2019-06152
Federal Register, Volume 84 Issue 62 (Monday, April 1, 2019)
[Federal Register Volume 84, Number 62 (Monday, April 1, 2019)]
[Rules and Regulations]
[Pages 12074-12081]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-06152]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Amendment to Comparability Determination for Japan: Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Notification of Amendment to Comparability Determination for
Margin Requirements for Uncleared Swaps under the Laws of Japan.
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SUMMARY: The following is an amendment (this ``Amendment'') to the
Comparability Determination for Japan: Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants of the
Commodity Futures Trading Commission (``Commission'' or ``CFTC'')
published on September 15, 2016 (the ``Japan Determination''). This
Amendment amends the Japan Determination by: Making a positive
determination of comparability with respect to the scope of entities
subject to margin requirements, and making a positive determination of
comparability with respect to the treatment of inter-affiliate
transactions. All other findings and determinations contained in the
Japan Determination remain unchanged and in full force and effect.
DATES: This Amendment to the Japan Determination is effective April 1,
2019.
FOR FURTHER INFORMATION CONTACT: Matthew B. Kulkin, Director, 202-418-
5213, [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
On September 15, 2016, the Commission published the Japan
Determination,\1\ which provided the
[[Page 12075]]
analysis and determination of the 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. Although discussed in the Japan
Determination, the Commission did not make a finding regarding whether
the scope of entities subject to the JFSA's margin requirements for
non-cleared OTC derivatives was comparable in outcome to the scope of
entities subject to the Commission's margin requirements for uncleared
swaps. As discussed below, the Commission now finds that it is.
Further, the Japan Determination found the JFSA's margin requirements
for non-cleared OTC derivatives between affiliates not comparable in
outcome to the Commission's margin requirements for uncleared swaps
between affiliates. As discussed below, the Commission has reconsidered
this finding and now finds that such requirements are comparable in
outcome to the Commission's own.
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\1\ See Comparability Determination for Japan: Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants, 81 FR 63376 (Sept. 15, 2016).
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II. Regulatory Background
Pursuant to section 4s(e) of the CEA,\2\ the Commission is required
to promulgate margin requirements for uncleared swaps applicable to
each SD and MSP for which there is no U.S. Prudential Regulator
(collectively, ``Covered Swap Entities'' or ``CSEs'').\3\ The
Commission published final margin requirements for such CSEs in January
2016 (the ``CFTC Margin Rule'').\4\
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\2\ 7 U.S.C. 1 et. seq.
\3\ See 7 U.S.C. 6s(e)(1)(B). SDs and MSPs for which there is a
U.S. Prudential Regulator must meet the margin requirements for
uncleared swaps established by the applicable U.S. 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 U.S.
Prudential Regulators published final margin requirements in
November 2015. See Margin and Capital Requirements for Covered Swap
Entities, 80 FR 74840 (Nov. 30, 2015).
\4\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016). The CFTC
Margin Rule, which became effective April 1, 2016, is codified in
part 23 of the Commission's regulations. See Sec. Sec. 23.150-
23.159, 161. The Commission's regulations are found in Chapter 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 CFTC Margin Rule (hereinafter, the ``Cross-Border
Margin Rule'').\5\ The Cross-Border Margin Rule sets out the
circumstances under which a CSE is allowed to satisfy the requirements
under the CFTC 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 in outcome to the CFTC Margin Rule
(``comparability determinations''). The Commission stated that
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.\6\
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\5\ 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 Sec. 23.160.
\6\ 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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On June 17, 2016, the JFSA 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 CFTC Margin Rule. In due course, the Commission
published the Japan Determination on September 15, 2017.
III. Margin Requirements for Swaps Activities in Japan
As represented to the Commission by the JFSA, margin requirements
for swap activities in Japan are governed by the Financial Instruments
and Exchange Act, No. 25 of 1948 (the ``Japan FIEA''), covering
Financial Instrument Business Operators (``FIBOs'') and Registered
Financial Institutions (``RFIs''), which include regulated banks,
cooperatives, insurance companies, pension funds, and investment
funds.\7\ The Japanese Prime Minister delegated broad authority to
implement these laws to the JFSA. Pursuant to this authority, the JFSA
has promulgated the FIB Ordinance,\8\ Supervisory Guidelines,\9\ and
Public Notifications.\10\ These requirements supplement the
requirements of the Japan FIEA with more detailed direction with
respect to margin requirements.\11\
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\7\ The Commission has provided the JFSA with opportunities to
review and comment on the Commission's description of the JFSA's
laws and regulations on which the Japan Determination and this
Amendment are based. The Commission relies on the accuracy and
completeness of such review and any corrections received in making
its comparability determinations. A comparability determination,
including any amendments made thereto, based on an inaccurate
description of foreign laws and regulations may not be valid.
