
---------------------------------------------------------------------------
\90\ See Supervisory Guideline Section IV-2-4(4)(i)(A) and
(ii)(A).
---------------------------------------------------------------------------
5. Commission Determination
Based on the foregoing and the representations of the applicant,
the Commission has determined that the amounts of initial and variation
margin calculated under the methodologies required under the JFSA's
margin rules would be similar to those calculated under the
methodologies required under the Final Margin Rule. Specifically, under
the Final Margin Rule and the JFSA's margin rules:
The definitions of initial and variation margin are
similar, including the description of potential future exposure agreed
under the BCBS/IOSCO Framework;
Margin models and/or a standardized margin schedule may be
used to calculate initial margin;
Criteria for historical data to be used in initial margin
models is similar;
Initial margin models must be submitted for review by a
regulator prior to use;
Eligibility for netting is similar;
Correlations may be recognized within broad risk
categories, but not across such risk categories;
The required method of calculating initial margin using
standardized margin rates is essentially identical; and
The proscribed standardized margin rates are essentially
identical.
Accordingly, the Commission finds that the methodologies for
calculating the amounts of initial and variation margin for uncleared
OTC derivatives under the laws of Japan are comparable in outcome to
those of the Final Margin Rule.
F. Process and Standards for Approving Margin Models
Pursuant to the BCBS/IOSCO Framework, initial margin models may be
either internally developed or sourced from counterparties or third-
party vendors but in all such cases, models must be approved by the
appropriate supervisory authority.\91\
---------------------------------------------------------------------------
\91\ See BCBS/IOSCO Framework Requirement 3.3.
---------------------------------------------------------------------------
1. Commission Requirement for Margin Model Approval
In keeping with the BCBS/IOSCO Framework, the Final Margin Rule
generally requires:
CSEs shall obtain the written approval of the Commission
or a registered futures association to use a model to calculate the
initial margin required.\92\
---------------------------------------------------------------------------
\92\ See 17 CFR 23.154(b)(1)(i).
---------------------------------------------------------------------------
The Commission or a registered futures association will
approve models that demonstrate satisfaction of all of the requirements
for an initial margin model set forth above in Section IV(E)(2), in
addition to the requirements for annual review; \93\ control,
oversight, and validation mechanisms; \94\ documentation; \95\ and
escalation procedures.\96\
---------------------------------------------------------------------------
\93\ See 17 CFR 23.154(b)(4), discussed further below.
\94\ See 17 CFR 23.154(b)(5), discussed further below.
\95\ See 17 CFR 23.154(b)(6), discussed further below.
\96\ See 17 CFR 23.154(b)(7), discussed further below.
---------------------------------------------------------------------------
CSEs must notify the Commission and the registered futures
association in writing 60 days prior to, extending the use of an
initial margin model to an additional product type; making any change
to the model that would result in a material change in the CSE's
assessment of initial margin requirements; or making any material
change to modeling assumptions.
The Commission or the registered futures association may
rescind its approval, or may impose additional conditions or
requirements if the Commission or the registered futures association
determines, in its discretion, that a model no longer complies with the
requirements for an initial margin model summarized above in Section
IV(E)(2).
2. Japan Requirements for Approval of Margin Models
In keeping with the BCBS/IOSCO Framework, the JFSA's margin rules
generally require:
FIBOs/RFIs must file notice with the JFSA of an intention
to use a quantitative calculation model to estimate an amount of
potential future exposure, including a description of the model's
methodology and structure, the model's compliance with JFSA rules for
use of quantitative calculation models summarized above in Section
IV(E)(4), and the policies and procedures of a ``model control
unit''.\97\
---------------------------------------------------------------------------
\97\ JFSA Public Notice No. 15, Article 1(2) and Article 7. The
requirements for a model control unit are discussed in Section IV(I)
below.
---------------------------------------------------------------------------
FIBOs/RFIs must notify the JFSA without delay of a change
in any matters set out in the notice of an intention to use a
quantitative calculation model, and any failure to comply with the JFSA
rules for use of a quantitative calculation model summarized above in
Section IV(E)(4).\98\
---------------------------------------------------------------------------
\98\ See JFSA Public Notice No. 15, Article 8(1).
---------------------------------------------------------------------------
FIBOs/RFIs must establish a proper management framework to
use a quantitative calculation model and the JFSA supervises compliance
with the model requirements.\99\
---------------------------------------------------------------------------
\99\ See Supervisory Guideline Section IV-2-4(4)(ii)(C).
---------------------------------------------------------------------------
3. Commission Determination
Based on the foregoing and the representations of the applicant,
the Commission has determined that the requirements for submission of
margin models to the JFSA, in the case of FIBOs/RFIs, are comparable to
and as comprehensive as the regulatory approval requirements of the
Final Margin Rule. Specifically, the notice of an intent to use a
quantitative calculation model required under the JFSA's margin rules,
prior to its use, must contain a comprehensive explanation and
evaluation of the proposed model that is comparable in all material
respects to the approval procedures required under the Final Margin
Rule. While the Commission recognizes that a notice of intent to the
JFSA is not the same as requiring a specific approval from a regulator,
the JFSA has represented that it would use its supervisory powers to
prohibit the use of an inadequate quantitative calculation model. In
light of this representation by the JFSA, the Commission finds that
such requirements under the laws of Japan are comparable to those of
the Final Margin Rule.
G. Timing and Manner for Collection or Payment of Initial and Variation
Margin
1. Commission Requirement for Timing and Manner for Collection or
Payment of Initial and Variation Margin
With respect to the timing and manner for collection or posting of
[[Page 63386]]
initial margin, the Final Margin Rule generally provides that:
Where a CSE is required to collect initial margin, it must
be collected on or before the business day after execution of an
uncleared swap, and thereafter the CSE must continue to hold initial
margin in an amount equal to or greater than the required initial
margin amount as re-calculated each business day until such uncleared
swap is terminated or expires.
Where a CSE is required to post initial margin, it must be
posted on or before the business day after execution of an uncleared
swap, and thereafter the CSE must continue to post initial margin in an
amount equal to or greater than the required initial margin amount as
re-calculated each business day until such uncleared swap is terminated
or expires.
Required initial margin amounts must be posted and
collected by CSEs on a gross basis (i.e., amounts to be posted may not
be set-off against amounts to be collected from the same counterparty).
With respect to the timing and manner for collection or posting of
variation margin, the Final Margin Rule generally provides that:
Where a CSE is required to collect variation margin, it
must be collected on or before the business day after execution of an
uncleared swap, and thereafter the CSE must continue to collect the
required variation margin amount, if any, each business day as re-
calculated each business day until such uncleared swap is terminated or
expires.\100\
---------------------------------------------------------------------------
\100\ See 17 CFR 23.153(a).
---------------------------------------------------------------------------
Where a CSE is required to post variation margin, it must
be posted on or before the business day after execution of an uncleared
swap, and thereafter the CSE must continue to post the required
variation margin amount, if any, each business day as re-calculated
each business day until such uncleared swap is terminated or
expires.\101\
---------------------------------------------------------------------------
\101\ See 17 CFR 23.153(b).
---------------------------------------------------------------------------
With respect to both initial and variation margin, a CSE shall not
be deemed to have violated its obligation to collect or post margin if,
inter alia, it makes timely initiation of dispute resolution
mechanisms, including pursuant to Sec. 23.504(b)(4).\102\
---------------------------------------------------------------------------
\102\ See 17 CFR 23.153(e)(2)(i).
---------------------------------------------------------------------------
2. Japan Requirements for Timing and Manner for Collection of Initial
and Variation Margin
With respect to the timing and manner for collection or posting of
initial margin, the JFSA's margin rules generally provide that:
Initial margin must be calculated upon execution,
termination, or modification of a non-cleared OTC derivative.\103\
---------------------------------------------------------------------------
\103\ See FIB Ordinance Article 123(1)(xxi)-6(a). As represented
by the JFSA, this requirement is interpreted to mean that IM shall
be recalculated in any of the following circumstances:
(a) A new contract is executed with a counterparty;
(b) An existing contract with a counterparty expires;
(c) A relationship of rights pertaining to non-cleared OTC
derivatives is changed;
(d) Recalibration is deemed necessary due to fluctuations of
markets or other grounds or
(e) One month has elapsed since the latest recalculation.
---------------------------------------------------------------------------
Initial margin must be calculated when necessary based on
market changes.\104\
---------------------------------------------------------------------------
\104\ See id.
---------------------------------------------------------------------------
In any event, initial margin must be calculated no later
than one month after the last calculation of initial margin.\105\
---------------------------------------------------------------------------
\105\ See id.
---------------------------------------------------------------------------
Where FIBOs/RFIs are required to collect initial margin,
it must call for the initial margin amount immediately after
calculation and collect such amount as soon as practicable.\106\
---------------------------------------------------------------------------
\106\ See FIB Ordinance Article 123(1)(xxi)-6(b) and (c).
---------------------------------------------------------------------------
Where FIBOs/RFIs are required to post initial margin, it
must be posted as soon as practicable after it receives a call for an
initial margin amount.\107\
---------------------------------------------------------------------------
\107\ See FIB Ordinance Article 123(1)(xxi)-6(f).
