2019-06319
Federal Register, Volume 84 Issue 64 (Wednesday, April 3, 2019)
[Federal Register Volume 84, Number 64 (Wednesday, April 3, 2019)]
[Rules and Regulations]
[Pages 12908-12929]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-06319]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Comparability Determination for Australia: Margin Requirements
for Uncleared Swaps for Swap Dealers and Major Swap Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Notification of determination.
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SUMMARY: The following is the analysis and determination of the
Commodity Futures Trading Commission (``Commission'') regarding a
request by the Australian Prudential Regulation Authority (``APRA'')
that the Commission determine that laws and regulations applicable in
Australia 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, the Commission has found the margin requirements for
uncleared swaps under the laws and regulations of Australia comparable
to those under the Commodity Exchange Act (``CEA'') and Commission
regulations.
DATES: This determination was made and issued by the Commission on
March 27, 2019.
FOR FURTHER INFORMATION CONTACT: Matthew Kulkin, Director, 202-418-
5213, [email protected]; Frank Fisanich, Deputy Director, 202-418-5949,
[email protected]; or Lauren Bennett, Special Counsel, 202-418-5290,
[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 U.S. Prudential Regulator
(collectively, ``Covered Swap Entities'' or ``CSEs'').\2\ The
Commission published final margin requirements for such CSEs in January
2016 (``CFTC 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
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) (``U.S. Prudential Regulators'
Margin Rule'').
\3\ 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
through 23.159, 23.161. The Commission's regulations are found in
chapter I of title 17 of the Code of Federal Regulations, 17 CFR
parts 1 through 199.
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[[Page 12909]]
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 (``CFTC Cross-Border Margin Rule'').\4\ The CFTC
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 outlines a framework for
assessing whether a foreign jurisdiction's margin requirements are
comparable to the CFTC Margin Rule (``comparability determinations'').
The Commission promulgated the CFTC Cross-Border Margin Rule after
close consultation with the U.S. 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 CFTC Cross-Border
Margin Rule, which became effective August 1, 2016, is codified in
part 23 of the Commission's regulations. See Sec. 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 U.S. 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 request for comment, 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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The Commission considered APRA's prudential standards and public
consultation papers, in addition to supplemental materials provided by
APRA, in making this determination. The Commission's analysis and
comparability determination for Australia regarding the CFTC Margin
Rule is detailed below.
II. CFTC Cross-Border Margin Rule
A. Regulatory Objective of Margin Requirements
The regulatory objective of the CFTC 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 utilize 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 CFTC Margin Rule, 81 FR at 689.
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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
45300-01 (referencing the Restatement (Third) of Foreign Relations
Law of the United States).
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B. Substituted Compliance
To address these concerns, the CFTC Cross-Border Margin Rule
provides that, subject to certain findings and conditions, a CSE is
permitted to satisfy the requirements of the CFTC 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 Working Group on Margin
Requirements 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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The CFTC Cross-Border Margin Rule requires that applicants for a
comparability determination provide copies of the relevant foreign
jurisdiction's margin requirements \10\ and descriptions of their
objectives,\11\ how they differ from the BCBS/IOSCO Framework,\12\ and
how they address the elements of the Commission's margin
requirements.\13\ The applicant must
[[Page 12910]]
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.\14\
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\10\ See Sec. 23.160(c)(2)(v).
\11\ See Sec. 23.160(c)(2)(i).
\12\ See Sec. 23.160(c)(2)(iii). See also Sec. 23.160(a)(3)
(defining ``international standards'' as based on the BCBS-ISOCO
Framework).
\13\ See Sec. 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.
\14\ See id.
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C. Standard of Review for Comparability Determinations
The CFTC 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;
\15\ whether the relevant foreign jurisdiction's margin requirements
achieve comparable outcomes to the Commission's corresponding margin
requirements; \16\ and the ability of the relevant regulatory authority
or authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's margin requirements.\17\
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\15\ See Sec. 23.160(c)(3)(i).
\16\ See Sec. 23.160(c)(3)(ii). As discussed above, the
Commission's CFTC 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 a minimum in order
to be deemed comparable to the Commission's corresponding margin
requirements.
\17\ See Sec. 23.160(c)(3)(iii). See also Sec.
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 outcomes-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 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.\18\ Accordingly, where
relevant to the Commission's comparability analysis, the BCBS/IOSCO
Framework is discussed to explain certain internationally agreed upon
concepts. In addition, considerations of comity are particularly
relevant to the substituted compliance determination under this type of
international framework.\19\
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\18\ The CFTC 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 CFTC 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 CFTC Margin Rule, 81 FR at 644. In addition, the
definition of uncleared swap was amended to not include swaps
cleared by derivatives clearing organizations 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.'').
\19\ It is noted that APRA has provided reciprocal recognition
of the CFTC Margin Rule.
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The CFTC Cross-Border Margin Rule provided a detailed discussion
regarding the facts and circumstances under which substituted
compliance for the requirements under the CFTC 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 CFTC Cross-Border Margin
Rule with respect to the CSE's particular status and circumstances.
D. Conditions to Comparability Determinations
The CFTC Cross-Border Margin Rule provides that the Commission may
impose terms and conditions it deems appropriate in issuing a
comparability determination.\20\ Any specific terms and conditions with
respect to margin requirements are discussed in the Commission's
determinations detailed below.
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\20\ See Sec. 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.\21\
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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\21\ See CFTC Cross-Border Margin Rule, 81 FR at 34839.
\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
U.S. Department of Justice, or any applicable U.S. Prudential
Regulator. See Sec. Sec. 23.203 and 23.606. A CSE that is eligible
to avail itself of substituted compliance pursuant to the
Commission's Comparability Determination for Australia: Certain
Entity-Level Requirements must comply with the Commission's
requirements to: (i) Make records required by Sec. 23.201 open to
inspection by any representative of the Commission, the United
States Department of Justice, or any applicable U.S. Prudential
Regulator in accordance with Sec. 23.203(b)(2); and (ii) produce
information to Commission staff and the staff of an applicable U.S.
Prudential Regulator in accordance with Sec. 23.606(a)(2).
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Finally, the Commission considers an application to be a
representation by the applicant that the laws and regulations submitted
are finalized,\23\ 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 \24\ of CSEs
\25\ in the relevant jurisdictions.\26\
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\23\ The Commission notes that finalized rules of the foreign
jurisdiction must be in full force and effect before a CSE may rely
on this comparability determination for purposes of substituted
compliance.
\24\ ``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.
\25\ 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.
\26\ The Commission has provided APRA with opportunities to
review and comment on the Commission's description of APRA's laws
and regulations on which this comparability determination is based.
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.
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[[Page 12911]]
III. Margin Requirements for Swaps Activities in Australia
As represented to the Commission by the applicant, margin
requirements for swap activities in Australia are governed by APRA's
Prudential Standard CPS 226: Margining and risk mitigation for non-
centrally cleared derivatives (including the Explanatory Statement and
Regulation Impact Statement) (``CPS 226''), covering: (i) Authorized
deposit-taking institutions (``ADIs,'' including foreign ADIs and
authorized banking non-operating holding companies); (ii) general
insurers (including foreign general insurers operating as foreign
branches in Australia, authorized insurance non-operating holding
companies and parent entities of Level 2 \27\ insurance groups); (iii)
life companies (including friendly societies, eligible foreign life
insurance companies, and registered life non-operating holding
companies); and (iv) registrable superannuation entities (collectively,
``APRA covered entities'').\28\
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\27\ APRA has represented that a Level 2 group is APRA's
broadest regulatory consolidation for capital adequacy purposes for
banking and general insurance entities, and includes all
subsidiaries of the head of the group, including those incorporated
outside Australia, except for non-consolidated subsidiaries.
\28\ See CPS 226, Paragraphs 2 and 3. An APRA covered entity
that is a parent of a Level 2 group must ensure that certain
affiliates comply with the requirements of APRA's margin rules as if
those affiliates were themselves APRA covered entities. See CPS 226,
Paragraph 4.
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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 CFTC Margin Rule and a description of such
requirements. Immediately following a description of the requirement(s)
of the CFTC 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 CFTC 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 CFTC 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 utilize
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.\29\
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\29\ See CFTC Cross-Border Margin Rule, 81 FR at 34819.
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2. APRA Statement of Regulatory Objectives
The regulatory objectives of CPS 226 are to improve prudential
safety, reduce systemic risk, and promote central clearing.\30\
Further, APRA's margin regime incorporates additional risk mitigation
requirements in relation to non-centrally cleared derivatives that are
intended to increase the transparency of bilateral positions between
counterparties, promote legal certainty over the terms of non-centrally
cleared derivative transactions, and facilitate the timely resolution
of disputes.\31\ To ensure that these objectives are achieved, the laws
and regulations of Australia prescribe that financial institutions
shall establish an appropriate framework for margin requirements, in
line with the BCBS/IOSCO Framework.
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\30\ See CPS 226 Explanatory Statement, Page 4.
\31\ See APRA Discussion Paper, Margining and risk mitigation
for non-centrally cleared derivatives (``APRA Discussion Paper''),
Page 8, available at https://www.apra.gov.au/margining-and-risk-mitigation-non-centrally-cleared-derivatives.
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B. Products Subject to Margin Requirements
The Commission's CFTC Margin Rule applies only to uncleared swaps.
Swaps are defined in section 1a(47) of the CEA \32\ and Commission
regulations.\33\ ``Uncleared swap'' is defined for purposes of the CFTC
Margin Rule in Sec. 23.151 as 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.\34\
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\32\ 7 U.S.C. 1a(47).
\33\ See, e.g., Sec. 1.3, Swap.
\34\ Section 23.151.
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In Australia, APRA's margin rules apply to ``non-centrally cleared
derivatives,'' which are defined as derivatives \35\ that are not
cleared by a central counterparty.\36\ APRA's margin rules do not apply
to physically-settled foreign exchange forwards and swaps.\37\ 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 APRA's definitions
of ``derivative,'' and ``non-centrally cleared derivative,'' the
Commission believes that such definitions largely cover the same
products and instruments.