\8\ Cabinet Office Ordinance on Financial Instruments Business
(Cabinet Office Ordinance No. 52 of August 6, 2007), including
supplementary provisions (``FIB Ordinance'').
\9\ 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'').
\10\ 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'').
\11\ Collectively, the Japan 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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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].\12\
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\12\ See Cabinet Order No. 321 of 1965; Article 123(1)(xxi)-5 of
the FIB Ordinance; and Article 2(22) of FIEA.
As represented by the applicant, however, Japan has separate
definitions of ``OTC Derivatives'' and ``OTC
[[Page 12076]]
Commodity Derivatives.'' \13\ 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.\14\ 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,\15\ 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.
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\13\ Article 2, Paragraph 14 of the Commodity Derivatives Act
(Act No. 239 of August 5, 1950) defines OTC commodity derivatives.
\14\ 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.
\15\ See id.
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IV. Amendments to the Japan Determination
A. Entities Subject to Margin Requirements
The following amends and restates the entirety of the discussion
with respect to entities subject to margin requirements as it appeared
in the Japan Determination.\16\
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\16\ See Japan Determination 81 FR at 63380-81.
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The scope of entities subject to the JFSA's margin requirements and
how it compares to the scope of entities subject to the CFTC Margin
Rule was discussed in the Japan Determination, but the Commission made
no determination of comparability or non-comparability.\17\ Instead,
the Commission noted certain differences with respect to the scope of
application of the two regimes, noted the possibility that the CFTC
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,
and reminded CSEs that substituted compliance is only available to a
CSE where it and its transaction are subject to both the CFTC Margin
Rule and the JFSA's margin requirements.\18\
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\17\ See id.
\18\ Or the METI/MAFF margin rules, as discussed above.
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Subsequent to publication of the Japan Determination, Commission
staff was made aware that the lack of a comparability determination
with respect to the scope of entities subject to the CFTC Margin Rule
and the JFSA's margin requirements was causing some confusion as to the
scope of substituted compliance available under the Japan
Determination. Specifically, the Japan Determination spoke only to the
comparability of certain requirements under the Japan FIEA and the FIB
Ordinance but did not determine whether margin requirements under the
JFSA Supervisory Guidelines could be considered in making a substituted
compliance determination with respect to Japanese entities that fall
under certain thresholds. To avoid any such confusion going forward,
the Commission is addressing the comparability of the scope of entities
subject to the jurisdictions' respective margin requirements, including
the JFSA Supervisory Guidelines.
The CFTC 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 U.S. Prudential Regulator. Thus, only such CSEs may rely on
the determinations herein for substituted compliance, while CSEs for
which there is a U.S. Prudential Regulator must look to the
determinations of the U.S. Prudential Regulators. The Commission has
consulted with the U.S. Prudential Regulators in making these
determinations.
CSEs are not required to collect and/or post margin with every
uncleared swap counterparty. The initial margin obligations of CSEs
under the CFTC Margin Rule apply only to uncleared swaps with
counterparties that meet the definition of ``covered counterparty'' in
Sec. 23.151.\19\ Such definition provides that a ``covered
counterparty'' is a counterparty to a swap with a CSE that is either a
financial end user \20\ that exceeds a certain threshold of swap
activity (``material swaps exposure'') \21\ or another SD or MSP.\22\
On the other hand, the variation margin obligations of CSEs under the
CFTC Margin Rule apply more broadly. Such obligations apply to
counterparties that are SDs or MSPs and all financial end users, not
just those with ``material swaps exposure.'' \23\ Thus, importantly for
comparison with the non-cleared OTC derivative margin requirements of
Japan, under the CFTC Margin Rule, CSEs must exchange variation margin
with any counterparty that falls within the definition of ``financial
end user'' without regard to the size of such counterparty's
involvement in the swap market or the risk it may present to the CSE.
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\19\ See Sec. 23.152.
\20\ See definition of ``Financial end user'' in Sec. 23.151.
In general, the definition covers entities involved in regulated
financial activity, including banks, brokers, intermediaries,
advisers, asset managers, collective investment vehicles, and
insurers.