---------------------------------------------------------------------------
Required initial margin amounts must be posted and
collected by FIBOs/RFIs on a gross basis (i.e., amounts to be posted
may not be set-off against amounts to be collected from the same
counterparty).
With respect to the timing and manner for collection or posting of
variation margin, the JFSA's margin rules generally provide that:
FIBOs/RFIs are required to calculate the variation margin
amount each business day.\108\
---------------------------------------------------------------------------
\108\ See FIB Ordinance Article 123(1)(xxi)-5(a).
---------------------------------------------------------------------------
Where FIBOs/RFIs are required to collect a variation
margin amount, it must be called for immediately and collected as soon
as practicable.\109\
---------------------------------------------------------------------------
\109\ See FIB Ordinance Article 123(1)(xxi)-5(b) and (c).
---------------------------------------------------------------------------
Where FIBOs/RFIs are required to post a variation margin
amount, it must be posted as soon as practicable.\110\
---------------------------------------------------------------------------
\110\ See FIB Ordinance Article 123(1)(xxi)-5(d).
---------------------------------------------------------------------------
3. Commission Determination
Having compared the JFSA's margin requirements applicable to the
timing and manner of collection and payment of initial and variation
margin to the Commission's corresponding margin requirements, the
Commission finds that the JFSA's margin requirements are, despite
apparent differences in certain respects, comparable in outcome.
Under the Final Margin Rule, where initial margin is required, a
CSE must calculate the amount of initial margin each business day. The
JFSA's margin rules allow a maximum of one month between initial margin
calculations under some circumstances. However, the JFSA has explained
that FIBOs/RFIs that are subject to the first phase of implementation
of the JFSA's margin rules for non-cleared OTC Derivatives (i.e., those
with the largest notional amounts of outstanding non-cleared OTC
Derivatives) regularly trade non-cleared OTC Derivatives. Accordingly,
because JFSA margin rules on calculation of initial margin require
FIBOs/RFIs to recalculate initial margin whenever transactions are
entered, expire, or are modified, and whenever fluctuations occur in
markets or other factors affecting the amount of initial margin, such
FIBOs/RFIs are likely to be required to recalculate initial margin each
business day. Only FIBOs/RFIs subject to the later phase of
implementation that do not regularly trade non-cleared OTC Derivatives
would not be required to recalculate initial margin each business day.
With respect to the timing of collecting/posting margin, the Final
Margin Rule requires CSEs to collect/post any required margin amount
(whether initial or variation) within one business day. The JFSA's
margin rules specify only that margin be collected or posted ``as soon
as practicable,'' which presumably could be longer than one business
day. However, the JFSA has represented that, as a supervisory matter,
it would expect FIBOs/RFIs that are subject to the first phase of
implementation of the JFSA's margin rules for non-cleared OTC
Derivatives (i.e., those with the largest notional amounts of
outstanding non-cleared OTC Derivatives) to collect or post margin, as
applicable, within one business day, with some flexibility for cross-
border transactions. FIBOs/RFIs subject to the later phase of
implementation would be expected to collect or post margin, as
applicable, within two business days, again with some flexibility for
cross-border transactions.
In addition, the JFSA has represented that the timing of margin
collection and posting will naturally shorten over a relatively brief
period of time because the industry in Japan has committed to move
toward T+1 settlement of financial instruments by 2018.
[[Page 63387]]
Finally, the Commission understands that transactions in Japanese
Government Bonds (``JGBs'') currently settle in 2 or 3 business days.
The JFSA believes this will shorten to T+1 by 2018. However, the
Commission is cognizant that if it does not find comparability on this
element, JGB's may become ineligible for use as collateral whenever the
Final Margin Rule is applicable and thus the market will lose a safe
and highly liquid form of eligible collateral, perhaps increasing
certain types of risk.
Given the representations of the JFSA with respect to its
expectations on compliance with its margin rules in practice, and the
current settlement cycle for JGBs, the Commission finds that the
requirements of the JFSA's rules with respect to the timing and manner
for collection or payment of initial and variation margin are
comparable.
H. Margin Threshold Levels or Amounts
The BCBS/IOSCO Framework provides that initial margin could be
subject to a threshold not to exceed EUR 50 million. The threshold is
applied at the level of the consolidated group to which the threshold
is being extended and is based on all non-centrally cleared derivatives
between the two consolidated groups.
Similarly, to alleviate operational burdens associated with the
transfer of small amounts of margin, the BCBS/IOSCO Framework provides
that all margin transfers between parties may be subject to a de-
minimis minimum transfer amount not to exceed EUR 500,000.
1. Commission Requirement for Margin Threshold Levels or Amounts
In keeping with the BCBS/IOSCO Framework, with respect to margin
threshold levels or amounts the Final Margin Rule generally provides
that:
CSEs may agree with their counterparties that initial
margin may be subject to a threshold of no more than $50 million
applicable to a consolidated group of affiliated counterparties.\111\
---------------------------------------------------------------------------
\111\ See 17 CFR 23.154(a)(3) and definition of ``initial margin
threshold'' in 17 CFR 23.151.
---------------------------------------------------------------------------
CSEs are not required to collect or to post initial or
variation margin with a counterparty until the combined amount of
initial margin and variation margin to be collected or posted is
greater than $500,000 (i.e., a minimum transfer amount).\112\
---------------------------------------------------------------------------
\112\ See 17 CFR 23.152(b)(3).
---------------------------------------------------------------------------
2. Japan Requirements for Margin Threshold Levels or Amounts
Also in keeping with the BCBS/IOSCO Framework, with respect to
margin threshold levels or amounts, the JFSA's margin requirements
generally provide that:
FIBOs/RFIs may agree with their counterparties that
initial margin may be subject to a threshold of no more than JPY 7
billion applicable to a consolidated group of affiliated
counterparties.\113\
---------------------------------------------------------------------------
\113\ JFSA Public Notice No. 17, Article 3(2).
---------------------------------------------------------------------------
FIBOs/RFIs are not required to collect or to post initial
or variation margin with a counterparty until the combined amount of
initial margin and variation margin to be collected or posted is
greater than JPY 70 million (i.e., a minimum transfer amount).\114\
---------------------------------------------------------------------------
\114\ See FIB Ordinance Article 123(1)(xxi)-5(b) and (xxi)-6(b).
---------------------------------------------------------------------------
3. Commission Determination
Based on the foregoing and the representations of the applicant,
the Commission has determined that the JFSA requirements for margin
threshold levels or amounts, in the case of FIBOs/RFIs, are comparable
to those required by the Final Margin Rule, in the case of CSEs.
The Commission notes that at current exchange rates, JPY 7 billion
is approximately $68 million, while JPY 70 million is approximately
$680,000. Although these amounts are greater than those permitted by
the Final Margin Rule, the Commission recognizes that exchange rates
will fluctuate over time and thus the Commission finds that such
requirements under the laws of Japan are comparable in outcome to those
of the Final Margin Rule.
I. Risk Management Controls for the Calculation of Initial and
Variation Margin
1. Commission Requirement for Risk Management Controls for the
Calculation of Initial and Variation Margin
With respect to risk management controls for the calculation of
initial margin, the Final Margin Rule generally provides that:
CSEs are required to have a risk management unit pursuant
to Sec. 23.600(c)(4). Such risk management unit must include a risk
control unit tasked with validation of a CSEs initial margin model
prior to implementation and on an ongoing basis, including an
evaluation of the conceptual soundness of the initial margin model, an
ongoing monitoring process that includes verification of processes and
benchmarking by comparing the CSE's initial margin model outputs
(estimation of initial margin) with relevant alternative internal and
external data sources or estimation techniques, and an outcomes
analysis process that includes back testing the model.\115\
---------------------------------------------------------------------------
\115\ See 17 CFR 23.154(b)(5).
---------------------------------------------------------------------------
In accordance with Sec. 23.600(e)(2), CSEs must have an
internal audit function independent of the business trading unit and
the risk management unit that at least annually assesses the
effectiveness of the controls supporting the initial margin model
measurement systems, including the activities of the business trading
units and risk control unit, compliance with policies and procedures,
and calculation of the CSE's initial margin requirements under this
part.\116\
---------------------------------------------------------------------------
\116\ See 17 CFR 23.154(b)(5)(iv).
---------------------------------------------------------------------------
At least annually, such internal audit function shall
report its findings to the CSE's governing body, senior management, and
chief compliance officer.\117\
---------------------------------------------------------------------------
\117\ See 17 CFR 23.154(b)(5)(iv).
---------------------------------------------------------------------------
With respect to risk management controls for the calculation of
variation margin, the Final Margin Rule generally provides that:
CSEs must maintain documentation setting forth the
variation methodology with sufficient specificity to allow a
counterparty, the Commission, a registered futures association, and any
applicable prudential regulator to calculate a reasonable approximation
of the margin requirement independently.
CSEs must evaluate the reliability of its data sources at
least annually, and make adjustments, as appropriate.