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\35\ For the purposes of CPS 226, a ``derivative'' is defined as
(i) a derivative within the meaning of Chapter 7 of the Corporations
Act of 2001; or (ii) an arrangement that is a forward, swap, or
option, or any combination of those things, in relation to one or
more commodities. See CPS 226, Paragraph 9(g).
\36\ See CPS 226, Paragraph 9(r). Non-centrally cleared
derivatives do not include exchange traded derivatives, securities
financing transactions, or indirectly cleared derivatives that are
intermediated through a clearing member on behalf of a non-member
client where the client is subject to the margin requirements of the
central counterparty, or where the client provides margin consistent
with the central counterparty's margin requirements. Id.
\37\ See CPS 226, Paragraphs 12 and 18. Pursuant to a
determination by the Secretary of the Treasury, foreign exchange
swaps and foreign exchange forwards are exempt from the definition
of the term ``swap'' under the CEA. See Determination of Foreign
Exchange Swaps and Foreign Exchange Forwards Under the Commodity
Exchange Act, 77 FR 69694 (Nov. 20, 2012). Accordingly, such
transactions are not subject to the CFTC Margin Rule. See 81 FR at
638. Notwithstanding that foreign exchange swaps and foreign
exchange forwards are exempt from the definition of swap, CSEs
remain subject to the Commission's requirements for swap transaction
reporting and business conduct standards with respect to such
transactions.
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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-centrally cleared derivative as defined under the
laws of Australia. In such cases, the CFTC Margin Rule would apply to
the transaction but APRA's margin rules would not apply and thus,
substituted compliance would not be available. The CSE could not choose
to comply with APRA's margin rules in place of the CFTC Margin Rule.
[[Page 12912]]
Likewise, if a transaction is a non-centrally cleared derivative as
defined under the laws of Australia but not an uncleared swap subject
to the CFTC Margin Rule, a CSE could not choose to comply with the CFTC
Margin Rule pursuant to this determination. CSEs are solely responsible
for determining whether a particular transaction is both an uncleared
swap and a non-centrally cleared derivative before relying on
substituted compliance under the comparability determinations set forth
below.
C. Entities Subject to Margin Requirements
The CFTC Margin Rule and CFTC 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.\38\ Thus, only such CSEs may
rely on the determinations herein for substituted compliance, while SDs
and MSPs 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.
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\38\ See description of the U.S. Prudential Regulators in supra
note 2.
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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.\39\ Such definition provides that a ``covered
counterparty'' is a counterparty to a swap with a CSE that is either a
financial end user \40\ that exceeds a certain threshold of swap
activity (``material swaps exposure'') \41\ or another SD or MSP.\42\
On the other hand, the variation margin obligations of CSEs under the
CFTC Margin Rule apply more broadly. Such obligations apply to CSEs
transacting with SDs, MSPs, and all financial end users, not just those
with material swaps exposure.\43\ Thus, importantly for comparison with
the non-centrally cleared derivative margin requirements of Australia,
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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\39\ See Sec. 23.152.
\40\ See definition of ``Financial end user'' in Sec. 23.150.
In general, the definition covers entities involved in regulated
financial activity, including banks, brokers, intermediaries,
advisers, asset managers, collective investment vehicles, and
insurers.
\41\ 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 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 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.
\42\ See definition of ``swap entity'' in Sec. 23.150.
\43\ See Sec. 23.153.
---------------------------------------------------------------------------
All APRA covered entities are subject to the margin requirements in
CPS 226. Similar to the CFTC Margin Rule's exclusion of non-CSE
counterparties that do not meet the definition of ``financial end
user,'' APRA's margin rules state that APRA covered entities are only
required to exchange margin with certain types of financial
institutions \44\ (collectively, ``APRA covered counterparties''). Also
similar to the CFTC Margin Rule's material swaps exposure threshold for
application of initial margin requirements, APRA's margin rules require
initial margin to be exchanged only when an APRA covered entity and its
APRA covered counterparty each belong to a margining group \45\ whose
aggregate month-end average notional amount of non-centrally cleared
derivatives for a pre-defined three-month reference period exceeds a
``qualifying level'' of AUD 12 billion, subject to a phase-in period
(``APRA Initial Margin Threshold'').\46\ The implementation timetable
for APRA's initial margin requirements is as follows: \47\
---------------------------------------------------------------------------
\44\ A ``financial institution'' includes, but is not limited to
any institution engaged substantively in one or more of the
following activities: Banking; leasing; issuing credit cards;
portfolio management; management of securitization schemes; equity
and/or debt securities, futures and commodity trading and broking;
custodial and safekeeping services; insurance and similar activities
that are ancillary to the conduct of these activities. See CPS 226,
Paragraph 9(i). Further, an APRA covered counterparty excludes: (i)
Sovereigns, central banks, multilateral development banks, public
sector entities and the Bank for International Settlements; (ii) a
covered bond special purpose vehicle that enters into derivative
transactions for the sole purpose of hedging; and (iii) a
securitization special purpose vehicle in a traditional
securitization that enters into derivative transactions for the sole
purpose of hedging. See CPS 226, Paragraph 9(f).
\45\ A ``margining group'' is comprised of one or more entities
within the meaning of Australian Accounting Standard AASB 10
Consolidated Financial Statements (``AASB 10''). AASB 10 establishes
principles for the presentation and preparation of consolidated
financial statements when an entity controls one or more other
entities, and defines a group as a parent and its subsidiaries,
where a subsidiary is an entity that is controlled by another
entity. See CPS 226, Paragraph 9(n); Australian Accounting Standard
AASB 10 Consolidated Financial Statements, Appendix A. An APRA
covered entity may elect to apply equivalent foreign accounting
standards that apply to the consolidated financial statements of the
APRA covered entity or APRA covered counterparty, as relevant. See
CPS 226, Paragraph 9(n).
\46\ See CPS 226, Paragraph 17.
\47\ See CPS 226, Paragraph 18.
------------------------------------------------------------------------
Reference period Qualifying level Margining period
------------------------------------------------------------------------
March, April and May 2016..... AUD 4.5 trillion. 1 March 2017 to 31
August 2017.
March, April and May 2017..... AUD 3.375 1 September 2017 to
trillion. 31 August 2018.
March, April and May 2018..... AUD 2.25 trillion 1 September 2018 to
31 August 2019.
March, April and May 2019..... AUD 1.125 1 September 2019 to
trillion. 31 August 2020.
From March 2020, March, April AUD 12 billion... 1 September of the
and May of each subsequent year referred to in
calendar year. the first column of
this row to 31
August of the next
calendar year.
------------------------------------------------------------------------
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, APRA's margin rules require variation margin to be exchanged
only when an APRA covered entity and its APRA covered counterparty each
belong to a margining group whose aggregate month-end average notional
amount of non-
[[Page 12913]]
centrally cleared derivatives for a pre-defined three-month reference
period exceeds a ``qualifying level'' of AUD 3 billion (``APRA
Variation Margin Threshold'').\48\ The implementation timetable for
APRA's variation margin requirements is as follows: \49\
---------------------------------------------------------------------------
\48\ See CPS 226, Paragraph 11.
\49\ See CPS 226, Paragraph 12.
------------------------------------------------------------------------
Reference period Qualifying level Margining period
------------------------------------------------------------------------
March, April and May 2016..... AUD 3 billion.... 1 March 2017 to 31
August 2017.
March, April and May 2017..... AUD 3 billion.... 1 September 2017 to
31 August 2018.
March, April and May of each AUD 3 billion.... 1 September of the
subsequent calendar year. year referred to in
the first column of
this row to 31
August of the next
calendar year.
------------------------------------------------------------------------
Accordingly, (i) when either the APRA covered entity or its APRA
covered counterparty belong to a margining group whose non-centrally
cleared derivatives activities fall below the APRA Initial Margin
Threshold, an APRA covered entity is not required to comply with the
initial margin requirements of CPS 226; (ii) when either the APRA
covered entity or its APRA covered counterparty belong to a margining
group whose non-centrally cleared derivatives activities fall below the
APRA Variation Margin Threshold, an APRA covered entity is not required
to comply with the variation margin requirements of CPS 226; and (iii)
when the APRA covered entity transacts with a non-APRA covered
counterparty, the APRA covered entity is not required to comply with
either the initial or variation margin requirements of CPS 226
(transactions described in (ii) and (iii) are hereinafter referred to
as ``Supervised Transactions'').
Notwithstanding APRA's margin thresholds, entities that are subject
to both the CFTC Margin Rule and CPS 226 would also be required to
comply with APRA's risk management framework, which requires such
entities to have systems in place for identifying, measuring,
evaluating, monitoring, reporting, and controlling or mitigating
material risks (``CPS 220'').\50\ Such risks include: (i) Credit risk,
(ii) market and investment risk; (iii) liquidity risk; (iv) insurance
risk; (v) operational risk; (vi) risk arising from strategic objectives
and business plans; and (vii) any other risk that, singly or in
combination with different risks, may have a material impact on the
institution.\51\
---------------------------------------------------------------------------
\50\ See APRA Prudential Standard CPS 220--Risk Management
(``CPS 220''), available at https://www.apra.gov.au/sites/default/files/Prudential-Standard-CPS-220-Risk-Management-%28July-2017%29.pdf.
\51\ See CPS 220, Paragraph 26.
---------------------------------------------------------------------------
APRA represented that, given the highly concentrated nature of
Australia's non-centrally cleared derivatives market, the exclusion of
small market participants from APRA's margin requirements would have a
minimal impact on the reduction of systemic risk.\52\ APRA further
stated that the APRA Variation Margin Threshold was intended to limit
the competitive disadvantage to small firms faced with the considerable
costs associated with compliance of the full extent of the margin
requirements in CPS 226, and to avoid the creation of a disincentive
for the use of non-centrally cleared derivatives for hedging
purposes.\53\
---------------------------------------------------------------------------
\52\ See APRA Response to Submissions, Margining and risk
mitigation for non-centrally cleared derivatives (``APRA Response to
Submissions''), Page 22, available at https://www.apra.gov.au/margining-and-risk-mitigation-non-centrally-cleared-derivatives.