\21\ See Sec. 23.150, which defines the initial margin
threshold for financial end users as ``material swaps exposure.''
Material swaps exposure for a financial end user 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 counts 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 the
calculation, an entity does not count a swap that is exempt pursuant
to Sec. 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.
\22\ See definition of ``swap entity'' in Sec. 23.150.
\23\ See Sec. 23.153.
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Pursuant to Article 29 of the Japan 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'') \24\--must register
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, including transacting in OTC
derivatives. 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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\24\ See Article 2(8)(iv) of the FIEA.
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The JFSA margin requirements generally apply to Type I FIBOs and
[[Page 12077]]
RFIs (``JFSA Covered Entities''), and JFSA Covered Entities must comply
with such requirements when transacting with each other as well as with
foreign financial entities that enter into non-centrally cleared OTC
derivatives ``as a business'' in a foreign jurisdiction where the legal
validity of close-out netting is appropriately confirmed.\25\ These
entities are collectively referred to hereinafter as ``JFSA Covered
Counterparties.'' All current CSEs established under the laws of Japan
are registered in Japan as Type I FIBOs under the supervision of the
JFSA, and are thus JFSA Covered Entities.
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\25\ See FIB Ordinance, Article 123(10)(i)(a) and Article
123(11)(i)(a). However, foreign governments, foreign central banks,
multilateral development banks, and the Bank for International
Settlements are excluded. See id.
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Similar to the CFTC Margin Rule's ``material swaps exposure''
threshold for application of the initial margin requirements, the FIB
Ordinance requires initial margin with JFSA Covered Counterparties only
when both counterparties meet or exceed a certain threshold of non-
cleared OTC derivatives activity (the ``JFSA Initial Margin
Threshold'').\26\ But, dissimilar to the CFTC Margin Rule's requirement
that CSEs exchange variation margin with all swap entity and
``financial end user'' counterparties regardless of the level of
activity in uncleared swaps, the JFSA margin requirements only require
JFSA Covered Entities to exchange variation margin with JFSA Covered
Counterparties when both counterparties exceed a minimum trading volume
threshold (the ``JFSA Variation Margin Threshold'').\27\ The JFSA
represents such minimum threshold is expected to exclude only those
market participants that present so little risk, at an individual firm
level, that the considerable costs associated with compliance are not
warranted.
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\26\ See FIB Ordinance, Article 123(11)(iv). 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. As of the date of this determination, JPY
1.1 trillion is equivalent to approximately USD 10 billion.
\27\ In general, a JFSA Covered Entity has exceeded the JFSA
Variation Margin Threshold if the average total amount of the
notional principal of its 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
billion (approximately $2.7 billion).
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Finally, non-centrally cleared OTC derivatives with JFSA Covered
Counterparties below the JFSA Variation Margin Threshold and with
counterparties that are not JFSA Covered Counterparties (together,
``Supervised Counterparties'') are only subject to the JFSA Supervisory
Guidelines, which require the establishment of an appropriate risk
management system in accordance with relevant margin requirements under
the JFSA FIEA, but with considerable latitude to tailor such
requirements based on the risk profiles and individual circumstances of
the Supervised Counterparties.\28\
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\28\ See JFSA Supervisory Guidelines at IV-2-4(4)(i).
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Despite the definitional differences and differences in activity
thresholds with respect to the scope of application of the CFTC Margin
Rule and the JFSA's margin requirements, the Commission notes that in
transactions between counterparties with the highest levels activity in
uncleared swaps (and thus presumably present the most risk), both the
CFTC Margin Rule and the JFSA margin requirements require both initial
and variation margin. CSEs that exceed the JFSA Initial Margin
Threshold transacting with JFSA Covered Counterparties that also exceed
the JFSA Initial Margin Threshold would be required to collect and post
initial and variation margin in amounts and with frequencies found
comparable to the same requirements under the CFTC Margin Rule pursuant
to the Japan Determination.\29\ Although the ``material swaps
exposure'' threshold under the CFTC Margin Rule (denominated in USD) is
currently lower than the JFSA Initial Margin Threshold (denominated in
JPY), the Commission recognizes that both are of relatively similar
magnitudes and differences between the two are largely due to
fluctuating JPY/USD exchange rates. Given that the initial margin
thresholds serve the same purpose and are of relatively similar
magnitudes, the Commission has concluded that the JFSA Initial Margin
Threshold is comparable in purpose and effect to the CFTC ``material
swaps exposure'' threshold. The Commission also notes that if a CSE/
JFSA Covered Entity enters into an uncleared swap with a CSE that is a
U.S. person, then it will be required to exchange variation margin and
post initial margin in accordance with the CFTC Margin Rule because
substituted compliance for variation margin and the collection of
initial margin is not available.\30\ This requirement significantly
limits the extent to which differences between the JFSA Initial Margin
Threshold and the CFTC ``material swaps exposure'' threshold could
negatively impact systemic risk in the United States.