CSEs, upon request of the Commission or a registered
futures association, must provide further data or analysis concerning
the variation methodology or a data source, including: The manner in
which the methodology meets the requirements of the Final Margin Rule;
a description of the mechanics of the methodology; the conceptual basis
of the methodology; the empirical support for the methodology; and the
empirical support for the assessment of the data sources.
2. Japan Requirements for Risk Management Controls for the Calculation
of Initial and Variation Margin
With respect to risk management controls for the calculation of
initial margin, the JFSA's margin requirements generally provide that:
Where FIBOs/RFIs use a quantitative calculation model to
[[Page 63388]]
calculate initial margin, it must establish a model control unit,
independent from units that execute non-cleared OTC derivatives,
responsible for the design and operation of a system for managing such
model.\118\
---------------------------------------------------------------------------
\118\ See JFSA Public Notice No. 15, Article 6(1)(i).
---------------------------------------------------------------------------
The model control unit must document policies, control,
and procedures for an operation of the quantitative calculation model
(including the criteria for assessment of the quantitative calculation
model and measures to be taken in cases where the results of the
assessment conflict with the criteria set in advance).\119\
---------------------------------------------------------------------------
\119\ See JFSA Public Notice No. 15, Article 6(1)(ii).
---------------------------------------------------------------------------
The model control unit shall document procedures and
results of back testing against changes in the mark-to-market value of
non-cleared OTC derivatives that occurred during a period equivalent to
a holding period of not less than 10 business days.\120\
---------------------------------------------------------------------------
\120\ See JFSA Public Notice No. 15, Article 6(1)(iii).
---------------------------------------------------------------------------
The model control unit shall establish procedures for
validating a quantitative calculation model and properly revising the
quantitative calculation model at the time of the development thereof
and periodically thereafter, as well as in the risk event where the
accuracy of the quantitative calculation model is impaired due to a
material modification to the quantitative calculation model or a
structural change in the market.\121\
---------------------------------------------------------------------------
\121\ See JFSA Public Notice No. 15, Article 6(1)(iv).
---------------------------------------------------------------------------
The model control unit shall confirm that a quantitative
calculation model can be properly operated with major counterparties by
testing the quantitative calculation model in an appropriate simulated
portfolio.\122\
---------------------------------------------------------------------------
\122\ See JFSA Public Notice No. 15, Article 6(1)(v).
---------------------------------------------------------------------------
An internal audit shall be conducted in principle at least
once a year with regard to a calculation process of potential future
exposure.\123\
---------------------------------------------------------------------------
\123\ See JFSA Public Notice No. 15, Article 6(1)(vi).
---------------------------------------------------------------------------
3. Commission Determination
Based on the foregoing and the representations of the applicant,
the Commission has determined that the JFSA requirements applicable to
FIBOs/RFIs pertaining to risk management controls for the calculation
of initial and variation margin are substantially the same as the
corresponding requirements under the Final Margin Rule. Specifically,
the Commission finds that under both the JFSA's requirements and the
Final Margin Rule, a CSE is required to establish a unit independent of
the trading desk that is tasked with comprehensively managing the
entity's use of an initial margin model, including establishing
controls and testing procedures. Accordingly, the Commission finds that
the JFSA's requirements pertaining to risk management controls over the
use of initial margin models are comparable in outcome to the controls
required by the Final Margin Rule.
J. Eligible Collateral for Initial and Variation Margin
As explained in the BCBS/IOSCO Framework, to ensure that
counterparties can liquidate assets held as initial and variation
margin in a reasonable amount of time to generate proceeds that could
sufficiently protect collecting entities from losses on non-centrally
cleared derivatives in the event of a counterparty default, assets
collected as collateral for initial and variation margin purposes
should be highly liquid and should, after accounting for an appropriate
haircut, be able to hold their value in a time of financial stress.
Such a set of eligible collateral should take into account that assets
which are liquid in normal market conditions may rapidly become
illiquid in times of financial stress. In addition to having good
liquidity, eligible collateral should not be exposed to excessive
credit, market and FX risk (including through differences between the
currency of the collateral asset and the currency of settlement). To
the extent that the value of the collateral is exposed to these risks,
appropriately risk-sensitive haircuts should be applied. More
importantly, the value of the collateral should not exhibit a
significant correlation with the creditworthiness of the counterparty
or the value of the underlying non-centrally cleared derivatives
portfolio in such a way that would undermine the effectiveness of the
protection offered by the margin collected. Accordingly, securities
issued by the counterparty or its related entities should not be
accepted as collateral. Accepted collateral should also be reasonably
diversified.
1. Commission Requirement for Eligible Collateral for Initial and
Variation Margin
With respect to eligible collateral that may be collected or posted
to satisfy an initial margin obligation, the Final Margin Rule
generally provides that CSEs may collect or post: \124\
---------------------------------------------------------------------------
\124\ See 17 CFR 23.156(a)(1).
---------------------------------------------------------------------------
Cash denominated in a major currency, being United States
Dollar (USD); Canadian Dollar (CAD); Euro (EUR); United Kingdom Pound
(GBP); Japanese Yen (JPY); Swiss Franc (CHF); New Zealand Dollar (NZD);
Australian Dollar (AUD); Swedish Kronor (SEK); Danish Kroner (DKK);
Norwegian Krone (NOK); any other currency designated by the Commission;
or any currency of settlement for a particular uncleared swap.
A security that is issued by, or unconditionally
guaranteed as to the timely payment of principal and interest by, the
U.S. Department of Treasury.
A security that is issued by, or unconditionally
guaranteed as to the timely payment of principal and interest by, a
U.S. government agency (other than the U.S. Department of Treasury)
whose obligations are fully guaranteed by the full faith and credit of
the U.S. government.
A security that is issued by, or fully guaranteed as to
the payment of principal and interest by, the European Central Bank or
a sovereign entity that is assigned no higher than a 20 percent risk
weight under the capital rules applicable to SDs subject to regulation
by a prudential regulator.
A publicly traded debt security issued by, or an asset-
backed security fully guaranteed as to the timely payment of principal
and interest by, a U.S. Government-sponsored enterprise that is
operating with capital support or another form of direct financial
assistance received from the U.S. government that enables the
repayments of the U.S. Government-sponsored enterprise's eligible
securities.
A security that is issued by, or fully guaranteed as to
the payment of principal and interest by, the Bank for International
Settlements, the International Monetary Fund, or a multilateral
development bank as defined in Sec. 23.151.
Other publicly-traded debt that has been deemed acceptable
as initial margin by a prudential regulator as defined in Sec. 23.151.
A publicly traded common equity security that is included
in: The Standard & Poor's Composite 1500 Index or any other similar
index of liquid and readily marketable equity securities as determined
by the Commission, or an index that a CSE's supervisor in a foreign
jurisdiction recognizes for purposes of including publicly traded
common equity as initial margin under applicable regulatory policy, if
held in that foreign jurisdiction.
Securities in the form of redeemable securities in a
pooled investment fund representing the security-holder's proportional
interest in the fund's net assets and that are issued and redeemed
[[Page 63389]]
only on the basis of the market value of the fund's net assets prepared
each business day after the security-holder makes its investment
commitment or redemption request to the fund, if the fund's investments
are limited to securities that are issued by, or unconditionally
guaranteed as to the timely payment of principal and interest by, the
U.S. Department of the Treasury, and immediately-available cash funds
denominated in U.S. dollars; or securities denominated in a common
currency and issued by, or fully guaranteed as to the payment of
principal and interest by, the European Central Bank or a sovereign
entity that is assigned no higher than a 20% risk weight under the
capital rules applicable to SDs subject to regulation by a prudential
regulator, and immediately-available cash funds denominated in the same
currency; and assets of the fund may not be transferred through
securities lending, securities borrowing, repurchase agreements,
reverse repurchase agreements, or other means that involve the fund
having rights to acquire the same or similar assets from the
transferee.
Gold.
A CSE may not collect or post as initial margin any asset
that is a security issued by: The CSE or a margin affiliate of the CSE
(in the case of posting) or the counterparty or any margin affiliate of
the counterparty (in the case of collection); a bank holding company, a
savings and loan holding company, a U.S. intermediate holding company
established or designated for purposes of compliance with 12 CFR
252.153, a foreign bank, a depository institution, a market
intermediary, a company that would be any of the foregoing if it were
organized under the laws of the United States or any State, or a margin
affiliate of any of the foregoing institutions; or a nonbank financial
institution supervised by the Board of Governors of the Federal Reserve
System under Title I of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5323).\125\
---------------------------------------------------------------------------
\125\ See 17 CFR 23.156(a)(2).
---------------------------------------------------------------------------
The value of any eligible collateral collected or posted
to satisfy initial margin requirements must be reduced by the following
haircuts: An 8% discount for initial margin collateral denominated in a
currency that is not the currency of settlement for the uncleared swap,
except for eligible types of collateral denominated in a single
termination currency designated as payable to the non-posting
counterparty as part of an eligible master netting agreement; and the
discounts set forth in the following table: \126\
---------------------------------------------------------------------------
\126\ See 17 CFR 23.156(a)(3).