Further, APRA estimated that although the APRA Variation Margin
Threshold would exclude approximately half of all market
participants from the requirement to exchange variation margin, over
80% of all transactions in the market would nonetheless be subject
to variation margin requirements. See APRA Regulation Impact
Statement, Page 13.
\53\ See APRA Discussion Paper, Page 19.
---------------------------------------------------------------------------
Despite the definitional differences and differences in activity
thresholds with respect to the scope of application of the CFTC Margin
Rule and APRA's margin requirements, the Commission notes that in
transactions between counterparties with the highest levels of activity
in uncleared swaps (and thus presumably present the most risk), both
the CFTC Margin Rule and APRA's margin requirements require both
initial and variation margin. CSEs that exceed the APRA Initial Margin
Threshold transacting with APRA covered counterparties that also exceed
the APRA Initial Margin Threshold would be required to collect and post
initial margin and variation margin in amounts and with frequencies
that are comparable to the same requirements under the CFTC Margin Rule
(as discussed elsewhere in this determination). Although the ``material
swaps exposure'' threshold under the CFTC Margin Rule (denominated in
USD) is currently lower than the APRA Initial Margin Threshold
(denominated in AUD), the Commission recognizes that they are of
approximately the same magnitude and further differences are largely
attributable to fluctuating AUD/USD exchange rates. Given that the
initial margin thresholds serve the same purpose and are of
approximately the same magnitude, the Commission has concluded that the
application of the APRA Initial Margin Threshold is comparable in
purpose and effect to the CFTC ``material swaps exposure'' threshold.
The Commission also notes that if a CSE/APRA 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.\54\ This requirement significantly limits the extent to
which differences between the APRA Initial Margin Threshold and the
CFTC ``material swaps exposure'' threshold could negatively impact
systemic risk in the United States.\55\
---------------------------------------------------------------------------
\54\ See Cross-Border Margin Rule, 81 FR at 34829.
\55\ This requirement also mitigates anti-evasion concerns.
---------------------------------------------------------------------------
With respect to Supervised Transactions that would be subject to
the CFTC Margin Rule but not subject to certain requirements of CPS
226, the Commission recognizes that APRA has determined that such
transactions generally involve small counterparties that do not present
risk that warrants the considerable costs associated with compliance
with the full scope of APRA's margin rules. The Commission also
recognizes that Supervised Transactions will remain subject to APRA's
risk management requirements under CPS 220.
The Commission also notes that application of the CFTC Margin Rule
to CSEs otherwise eligible for substituted compliance that are seeking
to enter Supervised Transactions in Australia that are subject to
APRA's risk management requirements under CPS 220 would place those
CSEs at a competitive disadvantage relative to other firms subject only
to the risk management requirements under CPS 220.
[[Page 12914]]
Accordingly, the Commission finds that the scope of entities
subject to the non-centrally cleared derivatives requirements under the
laws of Australia is comparable in purpose and outcome to the scope of
entities subject to the CFTC Margin Rule for purposes of Sec. 23.160.
A CSE that is an APRA covered entity and eligible for substituted
compliance under Sec. 23.160 may therefore classify its counterparties
in accordance with CPS 226 with respect to determining whether initial
or variation margin must be exchanged. For Supervised Transactions,
where certain margin requirements would apply under the CFTC Margin
Rule, but not under CPS 226 (e.g., the requirement to exchange
variation margin), a CSE that is an APRA covered entity and eligible
for substituted compliance under Sec. 23.160 may comply with the
relevant aspects of the CFTC Margin Rule by complying with the risk
management requirements of CPS 220.
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.\56\
---------------------------------------------------------------------------
\56\ See BCBS/IOSCO Framework, Element 6: Treatment of
transactions with affiliates.
---------------------------------------------------------------------------
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: (i) 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; (ii) both companies are consolidated with a
third company on a financial statement prepared in accordance with such
principles or standards; or (iii) for a company that is not subject to
such principles or standards, if consolidation as described in (i) or
(ii) above would have occurred if such principles or standards had
applied.\57\
---------------------------------------------------------------------------
\57\ See Sec. 23.151.
---------------------------------------------------------------------------
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 \58\ 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.\59\
---------------------------------------------------------------------------
\58\ ``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.''
\59\ See Sec. 23.159(a).
---------------------------------------------------------------------------
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.\60\ 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.\61\
---------------------------------------------------------------------------
\60\ See Sec. 23.159(c).
\61\ See id.
---------------------------------------------------------------------------
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.\62\ Such Framework, for example, states that although the
exchange of initial and variation margin by affiliated parties vary,
such exchange ``is not customary'' and that initial margin in
particular ``would likely create additional liquidity demands.'' \63\
Accordingly, the Framework states that ``[s]uch transactions may not
necessarily be suited to harmonization.'' \64\ 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 those other
jurisdictions where such margin was not required.\65\
---------------------------------------------------------------------------
\62\ See CFTC Margin Rule, 81 FR at 674.
\63\ See BCBS/IOSCO Framework, Element 6: Treatment of
transactions with affiliates.
\64\ Id.
\65\ See CFTC Margin Rule, 81 FR at 674.
---------------------------------------------------------------------------
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).\66\ 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.
---------------------------------------------------------------------------
\66\ See Sec. 23.159(b), U.S. Prudential Regulators' Margin
Rule, 80 FR at 74909.
---------------------------------------------------------------------------
2. Requirements for Inter-Affiliate Derivatives Under the Laws of
Australia
Pursuant to APRA's margin rules, an APRA covered entity is not
required to exchange initial margin with an APRA covered counterparty
that is also a member of the APRA covered entity's margining group.\67\
APRA's definition of ``margining group'' is similar to the Commission's
definition of ``margin affiliates'' for purposes of the CFTC Margin
Rule.\68\ Further, an APRA covered entity that is a foreign ADI, a
foreign general insurer operating as a foreign branch in Australia, or
an eligible foreign life insurance company is not required to exchange
variation margin with an APRA covered counterparty that is a member of
its margining group.\69\ An APRA covered entity is also not required to
exchange variation margin with an APRA covered counterparty that is a
member of its Level 2 group.\70\
---------------------------------------------------------------------------
\67\ See CPS 226, Paragraph 57.
\68\ See definition of ``margin affiliate'' in Sec. 23.150.
\69\ See CPS 226, Paragraph 58.
\70\ See CPS 226, Paragraph 59. A Level 2 group is APRA's
broadest regulatory consolidation for capital adequacy purposes for
banking and general insurance entities, and includes all
subsidiaries of the head of the group, including those incorporated
outside Australia, except for non-consolidated subsidiaries. APRA
has represented that, with respect to banking groups, the following
types of affiliates would be excluded from Level 2 consolidation:
Insurance; funds management; certain securitization special purpose
vehicles; and non-financial subsidiaries.
---------------------------------------------------------------------------
In addition, APRA has the discretionary authority to impose initial
and/or variation margin requirements between an APRA covered entity and
[[Page 12915]]
any of its affiliates where APRA deems appropriate to do so, in light
of regulatory arbitrage and contagion risks.\71\ APRA stated that it
would consider ``the impact on prudential safety, financial stability,
procyclicality, competition, and other factors'' in exercising this
discretionary authority.\72\
---------------------------------------------------------------------------
\71\ See CPS 226, Paragraph 61; see also APRA Response to
Submissions, Page 14.
\72\ See APRA Response to Submissions, Page 14.
---------------------------------------------------------------------------
APRA has observed that entities often perform risk management
decisions on a consolidated group basis, and frequently use inter-
affiliate derivatives for hedging purposes.\73\ Further, APRA stated
that the application of consolidated capital requirements to Level 2
groups allows APRA to maintain oversight and confidence that the Level
2 capital required adequately reflects the risk undertaken by entities
within the same Level 2 group.\74\ Accordingly, APRA limited its inter-
affiliate variation margin requirements to those affiliates that are
not part of the same Level 2 capital consolidation group. APRA stated
that its application of inter-affiliate variation margin requirements
is intended to minimize liquidity and operational burdens while also
reducing the risk of contagion to an APRA-regulated institution.\75\
---------------------------------------------------------------------------
\73\ See APRA Discussion Paper, Page 15.
\74\ See id.
\75\ See id.
---------------------------------------------------------------------------
3. Commission Determination
Having compared the outcomes of APRA's margin requirements
applicable to inter-affiliate non-centrally cleared derivatives to the
outcomes of the Commission's corresponding margin requirements
applicable to inter-affiliate uncleared swaps, and considered those
outcomes in the broader context of APRA'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 APRA's margin
requirements are comparable in outcome.
The CFTC and APRA both generally exclude inter-affiliate
transactions from their respective initial margin requirements.\76\
However, the scope of application of APRA's variation margin
requirements for inter-affiliate transactions is narrower than that
under the CFTC Margin Rule. Specifically, the CFTC Margin Rule requires
the exchange of variation margin between all margin affiliates, while
APRA only requires the exchange of variation margin between affiliates
that are not part of the same Level 2 capital consolidation group.
---------------------------------------------------------------------------
\76\ The CFTC Margin Rule only requires CSEs to collect initial
margin from non-U.S. affiliates that are not subject to comparable
initial margin collection requirements on their own outward facing
swaps with third parties.
---------------------------------------------------------------------------
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. APRA, on the other hand, has determined that this
credit risk can be adequately managed for Level 2 affiliates with
specific capital requirements and the more general risk management
standards that require APRA covered entities to establish and implement
policies and procedures for risk mitigation standards for non-centrally
cleared derivatives transactions with all of their counterparties.\77\
In 2013, the Commission found the risk management requirements for APRA
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.\78\ In addition, uncollateralized credit risk
from inter-affiliate swaps would be subject to capital requirements
under the Commission's proposed capital rules.\79\
---------------------------------------------------------------------------
\77\ See CPS 226, Paragraph 71. In this regard, APRA's position
is similar to a 2016 statement of then-CFTC Commissioner Christopher
Giancarlo regarding inter-affiliate swaps, ``[I]nter-affiliate swaps
provide an important risk management role within corporate groups.