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\29\ See Japan Determination, 81 FR at 63385-87.
\30\ See Cross-Border Margin Rule, 81 FR at 34829.
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With respect to uncleared swaps between CSEs and Supervised
Counterparties that would be subject to the CFTC Margin Rule but not
subject to the JFSA margin requirements other than the more flexible
JFSA Supervisory Guidelines, the Commission recognizes that the JFSA
has determined that Supervised Counterparties have so little activity
in the relevant uncleared derivatives that they do not present risk
that warrants the considerable costs associated with compliance to the
full extent of the JFSA margin requirements.
The Commission also notes that application of the CFTC Margin Rule
to these Supervised Counterparties would place CSEs otherwise eligible
for substituted compliance that are seeking to transact business in
Japan with Supervised Counterparties at a competitive disadvantage
relative to other firms subject only to the JFSA Supervisory
Guidelines.
With these factors in mind, the Commission has concluded that with
respect to the margin requirements for uncleared swaps between CSEs and
Supervised Counterparties, the JFSA Supervisory Guidelines are
comparable in purpose and outcome to the CFTC Margin Rule.
Accordingly, the Commission finds that the scope of entities
subject to non-cleared OTC derivatives margin requirements under the
laws of Japan is comparable in outcome to the scope of entities subject
to the CFTC Margin Rule for purposes of Sec. 23.160. A CSE that is a
JFSA Covered Entity and eligible for substituted compliance under Sec.
23.160 may therefore classify counterparties in accordance with the
margin requirements of the JFSA FIEA, FIB Ordinance, and JFSA
Supervisory Guidelines with respect to determining whether initial or
variation margin must be exchanged, or whether only the risk management
requirements of the JFSA Supervisory Guidelines will apply. Where only
the JFSA Supervisory Guidelines will apply to non-cleared OTC
derivatives with a counterparty, a CSE that is a JFSA Covered Entity
and eligible for substituted compliance under Sec. 23.160 may comply
with any relevant aspect of the CFTC Margin Rule by complying with the
JFSA Supervisory Guidelines.
B. Treatment of Inter-Affiliate Derivative Transactions
The Japan Determination was the first comparability determination
regarding uncleared swap margin requirements
[[Page 12078]]
issued by the Commission following the establishment of its substituted
compliance framework in May, 2016.\31\ In the two years since issuing
the Japan Determination, the Commission has issued one other
determination for the European Union (``EU''),\32\ and is issuing a
third for the requirements of the Australia Prudential Regulatory
Authority concurrently with this Amendment (the ``Australia
Determination''). The Commission has found the margin requirements for
uncleared swaps between affiliates applicable in both the EU and
Australia comparable in outcome to the Commission's requirements,
despite marked differences between the approach of the Commission and
the approach of those jurisdictions.\33\ In addition, Commission staff
is currently analyzing the comparability of the uncleared swap margin
requirements of a number of additional jurisdictions. Based on our
additional experience, the Commission is now weighing certain relevant
factors in its determination differently than when it first made the
Japan Determination, but still using an outcomes-based approach.\34\ In
the Japan Determination, the Commission concluded that the lack of a
margin requirement for inter-affiliate transactions meant that the
outcomes of the two jurisdictions' rules were not comparable. In doing
so, the Commission acknowledged the JFSA's general oversight of the
risk management practices of JFSA Covered Entities but did not believe
that this factor was sufficient to address the differences between the
two jurisdictions' margin regimes.\35\ The Commission has reconsidered
the effect of this factor in light of a more complete understanding of
the JFSA's oversight practices, and other relevant facts and
circumstances, in conducting its assessment of whether the Japanese
margin regime achieves an outcome that is comparable to that of the
CFTC Margin Rule.
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\31\ See Cross-Border Margin Rule.
\32\ See Comparability Determination for the European Union:
Margin Requirements for Uncleared Swaps for Swap Dealers and Major
Swap Participants, 82 FR 48394 (Oct. 18, 2017) (hereinafter, the
``EU Determination'').