Standardized Haircut Schedule
------------------------------------------------------------------------
------------------------------------------------------------------------
Cash in same currency as swap obligation................ 0.0
Eligible government and related debt (e.g., central 0.5
bank, multilateral development bank, GSE securities
identified in 17 CFR 23.156(a)(1)(iv)): Residual
maturity less than one-year............................
Eligible government and related debt (e.g., central 2.0
bank, multilateral development bank, GSE securities
identified in 17 CFR 23.156(a)(1)(iv)): Residual
maturity between one and five years....................
Eligible government and related debt (e.g., central 4.0
bank, multilateral development bank, GSE securities
identified in 17 CFR 23.156(a)(1)(iv)): Residual
maturity greater than five years.......................
Eligible corporate debt (including eligible GSE debt 1.0
securities not identified in 17 CFR 23.156(a)(1)(iv)):
Residual maturity less than one-year...................
Eligible corporate debt (including eligible GSE debt 4.0
securities not identified in 17 CFR 23.156(a)(1)(iv)):
Residual maturity between one and five years...........
Eligible corporate debt (including eligible GSE debt 8.0
securities not identified in 17 CFR 23.156(a)(1)(iv)):
Residual maturity greater than five years..............
Equities included in S&P 500 or related index........... 15.0
Equities included in S&P 1500 Composite or related index 25.0
but not S&P 500 or related index.......................
Gold.................................................... 15.0
------------------------------------------------------------------------
With respect to eligible collateral that may be collected or posted
to satisfy a variation margin obligation, the Final Margin Rule
generally provides that CSEs may collect or post: \127\
---------------------------------------------------------------------------
\127\ See 17 CFR 23.156(b)(1).
---------------------------------------------------------------------------
With respect to uncleared swaps with an SD or MSP, only
immediately available cash funds that are denominated in: U.S. dollars,
another major currency (as defined in Sec. 23.151), or the currency of
settlement of the uncleared swap.
With respect to any other uncleared swaps for which a CSE
is required to collect or post variation margin, any asset that is
eligible to be posted or collected as initial margin, as described
above.
The value of any eligible collateral collected or posted
to satisfy variation margin requirements must be reduced by the same
haircuts applicable to initial margin described above.\128\
---------------------------------------------------------------------------
\128\ See 17 CFR 23.156(b)(2).
---------------------------------------------------------------------------
Finally, CSEs must monitor the value and eligibility of collateral
collected and posted: \129\
---------------------------------------------------------------------------
\129\ See 17 CFR 23.156(c).
---------------------------------------------------------------------------
CSEs must monitor the market value and eligibility of all
collateral collected and posted, and, to the extent that the market
value of such collateral has declined, the CSE must promptly collect or
post such additional eligible collateral as is necessary to maintain
compliance with the margin requirements of Sec. Sec. 23.150 through
23.161.
To the extent that collateral is no longer eligible, CSEs
must promptly collect or post sufficient eligible replacement
collateral to comply with the margin requirements of Sec. Sec. 23.150
through 23.161.
2. Japan Requirements for Eligible Collateral for Initial and Variation
Margin
With respect to eligible collateral that may be collected or posted
to satisfy an initial or variation margin obligation, the JFSA's margin
requirements generally provide that RFIs/FIBOS may collect or post:
\130\
---------------------------------------------------------------------------
\130\ See FIB Ordinance, Article 123(8) and JFSA Public Notice
No. 16, Article 1(1).
---------------------------------------------------------------------------
Cash.
Debt that is issued by a central government, a central
bank, or an international financial institution.\131\
---------------------------------------------------------------------------
\131\ As listed in JFSA Public Notice No. 16, these are
generally: Bank for International Settlements, International
Monetary Fund, European Central Bank, European Community,
International Development Banks (limited to International Bank for
Reconstruction and Development, International Finance Corporation,
Multilateral Investment Guarantee Agency, Asian Development Bank,
African Development Bank, European Bank for Reconstruction and
Development, Inter-American Development Bank, European Investment
Bank, European Investment Fund, Nordic Investment Bank, Caribbean
Development Bank, Islamic Development Bank, International Finance
Facility for Immunisation and Council of Europe Development Bank),
or a regional government, Japan Finance Organization for
Municipalities or a government agency in Japan.
---------------------------------------------------------------------------
[[Page 63390]]
Debt that is issued by any other entity (excluding
securitizations) with certain high level credit risk ratings, but
excluding debt issued by a counterparty or any of its consolidated
affiliates.
Equity securities of issuers included in the major equity
index of certain designated countries, but excluding equity securities
issued by a counterparty or any of its consolidated affiliates.
Investment trust securities (excluding securities of the
counterparty or any of its consolidated affiliates) where the trust
invests in any of the foregoing items and its mark-to-market is
published each business day.
The value of any eligible collateral collected or posted to satisfy
initial margin requirements must be reduced by the following haircuts:
\132\
---------------------------------------------------------------------------
\132\ See FIB Ordinance, Article 123(8) and JFSA Public
Notification No. 16 of March 31, 2016, Article 2.
------------------------------------------------------------------------
------------------------------------------------------------------------
Cash................................... 0%.
Equities included in major stock 15%.
indices.
Government and central bank debt; 0.5%, 1%, or 15%, depending on
residual maturity of 1 year or less. class of credit rating
assigned by eligible credit
rating firms.\133\
Government and central bank debt; 2%, 3%, or 15%, depending on
residual maturity between 1 and 5 class of credit rating
years. assigned by eligible credit
rating firms.
Government and central bank debt; 4%, 6%, or 15% depending on
residual maturity of more than 5 years. class of credit rating
assigned by eligible credit
rating firms.
Corporate bonds; residual maturity of 1 1% or 2% depending on class of
year or less. credit rating assigned by
eligible credit rating firms.
Corporate bonds; residual maturity of 4% or 6%, depending on class of
between 1 and 5 years. credit rating assigned by
eligible credit rating firms.
Corporate bonds; residual maturity of 8% or 12%, depending on class
more than 5 years. of credit rating assigned by
eligible credit rating firms.
Investment trust securities............ The highest of the above ratios
applicable to investments of
the trust.
------------------------------------------------------------------------
In addition to the foregoing, under the JFSA's margin requirements,
if the currency of a collateral asset posted for the purposes of
initial margin is not the same as a currency specified in respect of
the transactions, an additional 8% haircut must be applied.\134\
---------------------------------------------------------------------------
\133\ See Bank Capital Adequacy Notice (JFSA Notice No. 19 of
2006, as amended).
\134\ See FIB Ordinance, Article 123(9) and JFSA Public Notice
No. 16, Article 2(2).
---------------------------------------------------------------------------
3. Commission Determination
Based on the foregoing and the representations of the applicant,
the Commission observes that the JFSA's requirements pertaining to
assets eligible for posting or collecting by FIBOs/RFIs as collateral
for uncleared OTC derivatives are similar to the requirements of the
Final Margin Rule, but are more stringent in some respects and less
stringent in others.
Specifically, the JFSA's requirements are more stringent where they
require a larger haircut than the Final Margin Rule on government,
central bank, and corporate debt where an issuer's credit risk ratings
are less than the highest levels provided by credit rating firms
regulated by the JFSA. However, the JFSA's requirements are less
stringent where they permit the same haircut for all equities (15%)
included in major equity indices of certain designated countries \135\
while the Final Margin Rule applies a 25% haircut for certain equities
not included in the S&P 500. The JFSA's requirements are also less
stringent with respect to the eligible collateral for variation margin
for non-cleared OTC Derivatives between FIBOs/RFIs that are CSEs and
FIBOs/RFIs that are SDs and MSPs (including other CSEs). The Final
Margin Rule only permits immediately available cash funds that are
denominated in U.S. dollars, another major currency (as defined in
Sec. 23.151), or the currency of settlement of the uncleared swap,
while the JFSA's requirements would permit any form of eligible
collateral (as described above).
---------------------------------------------------------------------------
\135\ See JFSA Public Notice No. 16, Article 1(1)(iv) and
Article 2.
---------------------------------------------------------------------------
In addition, the JFSA's margin rules allow eligible collateral in
the form of securities issued by bank holding companies, savings and
loan holding companies, certain intermediary holding companies, foreign
banks, depository institutions, market intermediaries, and margin
affiliates of the foregoing, all of which are prohibited by the Final
Margin Rule.\136\
---------------------------------------------------------------------------
\136\ See 17 CFR 23.156(a)(2).
---------------------------------------------------------------------------
Finally, the JFSA's margin rules also do not specifically address
requirements to monitor the eligibility of posted collateral.\137\
---------------------------------------------------------------------------
\137\ See 17 CFR 23.156(c).
---------------------------------------------------------------------------
While not identical, the Commission finds that the forms of
eligible collateral for initial and variation margin under the laws of
Japan provide comparable protections to the forms of eligible
collateral mandated by the Final Margin Rule. Specifically, the
Commission finds that the JFSA's margin regime ensures that assets
collected as collateral for initial and variation margin purposes are
highly liquid and able to hold their value in a time of financial
stress. Because under JFSA's margin regime, a non-defaulting party
would be able to liquidate assets held as initial and variation margin
in a reasonable amount of time to generate proceeds that could
sufficiently protect collecting entities from losses on uncleared swaps
in the event of a counterparty default, the Commission finds the JFSA's
margin regime with respect to the forms of eligible collateral for
initial and variation margin for uncleared swaps is comparable to the
Final Margin Rule.