They enable use of a single conduit on behalf of multiple affiliates
to net affiliates' trades, which reduces the overall risk of the
corporate group and the number of outward-facing swaps into which
the affiliates might otherwise enter. This, in turn, reduces
operational, market, counterparty credit and settlement risk. Rather
than increasing risk, inter-affiliate swaps allow entities within a
corporate group to transfer risk to the group entity best positioned
to manage it.'' See CFTC Margin Rule, 81 FR at 707.
\78\ See Notice of Comparability Determination for Certain
Requirements under Australian Regulation, 78 FR 78864, 78870 (Dec.
27, 2013). In that determination, the Commission noted that CPS 220,
which was in draft form at the time, would impose additional
compliance requirements on ADIs.
\79\ See Capital Requirements for Swap Dealers and Major Swap
Participants, 81 FR 91252, 91258 (Dec. 16, 2016). Further, many CSEs
are part of bank holding companies that are subject to consolidated
oversight by the U.S. Prudential Regulators.
---------------------------------------------------------------------------
The Commission notes that if a CSE/APRA 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.\80\ 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 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 APRA and the Commission, the Commission has concluded that the
outcome resulting from compliance with APRA's capital and risk
management requirements is comparable in outcome to compliance with the
CFTC Margin Rule with respect to uncleared swaps with Level 2
affiliates. Accordingly, the Commission finds that the requirements
under the laws of Australia with respect to inter-affiliate margin for
non-centrally cleared derivatives are comparable in outcome 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 APRA regarding the capital and risk management treatment
of the attendant risk of such swaps.
---------------------------------------------------------------------------
\80\ 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 Determination, the Commission has found
Australia 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
Australia that is a financial end user. See Sec. 23.159(c)(2)(iii).
---------------------------------------------------------------------------
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
[[Page 12916]]
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 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 \81\ 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:
---------------------------------------------------------------------------
\81\ 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
[[Page 12917]]
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 CFTC
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).\82\
---------------------------------------------------------------------------
\82\ See CFTC 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.\83\
---------------------------------------------------------------------------
\83\ See Sec. 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.\84\
---------------------------------------------------------------------------
\84\ See Sec. 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.\85\
---------------------------------------------------------------------------
\85\ See Sec. 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.\86\
---------------------------------------------------------------------------
\86\ See Sec. 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.\87\
---------------------------------------------------------------------------
\87\ See Sec. 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.\88\
---------------------------------------------------------------------------
\88\ 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.\89\
---------------------------------------------------------------------------
\89\ 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 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.\90\
---------------------------------------------------------------------------
\90\ See Sec. 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)(1) \91\
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.\92\
---------------------------------------------------------------------------
\91\ The standardized margin rates provided in Sec.
23.154(c)(1) are, in all material respects, the same as those
provided under the BCBS/IOSCO Framework. See supra note 81.
\92\ See Sec. 23.154(c).
---------------------------------------------------------------------------
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).\93\
---------------------------------------------------------------------------
\93\ See Sec. 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 CFTC
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.\94\
---------------------------------------------------------------------------
\94\ See Sec. 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.\95\
---------------------------------------------------------------------------
\95\ 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.\96\
---------------------------------------------------------------------------
\96\ See Sec. 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).\97\
---------------------------------------------------------------------------
\97\ See Sec. 23.153(e)(2)(i).
---------------------------------------------------------------------------
3. APRA Requirements for Calculation of Initial Margin
In keeping with the BCBS/IOSCO Framework described above, with
respect to the calculation of initial margin, APRA's margin rule
generally provides that:
APRA covered entities must post and collect initial margin
with an APRA covered counterparty to cover the potential future
exposure that could arise from future changes in the market value of a
non-centrally cleared derivative over the close-out period in the event
of a counterparty default.\98\
---------------------------------------------------------------------------
\98\ See CPS 226, Paragraphs 17 and 9(k). The standardized
margin rates provided in CPS 226 are, in all material respects, the
same as those provided under the BCBS/IOSCO Framework. See supra
note 81.
---------------------------------------------------------------------------
The required amount of initial margin posted and collected
must be calculated by either a model approach approved by APRA or the
standardized schedule set out in APRA's margin rules.\99\
---------------------------------------------------------------------------
\99\ See CPS 226, Paragraph 30.
---------------------------------------------------------------------------
APRA may, upon the request of an APRA covered entity,
approve the entity to calculate initial margin using a schedule already
in use for regulatory capital purposes prior to the application of
APRA's margin rules, provided that such a schedule is at least as
conservative as outlined in APRA's margin rules.\100\
---------------------------------------------------------------------------
\100\ See CPS 226, Attachment A, Paragraph 2.
---------------------------------------------------------------------------
When using the standardized schedule for initial margin,
APRA covered entities must calculate the sum of the net standardized
initial margin
[[Page 12918]]
amount separately for each netting agreement.\101\
---------------------------------------------------------------------------
\101\ See CPS 226, Attachment A, Paragraph 1. For each netting
agreement, the net standardized initial margin amount = 0.4 x gross
standardized initial margin amount + 0.6 x net-to-gross ratio of the
net current credit exposure of all transactions included in a
netting agreement to the gross current credit exposure of the same
transactions. See CPS 226, Attachment A, Paragraph 3(a).
---------------------------------------------------------------------------
APRA covered entities are not required to collect initial
margin for non-centrally cleared derivatives for which there is no
counterparty risk; accordingly, such derivatives may be excluded from
the initial margin calculation under both a model approach and the
standardized schedule.\102\
---------------------------------------------------------------------------
\102\ See CPS 226, Paragraph 31.
---------------------------------------------------------------------------
The calculation of initial margin for cross-currency swaps
differs depending on whether a model approach or the standardized
schedule is adopted:\103\
---------------------------------------------------------------------------
\103\ See CPS 226, Paragraph 32.
---------------------------------------------------------------------------
[ssquf] If a model approach is adopted, then the model does not
need to incorporate the risk associated with the fixed physically-
settled FX transactions associated with the exchange of principal. All
other risks of the cross-currency swap must be considered in the
calculation.
[ssquf] If the standardized schedule is adopted, then the initial
margin only needs to be calculated with reference to the relevant row
in the interest rates section of APRA's standardized schedule.
The initial margin calculated by the model approach must
be sufficiently conservative even during periods of low market
volatility. Calculation of the initial margin amount must be consistent
with at least a one-tailed 99% confidence interval over a 10-day time
horizon, based on historical data that includes a period of significant
financial stress and does not exceed an historical period of five
years. The historical data must be equally weighted for calibration
purposes.\104\
---------------------------------------------------------------------------
\104\ See CPS 226, Paragraph 34.
---------------------------------------------------------------------------
The period of financial stress used for calibration must
be identified and applied separately for each asset class.\105\
---------------------------------------------------------------------------
\105\ See CPS 226, Paragraph 35.
---------------------------------------------------------------------------
Transactions that are not subject to the same legally
enforceable netting agreement must not be considered in the same
initial margin model calculation.\106\
---------------------------------------------------------------------------
\106\ See CPS 226, Paragraph 36.
---------------------------------------------------------------------------
A model may allow for diversification, hedging and risk
offsets within an asset class provided these transactions are covered
by the same legally enforceable netting agreement. Any such allowance
requires approval by APRA as part of an initial margin model
approval.\107\
---------------------------------------------------------------------------
\107\ See CPS 226, Paragraph 37.
---------------------------------------------------------------------------
Initial margin calculations by a model for derivatives in
distinct asset classes must be performed without regard to derivatives
in other asset classes. That is, initial margin amounts calculated for
each asset class must not account for diversification benefits across
asset class and must be summed to calculate the initial margin amount
for a netting agreement.\108\
---------------------------------------------------------------------------
\108\ See CPS 226, Paragraph 38.
---------------------------------------------------------------------------
4. APRA Requirements for Calculation of Variation Margin
In keeping with the BCBS/IOSCO Framework described above, with
respect to the calculation of variation margin, APRA's margin rule
generally provides that:
APRA covered entities must exchange variation margin with
APRA covered counterparties to reflect the current mark-to-market
exposure resulting from changes in the market value of a non-centrally
cleared derivative.\109\
---------------------------------------------------------------------------
\109\ See CPS 226, Paragraphs 9(ab), 11. The exchange of
variation margin is executed pursuant to the implementation table
referenced in section IV(C) supra.
---------------------------------------------------------------------------
Transactions that are not subject to the same legally
enforceable netting agreement must not be considered in the same
variation margin calculation.\110\
---------------------------------------------------------------------------
\110\ See CPS 226, Paragraph 16.
---------------------------------------------------------------------------
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 APRA's margin
rules would be similar to those calculated under the methodologies
required under the CFTC Margin Rule. Specifically, under the CFTC
Margin Rule and APRA'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 are similar;
Initial margin models must be approved by a regulator;
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 prescribed standardized margin rates are essentially
identical.
Accordingly, the Commission finds that the methodologies for
calculating the amounts of initial and variation margin for non-
centrally cleared derivatives under the laws of Australia are
comparable in outcome to those of the CFTC Margin Rule for purposes of
Sec. 23.160.
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.\111\
---------------------------------------------------------------------------
\111\ See BCBS/IOSCO Framework Requirement 3.3.
---------------------------------------------------------------------------
1. Commission Requirement for Margin Model Approval
In keeping with the BCBS/IOSCO Framework, the CFTC 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.\112\
---------------------------------------------------------------------------
\112\ See Sec. 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)(1), in
addition to the requirements for annual review; \113\ control,
oversight, and validation mechanisms; \114\ documentation; \115\ and
escalation procedures.\116\
---------------------------------------------------------------------------
\113\ See Sec. 23.154(b)(4), discussed further infra.
\114\ See Sec. 23.154(b)(5), discussed further infra.
\115\ See Sec. 23.154(b)(6), discussed further infra.
\116\ See Sec. 23.154(b)(7), discussed further infra.
---------------------------------------------------------------------------
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
[[Page 12919]]
model summarized in section IV(E)(1) supra.