\33\ See e.g., the EU Determination, 82 FR at 48399-01.
\34\ See Sec. 23.160(c)(3).
\35\ See Japan Determination, 81 FR at 63382.
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The Commission notes that 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.\36\ In determining comparability,
considerations of comity are particularly relevant under this type of
international framework.\37\
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\36\ See BCBS/IOSCO Framework, Element 6: Treatment of
transactions with affiliates.
\37\ As discussed above, the CFTC and the JFSA participated in
the BCBS/IOSCO WGMR.
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The following amends and restates the entirety of the discussion
and determination of the Commission with respect to Commission
requirements for treatment of inter-affiliate transactions as it
appeared in the Japan Determination.
1. Commission Requirements for Inter-Affiliate Transactions
The Commission determined through its CFTC 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
paragraph (1) or (2) would have occurred if such principles or
standards had applied.\38\
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\38\ See Sec. 23.151.
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With respect to swaps between margin affiliates, the CFTC Margin
Rule, with one exception explained below, provides that a CSE is not
required to collect initial margin \39\ 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.\40\
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\39\ ``Initial margin'' is margin exchanged to protect against a
potential future exposure and is defined in Sec. 23.151 to mean the
collateral, as calculated in accordance with Sec. 23.154 that is
collected or posted in connection with one or more uncleared swaps.
\40\ See Sec. 23.159(a).
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In an exception to the foregoing general rule, the CFTC 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.\41\ This provision is an anti-evasion measure that
is designed to prevent the potential use of affiliates to avoid
collecting initial margin from third parties. For example, suppose an
unregistered non-U.S. affiliate of a CSE enters into a swap with a
financial end user and does not collect initial margin equivalent to
that which would have been required if such affiliate were subject to
the CFTC Margin Rule. 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. The rule would further require that the CSE collect
initial margin even if the affiliate routed the trade through one or
more other affiliates.\42\
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\41\ See Sec. 23.159(c).
\42\ See id.
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The Commission stated in the CFTC Margin Rule 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.\43\ 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.'' \44\ With an understanding that many authorities,
such as those in Europe and Japan, were 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.\45\
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\43\ See CFTC Margin Rule, 81 FR at 674.
\44\ See BCBS/IOSCO Framework, Element 6: Treatment of
transactions with affiliates.
\45\ See CFTC Margin Rule, 81 FR at 674.
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Unlike the general rule for initial margin, however, the CFTC
Margin Rule does require CSEs to exchange variation margin with margin
affiliates that are SDs, MSPs, or financial end users (as is also
required under the U.S. Prudential Regulators' rules).\46\ 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.
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\46\ See Sec. 23.159(b), Prudential Regulators' Margin Rule, 80
FR at 74909.
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[[Page 12079]]
2. Requirements for Inter-Affiliate OTC 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 ``Parent Companies of the FIBOs conducting the
transactions, Subsidiary Companies or Subsidiary Companies of the
Parent Companies (excluding the FIBOs), or an entity equivalent to
these under the laws and regulations of a foreign state.'' These terms
are defined in the Ministry of Finance of Japan's Ordinance on
Terminology, Forms, and Preparation Methods of Consolidated Financial
Statements,\47\ and the Commission recognizes that such are generally
defined in keeping with the Commission's definition of ``margin
affiliate'' for purposes of the CFTC Margin Rule, discussed above.
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\47\ See Ordinance of the Ministry of Finance No. 28 of October
30, 1976.
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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 an
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.
This capital requirement covers uncollateralized inter-affiliate
exposure. 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 alone. Rather, taking into
account capital requirements and the JFSA's supervision and inspection
programs, the 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 non-cleared OTC derivatives to the
outcomes of the Commission's corresponding margin requirements
applicable to inter-affiliate uncleared swaps and reconsidered those
outcomes in the broader context of the JFSA's prudential oversight of
risk management and capital requirements, the Commission finds that the
treatment of inter-affiliate transactions under the CFTC Margin Rule
and the treatment of those transactions under the JFSA's margin
requirements are comparable in outcome for purposes of Sec. 23.160.
The CFTC Margin Rule generally excludes transactions between CSEs
and their margin affiliates from its initial margin requirements \48\
and subjects such inter-affiliate transactions to its variation margin
requirements. The JFSA margin requirements, on the other hand, exclude
inter-affiliate transactions of JFSA Covered Entities from both initial
and variation margin requirements.
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\48\ See infra note 51.