K. Requirements for Custodial Arrangements, Segregation, and
Rehypothecation
As explained in the BCBS/IOSCO Framework, the exchange of initial
margin on a net basis may be insufficient to protect two market
participants with large gross derivatives exposures to each other in
the case of one firm's failure. Thus, the gross initial margin between
such firms should be exchanged.\138\
---------------------------------------------------------------------------
\138\ See BCBS/IOSCO Framework, Key principle 5.
---------------------------------------------------------------------------
Further, initial margin collected should be held in such a way as
to ensure that (i) the margin collected is immediately available to the
collecting party in the event of the counterparty's default, and (ii)
the collected margin must be subject to arrangements that protect the
posting party to the extent possible under applicable law in the
[[Page 63391]]
event that the collecting party enters bankruptcy.\139\
---------------------------------------------------------------------------
\139\ See id.
---------------------------------------------------------------------------
1. Commission Requirement for Custodial Arrangements, Segregation, and
Rehypothecation
In keeping with the principles set forth in the BCBS/IOSCO
Framework, with respect to custodial arrangements, segregation, and
rehypothecation, the Final Margin Rule generally requires that:
All assets posted by or collected by CSEs as initial
margin must be held by one or more custodians that are not the CSE, the
counterparty, or margin affiliates of the CSE or the counterparty.\140\
---------------------------------------------------------------------------
\140\ See 17 CFR 23.157(a) and (b).
---------------------------------------------------------------------------
CSEs must enter into an agreement with each custodian
holding initial margin collateral that:
[ssquf] Prohibits the custodian from rehypothecating, repledging,
reusing, or otherwise transferring (through securities lending,
securities borrowing, repurchase agreement, reverse repurchase
agreement or other means) the collateral held by the custodian;
[ssquf] May permit the custodian to hold cash collateral in a
general deposit account with the custodian if the funds in the account
are used to purchase an asset that qualifies as eligible collateral
(other than equities, investment vehicle securities, or gold), such
asset is held in compliance with this section, and such purchase takes
place within a time period reasonably necessary to consummate such
purchase after the cash collateral is posted as initial margin; and
[ssquf] Is a legal, valid, binding, and enforceable agreement under
the laws of all relevant jurisdictions including in the event of
bankruptcy, insolvency, or a similar proceeding.\141\
---------------------------------------------------------------------------
\141\ See 17 CFR 23.157(c)(1) and (2).
---------------------------------------------------------------------------
A posting party may substitute any form of eligible
collateral for posted collateral held as initial margin.\142\
---------------------------------------------------------------------------
\142\ See 17 CFR 23.157(c)(3).
---------------------------------------------------------------------------
A posting party may direct reinvestment of posted
collateral held as initial margin in any form of eligible
collateral.\143\
---------------------------------------------------------------------------
\143\ See id.
---------------------------------------------------------------------------
Collateral that is collected or posted as variation margin
is not required to be held by a third party custodian and is not
subject to restrictions on rehypothecation, repledging, or reuse.\144\
---------------------------------------------------------------------------
\144\ See Final Margin Rule, 81 FR at 672.
---------------------------------------------------------------------------
2. Japan Requirements for Custodial Arrangements, Segregation, and
Rehypothecation
In keeping with the principles set forth in the BCBS/IOSCO
Framework, with respect to custodial arrangements, segregation, and
rehypothecation, the JFSA's margin rules generally require that:
All assets posted by or collected by FIBOs/RFIs as initial
margin collateral must be held in a trust or other similar structure
(e.g., a custodial arrangement) that constitutes legal segregation or
its equivalent.\145\
---------------------------------------------------------------------------
\145\ See FIB Ordinance, Article 123(1)(xxi)-6(d).
---------------------------------------------------------------------------
The segregation structure must ensure that the collateral
will be immediately available to the collecting party in the event of
the posting party's default, and that the collateral will be
immediately returned to the posting party in the event of the
collecting party's bankruptcy.\146\
---------------------------------------------------------------------------
\146\ See id.
---------------------------------------------------------------------------
Rehypothecation, re-pledge, or re-use of collateral posted
as initial margin is prohibited, provided that cash can be re-used
where conducted by a safe method and managed in accordance with the
initial margin management requirements of the FIB Ordinance, Article
123(1)(xxi)-6(d).\147\
---------------------------------------------------------------------------
\147\ See FIB Ordinance Article 123(1)(xxi)-6(e).
---------------------------------------------------------------------------
Collateral that is collected or posted as variation margin
is not required to be held by a third party custodian and is not
subject to restrictions on rehypothecation, repledging, or reuse.\148\
---------------------------------------------------------------------------
\148\ See FIB Ordinance Article 123(1)(xxi)-6(d).
---------------------------------------------------------------------------
3. Commission Determination
The Commission notes that the JFSA's margin requirements with
respect to custodial arrangements are less stringent than those of the
Final Margin Rule in one material respect. Under the Final Margin Rule,
all assets posted by or collected by CSEs as initial margin must be
held by one or more custodians that are not the CSE, the counterparty,
or margin affiliates of the CSE or the counterparty.\149\ The JFSA's
margin rules do not prohibit a FIBO/RFI from using an affiliated entity
as custodian to hold initial margin collected from counterparties.
---------------------------------------------------------------------------
\149\ See 17 CFR 23.157(a) and (b).
---------------------------------------------------------------------------
However, the JFSA has explained that because the JFSA's margin
rules require initial margin to be held in a trust structure under the
Trust Act of Japan,\150\ the risk of use of an affiliated entity as
custodian may be mitigated. A trust account under the Trust Act of
Japan is commonly utilized when segregation of assets is required
because property deposited to such a trust account (``trust property'')
is legally recognized as segregated from the property of the trustor,
the property of the trust bank, and other trust property in the trust
account. Thus trust property in such a trust account is bankruptcy
remote from the trustor and the trust bank.\151\ Therefore, the JFSA
represents that initial margin held in a trust account with an
affiliate of a FIBO/RFI mitigates any risk that such initial margin
would be found part of the FIBO/RFI's estate or its affiliated trust
bank's estate in the event of the bankruptcy of either.
---------------------------------------------------------------------------
\150\ Act No. 108 of 2006 (the ``Trust Act of Japan'').
\151\ See Trust Act of Japan, Article 23(1) stating:
Except where based on a claim pertaining to an Obligation
Covered by the Trust Property . . . compulsory execution,
provisional seizure, provisional disposition or exercise of a
security interest, or an auction . . ., or collection proceedings
for delinquent national tax . . . is not allowed to be enforced
against property that comes under Trust Property.
---------------------------------------------------------------------------
Accordingly, despite the differences in required custodial
arrangements, the Commission has determined that the JFSA's margin
requirements applicable to FIBOs/RFIs pertaining to custodial
arrangements, segregation, and rehypothecation are comparable to the
corresponding requirements under the Final Margin Rule. Specifically,
the Commission finds that under both the JFSA's requirements and the
Final Margin Rule, a CSE/FIBO/RFI is required to segregate the initial
margin posted by its counterparties with a third-party custodian under
terms that constitute legal segregation, and such initial margin may
not be rehypothecated. Accordingly, the Commission finds that the
JFSA's requirements pertaining to custodial arrangements, segregation,
and rehypothecation are comparable in outcome to those required by the
Final Margin Rule.
L. Requirements for Margin Documentation
1. Commission Requirement for Margin Documentation
With respect to requirements for documentation of margin
arrangements, the Final Margin Rule generally provides that:
CSEs must execute documentation with each counterparty
that provides the CSE with the contractual right and obligation to
exchange initial margin and variation margin in such amounts, in such
form, and under such circumstances as are required by the Final Margin
Rule.\152\
---------------------------------------------------------------------------
\152\ See 17 CFR 23.158(a).
---------------------------------------------------------------------------
[[Page 63392]]
The margin documentation must specify the methods,
procedures, rules, inputs, and data sources to be used for determining
the value of uncleared swaps for purposes of calculating variation
margin; describe the methods, procedures, rules, inputs, and data
sources to be used to calculate initial margin for uncleared swaps
entered into between the CSE and the counterparty; and specify the
procedures by which any disputes concerning the valuation of uncleared
swaps, or the valuation of assets collected or posted as initial margin
or variation margin may be resolved.\153\
---------------------------------------------------------------------------
\153\ See 17 CFR 23.158(b).
---------------------------------------------------------------------------
2. Japan Requirements for Margin Documentation
With respect to requirements for documentation of margin
arrangements, the JFSA's margin rules generally provide that:
FIBOs/RFIs must establish an appropriate agreement with
each OTC derivative counterparty (such as an ISDA Master Agreement and
Credit Support Annex) documenting the calculation and transfer of
initial and variation margin.\154\
---------------------------------------------------------------------------
\154\ See Supervisory Guidelines, Section IV-2-4(4)(i)(A) and
(4)(ii)(A).