2. APRA Requirements for Approval of Margin Models
In keeping with the BCBS/IOSCO Framework, APRA's margin rules
generally require:
An APRA covered entity may apply to APRA for approval to
use a model for the calculation of initial margin for some or all of
its portfolio.\117\ APRA has further represented that it must approve
all margin models prior to their implementation.
---------------------------------------------------------------------------
\117\ See CPS 226, Paragraph 33.
---------------------------------------------------------------------------
Once an APRA covered entity has obtained approval to use a
model for the calculation of initial margin for an asset class, it must
continue to employ that model for that asset class on an ongoing basis
unless, or except to the extent that, the model approval is varied,
revoked, or suspended by APRA.\118\
---------------------------------------------------------------------------
\118\ See CPS 226, Paragraph 41.
---------------------------------------------------------------------------
APRA may, at any time, vary, revoke, or suspend a model
approval for the calculation of initial margin, or impose additional
conditions on a model approval.\119\
---------------------------------------------------------------------------
\119\ See CPS 226, Paragraph 42.
---------------------------------------------------------------------------
Prior notification to APRA is required for any material
changes to an initial margin model or risk measurement system. APRA's
prior written approval is required for any material changes to an
initial margin model which are not consistent with global industry
standards for initial margin models.\120\
---------------------------------------------------------------------------
\120\ See CPS 226, Paragraph 44.
---------------------------------------------------------------------------
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 APRA are comparable to the regulatory approval
requirements of the CFTC Margin Rule. Specifically, APRA covered
entities must submit their models to APRA for approval prior to their
implementation and notify APRA of material changes to the model. APRA
also retains the right to vary, suspend or revoke its approval at any
time. Accordingly, the Commission finds that such requirements under
the laws of Australia are comparable in outcome to those of the CFTC
Margin Rule for purposes of Sec. 23.160.
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
initial margin, the CFTC 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 CFTC 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.\121\
---------------------------------------------------------------------------
\121\ See Sec. 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.\122\
---------------------------------------------------------------------------
\122\ See Sec. 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).\123\
---------------------------------------------------------------------------
\123\ See Sec. 23.153(e)(2)(i).
---------------------------------------------------------------------------
2. APRA 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, APRA's margin rules generally provide that:
Initial margin must be calculated and called both at the
outset of a transaction and on a regular and consistent basis upon
changes in the measured potential future exposure. Settlement of
initial margin amounts must be conducted promptly.\124\
---------------------------------------------------------------------------
\124\ See CPS 226, Paragraph 21. APRA represented that its
initial margin requirements were intended to provide flexibility for
less significant financial counterparties that may find the daily
calculation and exchange of initial margin to be operationally
difficult. Given that changes to a portfolio would trigger a
requirement for the re-calculation and call of initial margin, APRA
represented that, in practice, the inter-bank/dealer market would
nonetheless calculate and exchange initial margin on a daily basis.
---------------------------------------------------------------------------
Initial margin must be posted and collected on a gross
basis.\125\
---------------------------------------------------------------------------
\125\ See CPS 226, Paragraph 20.
---------------------------------------------------------------------------
With respect to the timing and manner for collection or posting of
variation margin, APRA's margin rules generally provide that variation
margin must be calculated and called on a daily basis, and settlement
of variation margin amounts must be conducted promptly.\126\ In the
discussion paper that accompanied CPS 226, APRA stated that settlement
of variation margin should occur on a T+1 basis; however, such a
settlement timeframe may not be feasible in all circumstances due to,
for example, time zone and cross-border considerations, and therefore
has adopted a principles-based approach for the prompt settlement of
variation margin.\127\
---------------------------------------------------------------------------
\126\ See CPS 226, Paragraph 14.
\127\ See APRA Discussion Paper, Page 19.
---------------------------------------------------------------------------
3. Commission Determination
Having compared APRA'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 APRA's margin requirements are comparable in outcome for
purposes of Sec. 23.160.
Under the CFTC Margin Rule, where initial margin is required, a CSE
must calculate the amount of initial margin each business day. Although
APRA's margin rules only require that initial margin be calculated on a
``regular and consistent basis,'' APRA represented
[[Page 12920]]
that larger Australian banks and dealers whose portfolios change on a
daily basis will nonetheless calculate initial margin on a daily basis,
given that APRA's rules require that initial margin must be re-
calculated upon changes in potential future exposure. Both
jurisdictions require counterparties to calculate and call variation
margin on a daily basis.
With respect to the timing of the collection and posting of margin,
the CFTC Margin Rule requires CSEs to collect or post any required
margin amount (whether initial or variation) within one business day of
calculation. APRA's margin rules specify only that margin be collected
or posted ``promptly,'' which presumably could be longer than one
business day. APRA stated that, absent extenuating circumstances, the
settlement of variation margin should occur within one business day of
calculation. With respect to the settlement of initial margin, APRA
stated that its flexible approach is appropriate for ``less significant
financial counterparties'' and would not significantly impact systemic
risk.\128\ Specifically, the daily calculation and exchange of initial
margin would have a limited impact on risk for inactive traders, as a
counterparty's potential future exposure would be unlikely to change
significantly and variation margin would nonetheless be exchanged
daily. APRA has represented that the large internationally active banks
that are operating in Australia would generally calculate and exchange
margin on a daily basis, consistent with the CFTC Margin Rule, due to
daily changes to their portfolios.
---------------------------------------------------------------------------
\128\ As discussed above, the CFTC Margin Rule applies only to
SDs and MSPs for which there is no U.S. Prudential Regulator. SDs
and MSPs are registered by virtue of their substantial swaps
activity. By comparison, APRA's margin rules apply to a broader
range of entities, including depository institutions, insurance
companies, and superannuation firms. Thus, APRA's margin rules have
incorporated a greater flexibility with respect to the timing of
margin collection and posting in order to address the range in the
size and sophistication of the entities that are subject to its
margin requirements.
---------------------------------------------------------------------------
Given APRA's statements regarding the practical implementation of
its margin rules, the Commission finds that the requirements of APRA's
rules with respect to the timing and manner for collection or payment
of initial and variation margin are comparable in outcome for purposes
of Sec. 23.160.
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 CFTC 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.\129\
---------------------------------------------------------------------------
\129\ See Sec. 23.154(a)(3) and definition of ``initial margin
threshold'' in Sec. 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).\130\
---------------------------------------------------------------------------
\130\ See Sec. 23.152(b)(3).
---------------------------------------------------------------------------
2. APRA Requirements for Margin Threshold Levels or Amounts
Also in keeping with the BCBS/IOSCO Framework, with respect to
margin threshold levels or amounts, APRA's margin requirements
generally provide that:
The threshold applicable to the initial margin for each
margining group must not be greater than AUD 75 million. The threshold
is applied bilaterally at the aggregate level of the margining group
and is based on all non-centrally cleared derivative transactions
between the two margining groups.\131\
---------------------------------------------------------------------------
\131\ See CPS 226, Paragraph 22.
---------------------------------------------------------------------------
The combined variation margin and initial margin required
to be posted or collected pursuant to APRA's margin rules must be
subject to a de-minimis minimum transfer amount that must not exceed
AUD 750,000 (i.e., a minimum transfer amount).\132\
---------------------------------------------------------------------------
\132\ See CPS 226, Paragraph 28.
---------------------------------------------------------------------------
3. Commission Determination
Based on the foregoing and the representations of the applicant,
the Commission has determined that APRA's requirements for margin
threshold levels or amounts, in the case of APRA covered entities, are
comparable in outcome to those required by the CFTC Margin Rule for
purposes of Sec. 23.160.
The Commission notes that at current exchange rates, AUD 75 million
is approximately $53 million, while AUD 750,000 is approximately
$530,000. Although these amounts are greater than those permitted by
the CFTC Margin Rule, the Commission recognizes that exchange rates
will fluctuate over time and thus the Commission finds that such
requirements under the laws of Australia are comparable in outcome to
those of the CFTC Margin Rule for purposes of Sec. 23.160.
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 CFTC 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 CSE's 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.\133\
---------------------------------------------------------------------------
\133\ See Sec. 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.\134\
---------------------------------------------------------------------------
\134\ See Sec. 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.\135\
---------------------------------------------------------------------------
\135\ See Sec. 23.154(b)(5)(iv).
---------------------------------------------------------------------------
[[Page 12921]]
With respect to risk management controls for the calculation of
variation margin, the CFTC Margin Rule generally provides that:
CSEs must maintain documentation setting forth the
variation margin methodology with sufficient specificity to allow a
counterparty, the Commission, a registered futures association, and any
applicable U.S. 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 margin methodology or a data source, including: The
manner in which the methodology meets the requirements of the CFTC
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. APRA 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, APRA's margin requirements generally provide that:
Where APRA covered entities use a quantitative calculation
model to calculate initial margin, the models must be subject to an
independent internal governance process that: (i) Continuously monitors
and assesses the value of the model's risk assessments; (ii) tests the
model against realized data and experience; (iii) validates the
applicability of the model to the derivatives for which it is used;
(iv) regularly reviews the model in line with developments in global
industry standards for initial margin models; and (v) accounts for the
complexity of the products covered.\136\
---------------------------------------------------------------------------
\136\ See CPS 226, Paragraph 39.
---------------------------------------------------------------------------
APRA covered entities must ensure that an independent
review of the initial margin model and risk measurements system is
carried out initially and then regularly as part of the internal audit
process. This review must be conducted by functionally independent,
appropriately trained, and competent personnel, and must take place at
least once every three years or when a material change is made to the
model or the risk measurement system.\137\
---------------------------------------------------------------------------
\137\ See CPS 226, Paragraph 40.
---------------------------------------------------------------------------
With respect to risk management controls for the calculation of
variation margin, APRA's margin requirements generally provide that:
An APRA covered entity must agree with its APRA covered
counterparties and clearly document the process for determining the
value of each non-centrally cleared derivative transaction at any time
from the execution of the transaction to the termination, maturity, or
expiration thereof.\138\
---------------------------------------------------------------------------
\138\ See CPS 226, Paragraph 86.