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An uncleared swap with an affiliate presents credit risk to a CSE.
The Commission has determined that this credit risk must be managed by
marking open positions to market each day and requiring the posting or
collection of variation margin. If the affiliate were to default, the
margin provided by the affiliate would allow a CSE to continue to meet
its obligations. The JFSA on the other hand has determined that this
credit risk can be adequately managed by specific capital requirements
and more general risk management standards that require financial
holding companies and parent companies to measure, monitor, and manage
the risks caused by inter-affiliate transactions to holistically ensure
the safety and soundness of the consolidated companies of which JFSA
Covered Entities are a part. In 2013, the Commission found the JFSA's
risk management requirements for JFSA Covered Entities comparable to
the Commission's risk management requirements for SDs and MSPs under
subpart J of part 23 of the Commission's regulations.\49\ In addition,
uncollateralized credit risk from inter-affiliate swaps would be
subject to capital requirements under the Commission's proposed capital
rules for CSEs.\50\
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\49\ See Comparability Determination for Japan: Certain Entity-
Level Requirements, 78 FR 78910 (Dec. 27, 2013).
\50\ See Capital Requirements for Swap Dealers and Major Swap
Participants, 81 FR 91252, 91258 (Dec. 16, 2016).
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The Commission notes that if a CSE/JFSA Covered Entity enters into
an uncleared swap with a margin affiliate that is itself a CSE and a
U.S. person, then it will be required to exchange variation margin in
accordance with the CFTC Margin Rule because the U.S. CSE is required
to do so and substituted compliance for the inter-affiliate variation
margin requirement is not available to U.S. CSEs.\51\ In addition, the
Commission is aware of the historic volume and aggregate size of inter-
affiliate uncleared swaps of CSEs that may currently be eligible for
substituted compliance pursuant to this determination. Given the
inability to affirmatively transfer risk to U.S. margin affiliates that
are CSEs without variation margin, the historic level of relevant
inter-affiliate activity, and the capital and risk management
requirements of both the JFSA and the Commission, and considerations of
comity,\52\ the Commission has concluded that the requirements under
the laws of Japan with respect to inter-affiliate margin for uncleared
swaps are comparable to the requirements of the CFTC Margin Rule for
purposes of Sec. 23.160. The Commission intends to monitor the volume
and aggregate size of inter-affiliate swaps of CSEs that may be
eligible for substituted compliance pursuant to this determination and,
to the extent it deems prudent, may consult with the JFSA regarding the
capital and risk management treatment of the attendant risk of such
swaps.
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\51\ See Cross-Border Margin Rule, 81 FR at 34829. The
Commission notes that, subject to certain conditions, a CSE is
generally not required to collect initial margin from a margin
affiliate. See Sec. 23.159(a)(1). However, a CSE would be required
to collect initial margin from a margin affiliate that is a
financial end user where the margin affiliate is located in a
jurisdiction that the Commission has not found to be eligible for
substituted compliance with regard to the CFTC Margin Rule, and the
margin affiliate does not collect initial margin on its swaps with
unaffiliated third parties for which initial margin would be
required if the swap were subject to the CFTC Margin Rule. See Sec.
23.159(c)(2)(ii). With this Amendment, the Commission has found
Japan to be eligible for substituted compliance with regard to all
aspects of the CFTC Margin Rule, and thus, a CSE would generally not
be required to collect initial margin from a margin affiliate in
Japan that is a financial end user. See Sec. 23.159(c)(2)(iii).
\52\ It is noted that the JFSA has provided reciprocal
recognition of the CFTC Margin Rule.
[[Page 12080]]
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Issued in Washington, DC on March 26, 2019, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Amendment to Comparability Determination for Japan:
Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants
Appendix 1--Commission Voting Summary
On this matter, Chairman Giancarlo and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Chairman J. Christopher Giancarlo
Today the Commission is amending its previous comparability
determination for Japan with respect to margin requirements for
uncleared swaps published on September 15, 2016.\1\ The amendment
makes a positive determination of comparability with respect to the
scope of entities subject to margin requirements and the treatment
of inter-affiliate transactions. All other findings and
determinations contained in the original comparability determination
remain unchanged and in full force and effect.
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\1\ See Comparability Determination for Japan: Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants, 81 FR 63376 (Sep. 15, 2016), available at: https://www.govinfo.gov/content/pkg/FR-2016-09-15/pdf/2016-22045.pdf.