---------------------------------------------------------------------------
FIBOs/RFIs are required to have documentation with each
uncleared OTC derivative counterparty that, among other things,
identifies dispute resolution measures applicable to margin disputes
for uncleared OTC derivatives.\155\
---------------------------------------------------------------------------
\155\ See Article 37-3 of the FIEA and Article 99 of the FIB
Ordinance.
---------------------------------------------------------------------------
3. Commission Determination
Based on the foregoing and the representations of the applicant,
the Commission has determined that the JFSA's margin requirements
applicable to FIBOs/RFIs pertaining to margin documentation are
substantially the same as the margin documentation requirements under
the Final Margin Rule. Specifically, the Commission finds that under
both the JFSA's requirements and the Final Margin Rule, a CSE/FIBO/RFI
is required to enter into documentation with each OTC derivative/swap
counterparty that sets forth the method for calculating and
transferring initial and variation margin, as well dispute resolution
procedures. Accordingly, the Commission finds that the JFSA's
requirements pertaining to margin documentation are comparable to those
required by the Final Margin Rule.
M. Cross-Border Application of the Margin Regime
1. Cross-Border Application of the Final Margin Rule
The general cross-border application of the Final Margin Rule, as
set forth in the Cross-Border Margin Rule, is discussed in detail in
Section II above. However, Sec. 23.160(d) and (e) of the Cross-Border
Margin Rule also provide certain alternative requirements for uncleared
swaps subject to the laws of a jurisdiction that does not reliably
recognize close-out netting under a master netting agreement governing
a swap trading relationship, or that has inherent limitations on the
ability of a CSE to post initial margin in compliance with the
custodial arrangement requirements \156\ of the Final Margin Rule.\157\
---------------------------------------------------------------------------
\156\ See 17 CFR 23.157 and Section IV(K) above.
\157\ See 17 CFR 23.160(d) and (e).
---------------------------------------------------------------------------
Section 23.160(d) generally provides that where a jurisdiction does
not reliably recognize close-out netting, the CSE must treat the
uncleared swaps covered by a master netting agreement on a gross basis
with respect to collecting initial and variation margin, but may treat
such swaps on a net basis with respect to posting initial and variation
margin.\158\
---------------------------------------------------------------------------
\158\ See id.
---------------------------------------------------------------------------
Section 23.160(e) generally provides that where certain CSEs are
required to transact with certain counterparties in uncleared swaps
through an establishment in a jurisdiction where, due to inherent
limitations in legal or operational infrastructure, it is impracticable
to require posted initial margin to be held by an independent custodian
pursuant to Sec. 23.157, the CSE is required to collect initial margin
in cash (as described in Sec. 23.156(a)(1)(i)) and post and collect
variation margin in cash, but is not required to post initial margin.
In addition, the CSE is not required to hold the initial margin
collected with an unaffiliated custodian.\159\ Finally, the CSE may
only enter into such affected transactions up to 5% of its total
uncleared swap notional outstanding for each broad category of swaps
described in Sec. 23.154(b)(2)(v).
---------------------------------------------------------------------------
\159\ See 17 CFR 23.160(e) and 23.157(b).
---------------------------------------------------------------------------
2. Cross-Border Application of JFSA's Margin Regime
With respect to cross-border transactions, JFSA's margin
requirements generally provide that, where the JFSA's margin regime
would apply to a transaction that also would require compliance with
the margin regime of a foreign state, the Commissioner of the JFSA may
exempt such transactions from compliance with the JFSA's margin rules
if the Commissioner finds that such exemption is unlikely to be
contrary to the public interest or hinder protection of investors due
to a FIBO/RFI's compliance with the margin regime of the foreign state
that is recognized by the JFSA to be equivalent to the JFSA's margin
regime.\160\
---------------------------------------------------------------------------
\160\ See FIB Ordinance, Article 123(10)(v) and (11)(v).
---------------------------------------------------------------------------
With respect to non-cleared OTC Derivatives subject to the laws of
a jurisdiction that does not reliably recognize close-out netting under
a master netting agreement, the JFSA's margin regime generally provides
that an FIBO/RFI is exempt from the requirements to post or collect
either initial or variation margin.\161\ However, as represented by the
JFSA, the JFSA's margin regime also requires that, with respect to such
transactions, the FIBO/RFI must establish an appropriate risk
management framework for the risks of such transactions that may
include collecting margin on a gross basis.\162\
---------------------------------------------------------------------------
\161\ See FIB Ordinance, Article 123(10)(i) and (11)(i).
\162\ See Supervisory Guideline, IV-2-4(4)(iii)(C).
---------------------------------------------------------------------------
With respect to non-cleared OTC Derivatives subject to the laws of
a jurisdiction that has inherent limitations on the ability of a FIBO/
RFI to post initial margin in compliance with the custodial arrangement
requirements under the JFSA's margin rules, as represented by the JFSA,
the JFSA's margin rules provide that the FIBO/RFI is exempt only from
the requirement to post initial margin, but must still comply with the
requirement to collect initial margin and post/collect variation
margin.\163\
---------------------------------------------------------------------------
\163\ See FIB Ordinance 123(1)(xxi)-6(d), (e), and (f).
---------------------------------------------------------------------------
3. Commission Determination
Based on the foregoing and the representations of the applicant,
the Commission finds that the JFSA's margin regime with respect to its
cross-border application is comparable in outcome to that of the Final
Margin Rule as set forth in the Cross-Border Margin Rule.
First, the Commission recognizes that the JFSA's margin regime
permits substituted compliance to substantially the same extent as the
Cross-Border Margin Rule. For example, a CSE subject to the JFSA's
margin regime entering into a transaction with a counterparty in the
U.S., and thus subject to the Final Margin Rule, could request the
Commissioner of the JFSA to exempt
[[Page 63393]]
such transaction from compliance with the JFSA's margin regime upon a
finding that the Final Margin Rule is equivalent to the JFSA's margin
regime. Thus, where a CSE finds itself subject to both the Final Margin
Rule and JFSA's margin regime, but not in a situation where substituted
compliance is available under the Cross-Border Margin Regime, it could
apply to the JFSA for a finding of equivalence.
Second, with respect to transactions subject to the laws of a non-
netting jurisdiction, although the JFSA's margin regime exempts FIBOs/
RFIs from the otherwise applicable requirements to collect and post
margin, the JFSA's Supervisory Guidelines still require such entities
to establish an appropriate risk management framework to protect
against the risks of such transactions. The Commission notes that a CSE
is also required to have a risk management program pursuant Sec.
23.600, and thus the Commission has the authority to inquire as to the
adequacy of the risk management covering uncleared swaps in non-netting
jurisdictions.
Finally, with respect to non-cleared OTC Derivatives subject to the
laws of a jurisdiction that has inherent limitations on the ability of
a CSE/FIBO/RFI to post initial margin in compliance with the custodial
arrangement requirements of the JFSA's margin rules and the Final
Margin Rule, the Cross-Border Margin Rule would only require the CSE to
collect (but not post) initial margin in cash (but not hold such
initial margin with an unaffiliated custodian) \164\ and to post and
collect variation margin in cash. The Cross-Border Margin Rule would
also limit the CSE's ability to enter into such transactions to 5% of
its total uncleared swap notional outstanding for each broad category
of swap asset classes. Meanwhile, the JFSA's margin rules also exempt a
FIBO/RFI from the requirement to post initial margin, while still
requiring compliance with the requirement to collect initial margin and
post/collect variation margin.\165\ The JFSA margin rule does not have
the cash-only requirement, nor does it limit transactions to 5% of a
FIBO/RFI's total notional of uncleared swaps.
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\164\ See 17 CFR 23.160(e) and 23.157(b).
\165\ See FIB Ordinance 123(1)(xxi)-6(d), (e), and (f).
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Having considered the similarities and differences described above,
the Commission finds that: (1) The availability of reciprocity of
substituted compliance available from the JFSA makes the JFSA margin
regime comparable in this respect to that of the Final Margin Rule and
the Cross-Border Margin Rule; (2) the representations of the JFSA
regarding the extensive risk management requirements applicable to
transactions in non-netting jurisdictions makes the JFSA margin regime
comparable in this respect to that of the Final Margin Rule and the
Cross-Border Margin Rule; and (3) the generally similar requirements
for collection of initial margin and collection/posting of variation
margin for transactions in jurisdictions where compliance with
custodial arrangements is impracticable makes the JFSA margin regime
comparable in this respect to that of the Final Margin Rule and the
Cross-Border Margin Rule. Accordingly, the Commission finds the cross-
border aspects of the JFSA's margin regime comparable to that of the
Commission.
N. Supervision and Enforcement
The Commission has a long history of regulatory cooperation with
the JFSA, including cooperation in the regulation of registrants of the
Commission that are also FIBOs. Thus, the Commission finds that the
JFSA has the necessary powers to supervise, investigate, and discipline
entities for compliance with its margin requirements and recognizes the
JFSA's ongoing efforts to detect and deter violations of, and ensure
compliance with, the margin requirements applicable in Japan.