---------------------------------------------------------------------------
Documentation must include an alternative process or
approach by which counterparties will determine the value of the non-
centrally cleared derivative transaction in the event of the
unavailability or other failure of any inputs required to value the
transaction.\139\
---------------------------------------------------------------------------
\139\ See CPS 226, Paragraph 88.
---------------------------------------------------------------------------
An APRA covered entity must perform periodic reviews of
the agreed upon valuation process to take into account changes in
market conditions.\140\
---------------------------------------------------------------------------
\140\ See CPS 226, Paragraph 89.
---------------------------------------------------------------------------
3. Commission Determination
Based on the foregoing, the Commission has determined that APRA's
requirements applicable to APRA covered entities pertaining to risk
management controls for the calculation of initial and variation margin
are comparable to the corresponding requirements under the CFTC Margin
Rule. Specifically, the Commission finds that under both APRA's
requirements and the CFTC 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. Further, APRA's
margin requirements and the CFTC Margin Rule both require ongoing
reviews of firms' valuation methodologies. Although APRA's margin rules
only require an internal review of the margin model and risk
measurement system to be carried out once every three years, as
compared to the CFTC Margin Rule's requirement for an annual review,
APRA's margin rules also require a review to be conducted when a
material change is made to the model or risk management system. In
addition, margin model risk is further mitigated by APRA's requirement
that models must be subject to an internal governance process that,
among other things, continuously monitors and tests the models against
realized experience and developments in industry standards.
Accordingly, the Commission finds that, for purposes of Sec. 23.160,
APRA's requirements pertaining to risk management controls are
comparable in outcome to the controls required by the CFTC 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 CFTC Margin Rule generally
provides that CSEs may collect or post: \141\
---------------------------------------------------------------------------
\141\ See Sec. 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
[[Page 12922]]
(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 U.S. 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 U.S. 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 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 U.S.
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).\142\
---------------------------------------------------------------------------
\142\ See Sec. 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: \143\
---------------------------------------------------------------------------
\143\ See Sec. 23.156(a)(3).
Standardized Haircut Schedule
------------------------------------------------------------------------
Cash in same currency as swap obligation 0.0
------------------------------------------------------------------------
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)(v)): 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)(v)): 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)(v)): 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)(v)):
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)(v)):
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)(v)):
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 CFTC Margin Rule
generally provides that CSEs may collect or post: \144\
---------------------------------------------------------------------------
\144\ See Sec. 23.156(b)(1).
---------------------------------------------------------------------------
[[Page 12923]]
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.\145\
---------------------------------------------------------------------------
\145\ See Sec. 23.156(b)(2).
---------------------------------------------------------------------------
Finally, CSEs must monitor the value and eligibility of collateral
collected and posted: \146\
---------------------------------------------------------------------------
\146\ See Sec. 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. APRA 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, APRA's margin
requirements generally provide that APRA covered entities may collect
or post: \147\
---------------------------------------------------------------------------
\147\ See CPS 226, Paragraph 45.
---------------------------------------------------------------------------
Cash.\148\
---------------------------------------------------------------------------
\148\ See CPS 226, Paragraph 45(a).
---------------------------------------------------------------------------
Debt securities issued by Commonwealth, State and
Territory governments in Australia, central, state, and regional
governments in other countries, the Reserve Bank of Australia, central
banks in other countries, and the international banking agencies and
multilateral development banks (each with an External Credit Assessment
Institution (``ECAI'') rating of 3 or better).\149\
---------------------------------------------------------------------------
\149\ See CPS 226, Paragraph 45(b).
---------------------------------------------------------------------------
Debt securities issued by ADIs, overseas banks, Australian
and international local governments and corporates (each with an ECAI
rating of 3 or better).\150\
---------------------------------------------------------------------------
\150\ See CPS 226, Paragraph 45(c).
---------------------------------------------------------------------------
Unrated debt securities that are issued by an ADI or
overseas bank as senior debt and are listed on a recognized exchange.
All externally rated issues of the same seniority by the same issuer
must have a long-term or short-term ECAI rating of 3 or better, and the
entity holding the unrated security must have no information suggesting
that the unrated security justifies an ECAI rating of less than 3.\151\
---------------------------------------------------------------------------
\151\ See CPS 226, Paragraph 45(d).
---------------------------------------------------------------------------
Covered bonds with an ECAI rating of 3 or better.\152\
---------------------------------------------------------------------------
\152\ See CPS 226, Paragraph 45(e).
---------------------------------------------------------------------------
Senior securitization exposures with an ECAI rating of
1.\153\
---------------------------------------------------------------------------
\153\ See CPS 226, Paragraph 45(f).
---------------------------------------------------------------------------
Equities included in a major stock index.\154\
---------------------------------------------------------------------------
\154\ See CPS 226, Paragraph 45(g).
---------------------------------------------------------------------------
Gold bullion.\155\
---------------------------------------------------------------------------
\155\ See CPS 226, Paragraph 45(h).
---------------------------------------------------------------------------
Resecuritization exposures (irrespective of credit
ratings) are not eligible collateral.\156\
---------------------------------------------------------------------------
\156\ See CPS 226, Paragraph 46.
---------------------------------------------------------------------------
Securities issued by a counterparty to the transaction (or
by any person or entity related or associated with the counterparty) is
considered to have a material positive correlation with the credit
quality of the counterparty and thus are not eligible collateral.\157\
---------------------------------------------------------------------------
\157\ See CPS 226, Paragraph 47.
---------------------------------------------------------------------------
An APRA covered entity must have appropriate controls in
place to ensure that the collateral collected does not exhibit
significant wrong-way risk or significant concentration risk. The
controls must consider concentrations in terms of an individual issuer,
issuer type, and asset type.\158\
---------------------------------------------------------------------------
\158\ See CPS 226, Paragraph 48.
---------------------------------------------------------------------------
Risk-sensitive haircuts appropriately reflecting the credit,
market, and FX risk must be applied to the collateral.\159\ The
haircuts must be calculated using either a model approach approved by
APRA or the following standardized schedule: \160\
---------------------------------------------------------------------------
\159\ See CPS 226, Paragraph 50.
\160\ See CPS 226, Paragraph 50 and Attachment B. The risk-
sensitive haircut for an APRA covered entity may also be calculated
using a schedule already in use for regulatory capital purposes
prior to the application of CPS 226, provided that such a schedule
is at least as conservative as the CPS 226 schedule. The use of such
an alternative schedule for the risk-sensitive haircut must be
approved by APRA. Id.
------------------------------------------------------------------------
------------------------------------------------------------------------
Cash.................................................... 0%
------------------------------------------------------------------------
Debt securities under paragraph 45(b):
------------------------------------------------------------------------
residual maturity <=1 year.............................. 0.5%
residual maturity >1 year, <=5 years.................... 2%
residual maturity >5 years.............................. 4%
------------------------------------------------------------------------
Debt securities under paragraphs 45(c), 45(d), 45(e),45(f):
------------------------------------------------------------------------
residual maturity <=1 year.............................. 1%
residual maturity >1 year, <=5 years.................... 4%
residual maturity >5 years.............................. 8%
Equities included in a major stock index................ 15%
Gold.................................................... 15%
------------------------------------------------------------------------
With respect to initial margin, an additional FX haircut of eight
per cent of market value applies to all cash and non-cash collateral in
which the currency of the collateral asset differs from the termination
currency.\161\ Similarly, for purposes of variation margin, an
additional FX haircut of 8% of market value applies to all non-cash
collateral in which the currency of the collateral asset differs from
the agreed upon currency of an individual derivative contract, the
relevant master netting agreement, or the relevant credit support
annex.\162\
---------------------------------------------------------------------------
\161\ See CPS 226, Attachment B, Paragraph 4.
\162\ See CPS 226, Attachment B, Paragraph 3.
---------------------------------------------------------------------------
3. Commission Determination
Based on the foregoing and the representations of the applicant,
the Commission observes that APRA's
[[Page 12924]]
requirements pertaining to assets eligible for posting or collecting by
APRA covered entities as collateral for non-centrally cleared
derivatives are comparable to the requirements of the CFTC Margin Rule.
The Commission notes that there are some areas in which APRA's
requirements for eligible collateral are less strict than those in the
CFTC Margin Rule. For example, APRA allows for a broader range of forms
of eligible collateral, including debt securities issued by banks and
senior securitizations. This difference is mitigated, however, by
APRA's requirement that such debt securities either: (i) have certain
minimum credit ratings; or (ii) if unrated, are senior debt listed on a
recognized exchange and issued by entities whose comparable securities
have certain minimum credit ratings. Further, APRA's margin rules apply
a 15% haircut for all equities included on a major stock index, whereas
the CFTC Margin Rule permits a 15% haircut for equities included in the
S&P 500 or related index, and a 25% haircut for equities included in
the S&P 1500 or related index. In addition, unlike the CFTC Margin
Rule, APRA's margin rules do not delineate specific currencies which
may be used as collateral.
With respect to variation margin, the CFTC Margin Rule states that
CSEs are only permitted to exchange 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 when transacting with other swap entities. CSEs may post
and collect any form of eligible collateral as variation margin when
transacting with financial end users. By comparison, APRA's
requirements would permit any form of eligible collateral (as described
above) for transactions with all counterparties.
While not identical, the Commission finds that the forms of
eligible collateral for initial and variation margin under the laws of
Australia provide comparable protections to the forms of eligible
collateral mandated by the CFTC Margin Rule. Specifically, although
APRA's margin regime allows for a broader range of eligible collateral
with corresponding haircuts, such collateral must satisfy credit rating
restrictions that seek to ensure that it is liquid and able to hold its
value in a time of financial stress. APRA covered entities must also
continuously monitor the concentration risk of collateral. The
Commission recognizes that the list of eligible collateral under APRA's
margin regime was compiled by APRA in accordance with the standard set
forth in the BCBS/IOSCO Framework requiring that the assets held as
collateral are highly liquid and, after accounting for appropriate
haircuts, able to hold their value in a time of financial stress.\163\
Thus, the Commission finds APRA's margin regime with respect to the
forms of eligible collateral for initial and variation margin for
uncleared swaps is comparable in outcome to the CFTC Margin Rule for
purposes of Sec. 23.160.