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When the Commission issued its rule addressing the cross-border
application of margin requirements for uncleared swaps in 2016,\2\ I
expressed my disagreement with the approach the Commission
established as overly complex and unduly narrow.\3\ 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.
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\2\ 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), available at: https://www.govinfo.gov/content/pkg/FR-2016-05-31/pdf/2016-12612.pdf.
\3\ See Statement of Commissioner J. Christopher Giancarlo on
the Comparability Determination for Japan: Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants (Sep.
8, 2016), available at: https://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement090816b.
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This overly complex and unduly narrow approach was reflected in
the original comparability determination for Japan, which left firms
subject to an impractical patchwork of U.S. and foreign regulations
for cross-border transactions. I am pleased that the Commission has
reconsidered its original finding and now finds that the remaining
Japanese margin transaction requirements are comparable in outcome
to the Commission's own requirements.
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. Today's comparability
determination is further evidence that the Commission is committed
to showing deference to foreign jurisdictions that have comparable
regulatory and supervisory regimes.
Appendix 3--Supporting Statement of Commissioner Brian Quintenz
I support the expansion of the Commission's 2016 Margin
Comparability Determination for Japan (Determination).\1\ I am
pleased that the amendments to the Determination adopted by the
Commission today apply an outcomes-based approach to substituted
compliance and recognize the discretion of Japanese financial
regulators to implement reforms consistent with the G-20 framework
in a manner suited to their local markets. Moreover, the expanded
Determination is appropriately deferential to our counterparts in
Japan, who have already found CFTC margin regulations to be
comparable to their own.
---------------------------------------------------------------------------
\1\ Comparability Determination for Japan: Margin Requirements
for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81
FR 63376 (Sept. 15, 2016).
---------------------------------------------------------------------------
In the past, overly narrow comparability determinations have
sometimes required Commission staff to provide additional no-action
relief to address relatively minor differences between regimes. For
example, after the 2016 Japan Determination was issued, swap dealers
requested relief from the requirement to post and collect variation
margin on a T+1 timeframe with certain counterparties.\2\ Instead of
the T+1 standard, these firms requested a T+3 standard, in order to
accommodate the use of Japanese Government Bonds (a very common form
of collateral in Japan), which settle in two or three days. The
relief was needed in order to allow swap dealers to continue
transacting with smaller Japanese counterparties. I am pleased that
under the comprehensive Determination issued today, further no-
action relief will not be necessary because the Determination
appropriately accounts for swap dealers' various types of
counterparties and the timing of collateral exchanges.
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\2\ CFTC Staff Letter No. 17-13, Commission Regulation 23.153:
Time-Limited No-Action Position for the Timing of the Posting and
Collection of Variation Margin from Certain Counterparties Operating
in Japan (Feb. 23, 2017), https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/17-13.pdf.
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It is also important to note that while the Determination is
deferential to the approach taken in Japan, it limits the flow of
risk back to the United States. This is because under the
Commission's Cross-Border Margin Rule, when a U.S. swap dealer
enters into an uncleared swap with a Japanese swap dealer or end-
user, it is required to collect initial margin and variation margin
must be exchanged. In the case of uncleared swaps between affiliated
U.S. and non-U.S. swap dealers, variation margin is always required.
Moreover, the Commission will continue to work closely with the
Financial Services Agency of Japan to coordinate our supervision and
oversight of regulated entities that operate on a cross-border basis
in both the United States and Japan.\3\
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\3\ Memorandum of Cooperation Related to the Supervision of
Cross-Border Covered Entities (March 10, 2014), https://www.cftc.gov/idc/groups/public/%40internationalaffairs/documents/file/cftc-jfsamoc031014.pdf.
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I would like to thank the staff of the Division of Swap Dealer
and Intermediary Oversight for their hard work in issuing today's
amended Determination. I would also like to compliment Chairman
Giancarlo for his leadership on the cross-border regulation of the
global swaps market. The Chairman has presented a vision for cross-
border regulation grounded in deference and recognition that many of
our global counterparts have implemented post-crisis reforms
comparable to our own. I strongly support this vision and believe it
is essential to maintaining a liquid, competitive global swaps
market and avoiding regulatory-driven market fragmentation.
Appendix 4--Statement of Commissioner Dan M. Berkovitz
I support today's Amendment to Comparability Determination for
Japan: Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants (``Amended Japan Determination'').