V. Conclusion
As detailed above, the Commission has considered the scope and
objectives of the margin requirements for uncleared swaps under the
laws of Japan,\166\ whether such margin requirements achieve comparable
outcomes to the Commission's corresponding margin requirements; \167\
and the ability of the JFSA to supervise and enforce compliance with
the margin requirements for non-cleared OTC Derivatives under the laws
of Japan.\168\
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\166\ See 17 CFR 23.160(c)(3)(i).
\167\ See 17 CFR 23.160(c)(3)(ii). As discussed above, the
Commission's Final Margin Rule is based on the BCBS/IOSCO Framework;
therefore, the Commission expects that the relevant foreign margin
requirements would conform to such Framework at minimum in order to
be deemed comparable to the Commission's corresponding margin
requirements.
\168\ See 17 CFR 23.160(c)(3)(iii). See also 17 CFR
23.160(c)(3)(iv) (indicating the Commission would also consider any
other relevant facts and circumstances).
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Pursuant to the foregoing process, the Commission has noted several
differences in the margin regimes. However, the only difference for
which the Commission has found the JFSA's margin regime to be not
comparable is that the Final Margin Rule requires collection and
posting of variation margin, and in a limited circumstance, collection
of initial margin, for uncleared swaps between consolidated affiliates,
while the JFSA's margin rules do not require any margin to be posted or
collected on such transactions.\169\
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\169\ See Section IV(D) supra.
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Accordingly, a CSE that is subject to both the Final Margin Rule
and the JFSA's margin rules with respect to an uncleared swap that is
also a non-cleared OTC Derivative may rely on substituted compliance
for all aspects of the Final Margin Rule and the Cross-Border Margin
Rule except that such CSE must comply with the inter-affiliate margin
requirements of Sec. 23.159 of the Final Margin Rule.
Issued in Washington, DC, on September 8, 2016, by the
Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.
Appendices to Comparability Determination for Japan: Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants--Commission Voting Summary, Chairman's Statement, and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Massad and Commissioner Giancarlo voted
in the affirmative. Commissioner Bowen voted in the negative.
Appendix 2--Statement of Chairman Timothy G. Massad
Today, the CFTC has furthered its commitment to international
cooperation and harmonization.
By issuing this comparability determination with respect to
Japan's rules on margin for uncleared swaps, the Commission has
ensured that a Japanese swap dealer or major swap participant
registered with the CFTC can comply with many aspects of our margin
rules by meeting the corresponding Japan Financial Services Agency
(JFSA) requirements. This is an important and necessary step toward
building a strong international regulatory framework for the over-
the-counter swaps market, which is critical to ensuring the safety
and soundness of our own financial markets.
It's important to remember that we are still at the early stages
of developing this new global framework. Shortly after I took office
two years ago, there were significant differences between our rules,
Japan's rules, and the rules of other jurisdictions. We made
tremendous progress bringing those rules together since that time.
And today, we all share the same goal of a strong, international
framework. But there are still going to be differences, and we
understand our laws and the laws of other jurisdictions will never
be identical.
[[Page 63394]]
Our comparability determination reflects this understanding. In
this instance, as in other decisions, the Commission compared our
margin rule with each element of Japan's rules, carefully
considering the objectives and outcomes of its specific provisions.
We concluded that while there are differences in our margin
regimes, Japan's margin requirements achieve comparable outcomes.
The Commission identified only one area where we must make an
exception to that conclusion. Our margin rule requires the
collection and posting of variation margin and, in certain
circumstances, the collection of initial margin for uncleared swaps
between consolidated affiliates. However, the JFSA's margin rules do
not require any margin to be posted or collected on such
transactions.
As a result, the Commission has determined that certain entities
subject to both the CFTC's and the JFSA's margin rules with respect
to an uncleared swap may rely on the substituted compliance made
available under the CFTC's Cross-Border Margin Rule--with the
exception that these entities must comply with the CFTC's inter-
affiliate margin requirements. I believe this exception is
necessary, to help address the risk that can flow back into the
United States from offshore activity, even when the subsidiary is
not explicitly guaranteed by the U.S. parent. In addition, it will
prevent the potential buildup of current exposure among affiliates.
Let me also comment on the concerns regarding differences in our
rules with respect to the treatment of collateral, custodial
requirements, and swaps with counterparties in so-called ``non-
netting'' jurisdictions. I believe we should allow reliance on
Japanese rules in these areas. That is because our goal is
comparability in outcomes, and that goal is achieved in both cases.
First, on the treatment of collateral, it has been noted that
there is a difference in our rules on haircuts for equities. But it
is relatively small. We require a haircut of 15 percent on equities
included in the S&P 500, and 25 percent on the S&P 1500. Japan's
rules say 15 percent on major equity indices. But we should also
note that Japan imposes a larger discount than we do on government
bonds and corporate debt. Our comparability process should therefore
not insist on line-by-line identity, but rather decide what
differences are truly significant to overall outcomes.
Similarly, with respect to custodial requirements, I recognize
the importance of the protection of margin deposits, especially in
the event of the bankruptcy of a counterparty. The means that we
require in our rule--segregation with an independent custodian--are
not commonly used in Japan. But the Japan rules require the use of
trust structures which achieve the same goal under Japanese law, and
are recognized under Japanese law in bankruptcy.
With respect to treatment of non-netting jurisdictions, our rule
requires a swap dealer to collect initial margin on a gross basis
from a counterparty in a jurisdiction that doesn't clearly recognize
netting, while the JFSA rule says that the dealer must establish an
appropriate risk management framework that may, but is not required
to, include collection of margin. To measure outcomes, we must look
not only at the specifics but at how the rules work in different
scenarios. For example, Japanese swap dealers whose trades are
guaranteed by a U.S. person must follow our rules on this issue and
collect margin, regardless of what we decide as a matter of
substituted compliance. And Japanese swap dealers whose trades are
not guaranteed by a U.S. person, and who are not foreign
consolidated subsidiaries, would not be required to follow our rule
on this issue, regardless of what we decide as a matter of
substituted compliance. That is because such trades are excluded
from our rules. Japanese swap dealers who are foreign consolidated
subsidiaries (and whose trades are not guaranteed by a U.S. person)
would be entitled to substituted compliance, but if they engage in
trades with counterparties in non-netting jurisdictions they would
still be subject to the JFSA risk management requirements, and any
parent entity swap dealer would be subject to our consolidated risk
management requirements.
For these reasons, I believe it is appropriate to grant
substituted compliance without an exception on these issues.
In making these determinations, staff also considers another
jurisdiction's supervisory and enforcement authority in assessing
outcomes. And here, I agree with staff's conclusion, and want to
underscore the fact that we have a very strong and good relationship
with the JFSA. In fact, I met with Commissioner Mori and members of
his staff just a few months ago. There is mutual respect, and good
communication and cooperation between our agencies. We have worked
well together on a number of issues, including the formulation of
margin requirements. And this determination will strengthen that
relationship further.
Today's decision will contribute significantly to that
international framework and help make sure our derivatives markets
continue to be dynamic, competitive, and drivers of economic growth.
I want to particularly thank our staff in the Division of Swap
Dealer and Intermediary Oversight and in the Office of the General
Counsel for their work on this and the implementation of our margin
rules generally. I also thank Commissioners Bowen and Giancarlo for
their input and consideration of this determination.
Appendix 3--Dissenting Statement of Commissioner Sharon Y. Bowen
I thank the staff for all of its hard work on this margin
comparability determination. However, I cannot support it. I will be
voting no as I think it would introduce greater risk into the
derivatives markets--the very thing that we were sent here by the
American people to prevent.
There are just three questions I will answer in my remarks
today:
1. What is a margin comparability determination and why does it
matter?
2. What are the problems with this particular comparability
determination?
3. How can we fix it?
First, what is a margin comparability determination and why does it
matter?
For many Americans, a margin comparability determination is
truly a foreign concept. But it actually has great significance to
our economy. Margin is collateral. The 2008 derivatives market was
under-collateralized, and that is what caused it to explode and take
our economy with it. The American people expected us, as regulators,
to fix that by requiring sufficient collateral to address the risk.
We have done that with our margin rule.\1\
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\1\ Though, as noted in my dissent, this rule was far weaker
than it should have been due to how it dealt with inter-affiliate
margin. See Dissenting Statement of Commissioner Sharon Y. Bowen
Regarding Final Rule on Margin for Uncleared Swaps (Dec. 16, 2015),
available at http://www.cftc.gov/PressRoom/SpeechesTestimony/bowenstatement121615a.
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In a margin comparability determination, we are defining when
our U.S. dealers that are operating in the other jurisdiction, can
ignore our margin rule and follow the other jurisdiction's margin
rule. Allowing American companies to just follow one set of rules--
that of the jurisdiction they are in--makes sense when the rules are
basically accomplishing the same thing. I am in favor of that.
International comity, harmonization across jurisdictions, and having
an outcomes-based approach to comparability all make sense.