---------------------------------------------------------------------------
\163\ See APRA Discussion Paper, Page 24.
---------------------------------------------------------------------------
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.\164\
---------------------------------------------------------------------------
\164\ 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 event
that the collecting party enters bankruptcy.\165\ The BCBS-IOSCO
Framework acknowledges that ``there are many different ways to protect
provided margin,'' and that in some cases, ``access to assets held by
third-party custodians has been limited or practically difficult.''
\166\
---------------------------------------------------------------------------
\165\ See id.
\166\ See BCBS/IOSCO Framework, Commentary 5(i).
---------------------------------------------------------------------------
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 CFTC 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.\167\
---------------------------------------------------------------------------
\167\ See Sec. 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.\168\
---------------------------------------------------------------------------
\168\ See Sec. 23.157(c)(1) and (2).
---------------------------------------------------------------------------
A posting party may substitute any form of eligible
collateral for posted collateral held as initial margin.\169\
---------------------------------------------------------------------------
\169\ See Sec. 23.157(c)(3).
---------------------------------------------------------------------------
A posting party may direct reinvestment of posted
collateral held as initial margin in any form of eligible
collateral.\170\
---------------------------------------------------------------------------
\170\ 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.\171\
---------------------------------------------------------------------------
\171\ See CFTC Margin Rule, 81 FR at 672.
---------------------------------------------------------------------------
2. APRA Requirements for Custodial Arrangements, Segregation, and
Rehypothecation
With respect to custodial arrangements, segregation, and
rehypothecation, APRA's margin rules generally require that:
Initial margin must be held so as to ensure that: (i) The
margin collected is promptly available to the collecting party in the
event of the posting party's default; \172\ and (ii) the collected
margin must be subject to arrangements that protect the posting party
to the extent possible under applicable law in the event that the
collecting party enters insolvency or bankruptcy.\173\
---------------------------------------------------------------------------
\172\ APRA considers the requirement that initial margin be
promptly available to the collecting party in the event of the
posting party's default consistent in policy intent with a
requirement that initial margin be immediately available; i.e., that
initial margin must be available as soon as legally and
operationally possible.
\173\ See CPS 226, Paragraph 25. APRA further represented that
although it implemented a principles-based approach, in practice it
believes that most of the major Australian banks intend to use
third-party custodians to meet with requirements of CPS 226.
---------------------------------------------------------------------------
[[Page 12925]]
Initial margin must not be re-hypothecated, re-pledged or
re-used, but cash initial margin may be held in a demand deposit
account with a third-party custodian in the name of the posting
counterparty. The third-party custodian must not be affiliated with
either counterparty. APRA has represented that cash held in a custody
account may be reinvested in other forms of eligible collateral.
Contractual arrangements providing for the posting and collection of
initial margin must provide for initial margin to be held in a manner
that satisfies this requirement.\174\
---------------------------------------------------------------------------
\174\ See CPS 226, Paragraph 26.
---------------------------------------------------------------------------
Initial margin collected must be segregated from the
collector's proprietary assets. The initial margin collector must also
segregate initial margin provided in respect of one or more
counterparties from the assets of other parties if requested by the
relevant counterparty or counterparties.\175\
---------------------------------------------------------------------------
\175\ See CPS 226, Paragraph 27.
---------------------------------------------------------------------------
Eligible collateral that was originally posted or
collected may be substituted provided that: (i) both parties agree to
the substitution; (ii) the substitution is made on the terms applicable
to their agreement; and (iii) the substituted eligible collateral meets
all of the requirements of APRA's margin rules and the value of the
substituted eligible collateral, after the application of risk-
sensitive haircuts, is sufficient to meet the margin requirement.\176\
---------------------------------------------------------------------------
\176\ See CPS 226, Paragraph 49.
---------------------------------------------------------------------------
Collateral exchanged for variation margin is not subject
to custodial safekeeping requirements.
3. Commission Determination
The Commission notes that APRA's margin requirements with respect
to custodial arrangements are less stringent than those of the CFTC
Margin Rule in one respect. Under the CFTC 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.\177\ APRA's margin rules
permit, but do not require, cash initial margin to be held with a
third-party custodian. If a third-party custodian is used, it may not
be affiliated with either counterparty. Importantly, however, APRA's
margin rules do not prohibit an APRA covered entity itself (or an
affiliated entity for other than cash initial margin) from acting as
custodian to hold initial margin collected from counterparties, so long
as the margin is segregated from the collector's proprietary assets.
Further, where a third-party custodian is not used, APRA's margin rules
require collateral to be segregated from other counterparties'
collateral only at the request of the posting counterparty.
---------------------------------------------------------------------------
\177\ See Sec. 23.157(a) and (b).
---------------------------------------------------------------------------
As discussed above, the BCBS-IOSCO Framework contemplates multiple
methodologies for protecting initial margin. APRA has stated that its
margin safekeeping requirements were intended to allow flexible
approaches that would mitigate compliance costs without compromising
the protections available to counterparties.\178\ If a third-party
custodian is not used, APRA further represented that mere segregation
of assets, in the absence of a trust arrangement, would not be
sufficient to meet the requirements of CPS 226. APRA stated that
Australian insolvency law protects the posting party's right to recover
initial margin upon insolvency of the collecting party so long as it is
held by the collecting party on trust for the posting party.\179\
Accordingly, the Commission finds that APRA's margin requirements with
respect to custodial arrangements are comparable in outcome to the CFTC
Margin Rule for purposes of Sec. 23.160.
---------------------------------------------------------------------------
\178\ See APRA Discussion Paper, Page 22. APRA further
represented that many large banks will nonetheless use third-party
custodians.
\179\ APRA stated that in the event of a bankruptcy, trust
assets are not considered property of the collecting party, and
would be dealt with under the terms of the trust arrangement. See
Stansfield DIY Wealth Pty Ltd (in liq) [2014] NSWSC 1484.
---------------------------------------------------------------------------
L. Requirements for Margin Documentation
1. Commission Requirement for Margin Documentation
With respect to requirements for documentation of margin
arrangements, the CFTC 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 CFTC Margin
Rule.\180\
---------------------------------------------------------------------------
\180\ See Sec. 23.158(a).
---------------------------------------------------------------------------
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.\181\
---------------------------------------------------------------------------
\181\ See Sec. 23.158(b).
---------------------------------------------------------------------------
2. APRA Requirements for Margin Documentation
With respect to requirements for documentation of margin
arrangements, APRA's margin rules generally provide that:
An APRA covered entity must establish and implement
policies and procedures to execute written trading relationship
documentation with an APRA covered counterparty prior to or
contemporaneously with executing a non-centrally cleared derivative
transaction.\182\
---------------------------------------------------------------------------
\182\ See CPS 226, Paragraph 74.
---------------------------------------------------------------------------
The trading relationship documentation must: (i) Promote
legal certainty for non-centrally cleared derivative transactions; (ii)
include all material rights and obligations of the counterparties
concerning the non-centrally cleared derivative trading relationship,
including margin arrangements in accordance with applicable law, that
have been agreed between them; and (iii) be executed in writing or
through equivalent non-rewritable, non-erasable electronic means.\183\
---------------------------------------------------------------------------
\183\ See CPS 226, Paragraph 75.
---------------------------------------------------------------------------
An APRA covered entity must agree with its counterparties
and clearly document the process for determining the value of each non-
centrally cleared derivative transaction for the purpose of exchanging
margin.\184\
---------------------------------------------------------------------------
\184\ See CPS 226, Paragraph 86.
---------------------------------------------------------------------------
All agreements on valuation process must be documented in
the trading relationship documentation or trade confirmation.\185\
---------------------------------------------------------------------------
\185\ See CPS 226, Paragraph 87.
---------------------------------------------------------------------------
An APRA covered entity must have rigorous and robust
dispute resolution procedures in place with its counterparties prior to
or contemporaneously with executing a non-centrally cleared derivative
transaction.\186\
---------------------------------------------------------------------------
\186\ See CPS 226, Paragraph 90.
---------------------------------------------------------------------------
An APRA covered entity must have policies and procedures
to maintain trading relationship documentation for a reasonable period
of time after the maturity of any outstanding transactions with an APRA
covered counterparty.\187\
---------------------------------------------------------------------------
\187\ See CPS 226, Paragraph 76.
---------------------------------------------------------------------------
[[Page 12926]]
3. Commission Determination
Based on the foregoing, the Commission has determined that APRA's
margin requirements applicable to margin documentation are
substantially the same as the margin documentation requirements under
the CFTC Margin Rule. Specifically, the Commission finds that under
both APRA's requirements and the CFTC Margin Rule, a CSE/APRA covered
entity is required to enter into documentation with each counterparty
that sets forth the rights and obligations of the counterparties,
including margin arrangements in accordance with applicable law, as
well as the methodologies used for determining valuations. Accordingly,
the Commission finds that APRA's requirements pertaining to margin
documentation are comparable in outcome to those required by the CFTC
Margin Rule for purposes of Sec. 23.160.
M. Cross-Border Application of the Margin Regime
1. Cross-Border Application of the CFTC Margin Rule
The general cross-border application of the CFTC Margin Rule, as
set forth in the CFTC Cross-Border Margin Rule, is discussed in detail
in section II supra. However, Sec. 23.160(d) and (e) of the CFTC
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 \188\ of the CFTC Margin Rule.\189\
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\188\ See Sec. 23.157 and section IV(K) supra.
\189\ See Sec. 23.160(d) and (e). With respect to non-netting
jurisdictions, the CFTC margin rule generally provides that if a CSE
cannot conclude after sufficient legal review with a well-founded
basis that the netting agreement described in Sec. 23.152(c) meets
the definition of ``eligible master netting agreement'' set forth in
Sec. 23.151, the CSE must treat the uncleared swaps covered by the
agreement on a gross basis for the purposes of calculating and
complying with the requirements of Sec. Sec. 23.152(a) and
23.153(a) to collect margin, but the CSE may net those uncleared
swaps in accordance with Sec. Sec. 23.152(c) and 23.153(d) for the
purposes of calculating and complying with the requirements of this
part to post margin. A CSE that relies on this provision must have
policies and procedures ensuring that it is in compliance with the
requirements of this paragraph, and maintain books and records
properly documenting that all of the requirements of the provision
are satisfied.