The Commission's regulations governing margin requirements for
uncleared swaps (``CFTC Margin Rules'') help mitigate risks posed by
uncleared swaps to swap dealers, major swap participants, and the
overall U.S. financial system.\1\ In this regard, the CFTC Margin
Rules--and other rules around the world requiring margin for
uncleared swaps--are a fundamental component of the regulatory
reforms adopted in the wake of the 2008 financial crisis.
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\1\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
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In 2016, the CFTC adopted its cross-border margin rule to permit
swap dealers and major swap participants located in non-U.S.
jurisdictions to comply with the CFTC's Margin Rules by meeting the
similar rules of their home jurisdiction if the Commission has
deemed those rules comparable.\2\ This framework for ``substituted
compliance'' supports the global nature of the swaps market and
conforms to the directive in the Dodd-Frank Act for the Commission
to consult and coordinate with international regulators to establish
consistent international standards for the regulation of swaps
entities and activities.\3\ The
[[Page 12081]]
substituted compliance framework helps reduce duplicative and
overlapping regulatory requirements where effective comparable
regulation exists, facilitates the ability of U.S. market
participants to compete in foreign jurisdictions, and is consistent
with the principle of international comity.
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\2\ 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).
\3\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376, at section 752 (2010).
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The CFTC's cross-border margin rule establishes an outcomes-
based approach that considers a number of factors and does not
require strict conformity with the CFTC Margin Rules. As I have said
before, a comparability determination should not be based solely on
the home country's written laws and regulations, but also consider
the country's broader system of regulation, including oversight and
enforcement. In addition, the nature of the other country's relevant
markets may be taken into account. Finally, in considering these
issues, the Commission should keep in mind the principle of comity:
the reciprocal recognition of the legislative, executive, and
judicial acts of another jurisdiction.\4\ Given all of these
factors, the analysis for each determination often is unique and can
change over time as circumstances change.
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\4\ See Restatement (Third) of The Foreign Relations Law in the
United States, section 101 (1987) (Am. Law Inst. 2019); https://www.law.cornell.edu/wex/comity.
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The Amended Japan Determination finds comparability regarding
the scope of entities subject to the margin requirements and the
treatment of margining for inter-affiliate transactions. The
Commission's original determination for Japan's margin rules, issued
on September 15, 2016, did not find comparability in these areas.
Subsequently, it appeared that the absence of a finding of
comparability regarding the scope of entities and inter-affiliate
swaps issues was causing some confusion in applying the original
determination. The CFTC staff therefore further reviewed applicable
Japanese laws and regulations and engaged heavily with the Japan
Financial Services Agency (``JFSA'') to develop a more complete
understanding of how the JFSA regulates and supervises margining for
the scope of entities that enter into swaps and inter-affiliate swap
transactions. The in-depth analysis outlined in today's Amended
Japan Determination reflects a more holistic understanding by the
Commission of the JFSA's approach to managing the risks of swap
trading for the scope of relevant entities and inter-affiliate
swaps. The analysis also notes the potential for risks from these
swap activities returning to the United States is expected to be
significantly mitigated.
For example, although the JFSA does not require variation margin
for the same scope of entities covered by the CFTC Margin Rules, the
JFSA indicated that the entities excluded tend to be smaller and
have less regular involvement in the swap markets, thereby
presenting less risk to the financial system. Furthermore, as noted
in the determination, if a Japanese entity that would otherwise be
subject to the CFTC Margin Rules, but for substituted compliance,
enters into swaps with any U.S. entity covered by the CFTC Margin
Rules, then both entities are required to exchange margin per our
rules. This requirement limits the possibility of unmargined risk
coming to the U.S. Similarly, for inter-affiliate swap treatment, a
more complete understanding of the JFSA's approach to requiring
Japanese affiliates to hold more capital when margin is not
exchanged with other affiliates, among other things, helps offset
exposures not covered when margin is not collected.
As with other jurisdictions where the legal and regulatory
structure does not mirror our own, and the substituted compliance
determinations are based on the overall outcome of the regulatory
system, subsequent monitoring may be appropriate to confirm that our
initial understanding of the regulatory structure and the expected
outcomes is accurate. Accordingly, I encourage the CFTC staff to
periodically assess the implementation of this determination to
confirm our expectations are accurate.
I thank the CFTC staff for their thorough work on this
determination and appreciate their responsiveness to our comments
and suggestions. I would also like to thank my fellow Commissioners
for their collaboration in helping us reach this positive outcome.
[FR Doc. 2019-06152 Filed 3-29-19; 8:45 am]
BILLING CODE 6351-01-P