Unfortunately, that is not the scenario that we have here. While
Japanese law has some strong similarities to our own, there are some
areas of divergence that are significant and would allow American
companies to do overseas what they would never be allowed to do
here. And make no mistake; though these companies are physically
located in Japan, their cash line runs right back to the United
States. That risk could be borne again by American households. A
comparability determination should not be the back door way of
undoing or weakening our regulations and thereby incentivizing our
companies to send their risky business to their affiliates located
in Japan. That would not be good for our economy, Japan's economy,
or global financial stability overall.
This determination is doubly important because this is the first
one and thus sets the stage for others. By adopting a weak standard
today, we pave the way for even weaker determinations in the future.
Moreover, we are not establishing this determination in conjunction
with the Prudential Regulators, who oversee roughly half of U.S.
swap dealers and are our counterparts on these issues. We have
worked effectively with our Prudential counterparts on the
international Working Group on Margin Requirements (WGMR) \2\ thus
far; making this determination without harmonization amongst U.S.
regulators is ill-advised. Differences in requirements would only
open the door to regulatory arbitrage domestically.
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\2\ Working Group on Margin Requirements of the Basel Committee
on Banking Supervision and the International Organization of
Securities Commissions.
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[[Page 63395]]
Second, what is the problem with this particular comparability
determination?
The answer: Bankruptcy. Bankruptcy is something that we do not
like to think about, but in finance, it is something that we must
always consider when designing deals. We know the old adage: Hope
for the best, but plan for the worst. In my work as a law firm
partner and Acting Chair of the Securities Investor Protection
Corporation (SIPC), I have seen too many bankruptcies. And there are
three key differences in our margin rule and the Japanese margin
rule that would leave our American companies operating under
Japanese law vulnerable. The key differences are:
1. Where the customer money is kept. Our rules require customer
collateral to be held by a third party--not by either one of the
counterparties. This is a safeguard for bankruptcy. If the money is
held by one of the counterparties, then a bankruptcy court may use
that money to meet the counterparty's debts. Or in a stress event,
the counterparty could potentially take the customer money to meet
its obligation. If, however, the money is at a third party, it is
far more likely that it will get back to the customers that provided
it. Japanese law does not have a comparable rule. Thus, in a
bankruptcy situation, U.S. customers may be unable to receive back
their customer funds. This discrepancy is noted in the
determination,\3\ but the staff states that the fact that the funds
are segregated sufficiently mitigates against the risk. I disagree.
In my experience with bankruptcies, I have learned that access to
customer funds largely depends on the location of those funds.
Third-party custodianship is an important safeguard.
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\3\ See ``Comparability Determination for Japan: Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants,'' pp. 63-65. (``The Commission notes that the JFSA's
[Japan Financial Services Agency] margin requirements with respect
to custodial arrangements are less stringent than those of the Final
Margin Rule in one material respect. Under the Final Margin Rule,
all assets posted by or collected by CSEs as initial margin must be
held by one or more custodians that are not the CSE, the
counterparty, or margin affiliates of the CSE or the counterparty.
The JFSA's margin rules do not prohibit a FIBO/RFI from using an
affiliated entity as custodian to hold initial margin collected from
counterparties.'').
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2. Transacting with counterparties in bankruptcy-risky
jurisdictions. There are certain developing countries where there is
little certainty that collateral will be there if there is a
bankruptcy (non-netting jurisdictions), and/or where they do not
adequately protect customer funds from that of the dealer (``non-
segregation jurisdictions''). Under our rules, our U.S. dealers have
to limit the way they trade with counterparties in these bankruptcy-
vulnerable jurisdictions because we are not confident that our
American investors will get their money back in a bankruptcy
scenario.\4\ These safeguards vary depending on the circumstances
and include limiting the amount of business that our dealers can do
with these counterparties, and limiting the type of acceptable
collateral. Japan does not have these kinds of limits on their
dealers who deal in these bankruptcy-vulnerable jurisdictions. Thus,
the American companies operating in Japan could potentially have an
unlimited number of deals with counterparties in these developing
countries. This could put some of our major American financial
firms, and thus our economy, at risk.
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\4\ Id. at pp. 69-70. (``[W]ith respect to transactions subject
to the laws of a non-netting jurisdiction JFSA's margin regime
exempts FIBOs/RFIs from the otherwise applicable requirements to
collect and post margin. . . . [W]ith respect to non-cleared OTC
Derivatives subject to the laws of a jurisdiction that has inherent
limitations on the ability of a CSE/FIBO/RFI to post initial margin
in compliance with the custodial arrangement requirements of the
JFSA's margin rules and the Final Margin Rule . . . [t]he JFSA
margin rule does not have the cash-only requirement, nor does it
limit transactions to 5% of a FIBO/RFI's total notional of uncleared
swaps.'').
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3. Types of collateral allowed. There are significant
differences in the treatment of collateral between our margin rule
and the Japanese rule. First, while our rules limit daily variation
margin to cash for dealer-to-dealer swaps, under Japanese law,
variation margin could be in a number of much less liquid
instruments. And second, while we require a 25% haircut for certain
equities not included in the S&P 500, under Japanese law, equities
included in major equity indices of certain designated countries
just have a 15% blanket haircut.\5\ That means that we require our
companies to value equities much more conservatively than under
Japanese law. That means that in a crisis, American companies in
Japan could be exchanging instruments that are virtually worthless
since they cannot be readily converted to cash, thereby putting them
in jeopardy.
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\5\ Id. at pp. 58-59. (``[T]he JFSA's requirements are less
stringent where they permit the same haircut for all equities (15%)
included in major equity indices of certain designated countries
while the Final Margin Rule applies a 25% haircut for certain
equities not included in the S&P 500. The JFSA's requirements are
also less stringent with respect to the eligible collateral for
variation margin for non-cleared OTC Derivatives between FIBOs/RFIs
that are CSEs and FIBOs/RFIs that are SDs and MSPs (including other
CSEs). The Final Margin Rule only permits immediately available cash
funds that are denominated in U.S. dollars, another major currency
(as defined in Sec. 23.151), or the currency of settlement of the
uncleared swap, while the JFSA's requirements would permit any form
of eligible collateral (as described above). In addition, the JFSA's
margin rules allow eligible collateral in the form of securities
issued by bank holding companies, savings and loan holding
companies, certain intermediary holding companies, foreign banks,
depository institutions, market intermediaries, and margin
affiliates of the foregoing, all of which are prohibited by the
Final Margin Rule. Finally, the JFSA's margin rules also do not
specifically address requirements to monitor the eligibility of
posted collateral.'').
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If these were insignificant differences, I would happily brush
them aside and accept this comparability determination as is. But
these issues could mean the difference between an orderly
bankruptcy, and a disaster overseas that pulls down a significant
American financial company, and potentially our economy.
And last, how could we have fixed it?
Fixing this is actually rather simple. We could provide a
partial comparability determination--our American businesses could
follow the Japanese margin rule except in the areas above where they
would have to follow our rule. We have already done this in the
current draft in the area of inter-affiliate margin. We would simply
extend the same treatment to these three areas as well.
Unfortunately, that common sense approach was not followed here.
And that is why I am unable to vote for it. While our two
jurisdictions are partly comparable, there are significant areas in
which there are material divergences. A partial comparability
determination, as described above, would be the best way to strike
the balance between international harmonization and protection of
American financial companies that are located elsewhere but still
directly linked to our economy.
Appendix 4--Statement of Commissioner J. Christopher Giancarlo
When the Commission issued its rule addressing the cross-border
application of margin requirements for uncleared swaps in May of
this year \1\ I expressed my disagreement with the approach the
Commission established as overly complex and unduly narrow.\2\ I
also expressed my concern that the Commission's ``element-by-
element'' methodology for determining when substituted compliance
with a foreign regulator's margin regime would be permitted is
contrary to the principles-based, holistic analysis the Commission
has used in the past in certain circumstances \3\ and could result
in an impracticable patchwork of U.S. and foreign regulations for
cross-border transactions.\4\
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\1\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Cross-Border Application of the Margin
Requirements, 81 FR 34818, May 31, 2016.
\2\ Id. at 34853-54.
\3\ As I noted in my dissent, the Commission employs a
principles-based, holistic approach for substituted compliance
determinations under Commission Regulation 30.10 and for purposes of
permitting direct access by U.S. customers to foreign boards of
trade. Id. at 34853 n.5.
\4\ Id. at 34853-54.
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My concerns were realized last week when Asian swaps markets
ground to a halt amidst confusion about the application of new
margin rules to major market participants. Once again, there were
reports of counterparties avoiding trading with U.S. persons. I
believe this rule's subjectivity and complexity will continue to be
a source of regulatory uncertainty at the expense of U.S. financial
firms, their employees and the American businesses they serve.
I nevertheless support the comparability determination for
Japan. In this instance, the Commission has appropriately recognized
that certain differences between the U.S. margin regime and Japan's
margin regime achieve comparable outcomes. Wrong approach; right
outcome. I therefore vote in favor of the determination.
[FR Doc. 2016-22045 Filed 9-14-16; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: September 15, 2016