With respect to jurisdictions where compliance with custodial
arrangements is unavailable, Sec. Sec. 23.152(b), 23.157(b), and
23.160(d) do not apply to an uncleared swap entered into by a
Foreign Consolidated Subsidiary or a foreign branch of a U.S. CSE if
(i) inherent limitations in the legal or operational infrastructure
in the applicable foreign jurisdiction make it impracticable for the
CSE and its counterparty to post any form of eligible initial margin
collateral recognized pursuant to Sec. 23.156 in compliance with
the custodial arrangement requirements of Sec. 23.157; (ii) the CSE
is subject to foreign regulatory restrictions that require the CSE
to transact in uncleared swaps with the counterparty through an
establishment within the foreign jurisdiction and do not accommodate
the posting of collateral for the uncleared swap in compliance with
the custodial arrangements of Sec. 23.157 in the United States or a
jurisdiction for which the Commission has issued a comparability
determination under Sec. 23.160(c) with respect to Sec. 23.157;
(iii) the counterparty to the uncleared swap is a non-U.S. person
that is not a CSE, and the counterparty's obligations under the
uncleared swap are not guaranteed by a U.S. person; (iv) the CSE
collects initial margin for the uncleared swap in accordance with
Sec. 23.152(a) in the form of cash pursuant to Sec.
23.156(a)(1)(i), and posts and collects variation margin in
accordance with Sec. 23.153(a) in the form of cash pursuant to
Sec. 23.156(a)(1)(i); (v) for each broad risk category, as set out
in Sec. 23.154(b)(2)(v), the total outstanding notional value of
all uncleared swaps in that broad risk category, as to which the CSE
is relying on Sec. 23.160(e), may not exceed 5% of the CSE's total
outstanding notional value for all uncleared swaps in the same broad
risk category; (vi) the CSE has policies and procedures ensuring
that it is in compliance with the requirements of Sec. 23.160(e);
and (vii) the CSE maintains books and records properly documenting
that all of the requirements of Sec. 23.160(e) are satisfied.
---------------------------------------------------------------------------
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.\190\
---------------------------------------------------------------------------
\190\ See id.
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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.\191\ 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).
---------------------------------------------------------------------------
\191\ See Sec. Sec. 23.160(e) and 23.157(b).
---------------------------------------------------------------------------
2. Cross-Border Application of APRA's Margin Regime
With respect to cross-border transactions, APRA's margin
requirements state that APRA may approve substituted compliance in
relation to the margin requirements of a foreign jurisdiction where
those requirements are comparable in outcome with the BCBS/IOSCO
framework and APRA's margin rules.\192\ Where APRA grants substituted
compliance, an APRA covered entity will be deemed in compliance with
APRA's margin rules for transactions in which it complies with the
relevant foreign margin requirements in their entirety.\193\ APRA may
limit the scope or impose conditions on its substituted compliance
determinations.\194\ An APRA covered entity may only avail itself of
substituted compliance with respect to a foreign jurisdiction when a
transaction is subject to the margin requirements of that
jurisdiction.\195\
---------------------------------------------------------------------------
\192\ See CPS 226, Paragraph 62.
\193\ See CPS 226, Paragraph 63.
\194\ Id.
\195\ See CPS 226, Paragraph 64. An APRA covered entity may only
substitute compliance in APRA's margin rules with those of a foreign
jurisdiction where: (i) the APRA covered entity is transacting with
an APRA covered counterparty that is subject to the margin
requirements of a the relevant foreign jurisdiction; and/or (ii) the
APRA covered entity is directly subject to the margin requirements
of the relevant foreign jurisdiction. Id.
---------------------------------------------------------------------------
Where an APRA covered entity is a foreign ADI, a foreign general
insurer operating as a foreign branch in Australia, or an eligible
foreign life insurance company and is directly subject to margin
requirements that are substantially similar to the BCBS/IOSCO Framework
by its home jurisdiction, it may comply with its home jurisdiction's
requirements in their entirety in lieu of complying with APRA's margin
rules, subject to certain conditions.\196\ Specifically, the APRA
covered entity must complete an internal assessment that positively
demonstrates: (i) How it is directly subject to the requirements of the
foreign jurisdiction; (ii) how the requirements of the foreign
jurisdiction are substantially similar to the BCBS/IOSCO Framework; and
(iii) how it complies with those requirements.\197\
---------------------------------------------------------------------------
\196\ See CPS 226, Paragraph 65.
\197\ See CPS 226, Paragraph 65. The APRA covered entity's
internal assessment, and any additional information, must be made
available to APRA upon request. Id.
---------------------------------------------------------------------------
Similarly, where a member of an APRA covered entity's Level 2 group
that is incorporated outside of Australia is directly subject to margin
requirements of a foreign jurisdiction that are substantially similar
to the
[[Page 12927]]
BCBS/IOSCO Framework, the APRA covered entity may apply for approval by
APRA to comply, with respect to that member, with the foreign
jurisdiction's requirements in lieu of complying with the relevant
requirements of APRA's margin rules.\198\
---------------------------------------------------------------------------
\198\ See CPS 226, Paragraph 66.
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Further, an APRA covered entity is not required to exchange
variation margin or post or collect initial margin if there is any
doubt as to the enforceability of: (i) The netting agreement upon
insolvency or bankruptcy of the counterparty; \199\ or (ii) the
collateral agreement upon default of the counterparty.\200\ APRA
covered entities must monitor such exposures and set appropriate
internal limits and controls to manage its exposure to such
counterparties.\201\ APRA has represented that it will review such
thresholds, limits and controls though its supervisory processes and
monitor both entity and industry levels of exposures to these
jurisdictions.
---------------------------------------------------------------------------
\199\ See CPS 226, Paragraph 68.
\200\ See CPS 226, Paragraph 69.
\201\ See CPS 226, Paragraphs 68 and 69.
---------------------------------------------------------------------------
Finally, where a counterparty to a transaction is incorporated, and
operating, in a legal jurisdiction that does not permit it or its
counterparty to satisfy the safekeeping requirements of Paragraph 25 of
APRA's margin rules,\202\ an APRA covered entity is not required to
post or collect initial margin.\203\ APRA represented that although
there is no limit to such exposures, it intends to monitor the use of
this exemption as part of its supervisory program.
---------------------------------------------------------------------------
\202\ See CPS 226, Paragraph 25, which states that initial
margin must be held so as to ensure that: (a) the margin collected
is promptly available to the collecting party in the event of the
posting party's default; and (b) the collected margin must be
subject to arrangements that protect the posting party to the extent
possible under applicable law in the event that the collecting party
enters insolvency or bankruptcy.
\203\ See CPS 226, Paragraph 67. APRA has represented that this
exemption is intended to address legal impediments that currently
exist in New Zealand because the four largest banks regulated by
APRA have New Zealand subsidiaries that are subject to APRA's rules.
According to APRA, entities subject to New Zealand law are not able
to give, and enforce rights with respect to, margin provided by way
of security interest. APRA continues to engage in ongoing dialogue
with New Zealand regarding this use of this exemption.
---------------------------------------------------------------------------
3. Commission Determination
Although there are some differences in the cross-border application
of APRA's margin rules as compared to the CFTC Cross-Border Margin
Rule, the Commission finds that the cross-border application of APRA's
margin regime is comparable in outcome to that of the CFTC Margin Rule
as supplemented by the CFTC Cross-Border Margin Rule for purposes of
Sec. 23.160.
APRA implemented a final amendment to CPS 226 on September 1, 2017,
which permits substituted compliance with respect to the margin
requirements of fourteen foreign bodies, including the CFTC and the
U.S. Prudential Regulators.\204\ Accordingly, where a counterparty to a
transaction is subject to the uncleared margin requirements of APRA and
the CFTC, it may comply with the CFTC Margin Rule.
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\204\ Where an APRA covered entity and its APRA covered
counterparty are both members of the same margining group, APRA did
not grant substituted compliance with respect the following
jurisdictions: (i) Office of the Superintendent of Financial
Institutions, Canada; (ii) European Commission; (iii) Hong Kong
Monetary Authority; (iv) Financial Services Agency, Japan; (v)
Ministry of Agriculture, Forestry and Fisheries, Japan; (vi)
Monetary Authority of Singapore; and (vii) Swiss Financial Market
Supervisory Authority.
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The Commission notes some differences in the cross-border treatment
of netting and collateral agreements by APRA and the CFTC.
Specifically, the CFTC Cross-Border Margin Rule provides that a CSE
transacting in a jurisdiction that does not reliably recognize close-
out netting and/or collateral arrangements must collect initial and
variation margin on a gross basis, but may post on a net basis.\205\
APRA's margin regime differs in this respect in that it does not
require APRA covered entities to collect or post initial or variation
margin at all where the enforceability of netting agreements and/or
collateral arrangements are questionable. APRA stated that it
implemented these exceptions in consideration of: (i) The potential
liquidity burdens associated with exchanging margin on a gross basis;
(ii) the additional counterparty credit risk associated with posting
collateral to a jurisdiction where insolvency laws do not provide
certainty that posted collateral will be returned in the event of the
counterparty's insolvency; (iii) the higher regulatory capital
requirements that would apply to banking institutions for their non-
netting or uncollateralized exposures; and (iv) the commercial
limitations to requiring margin on a collect-only basis, or on a
collect-gross and post-net basis. However, pursuant to APRA's margin
rules, APRA covered entities are required to monitor the resulting
uncollateralized exposures and set appropriate internal limits and
controls to manage such exposures to counterparties in these
jurisdictions.\206\ APRA represented that although it did not prescribe
a quantitative limit for such exposures, it intends to review APRA
covered entities' internal thresholds, limits, and controls through its
supervisory process and monitor both entity and industry levels of
exposures to these non-netting jurisdictions. The Commission notes that
every CSE is required to have a risk management program pursuant to
Sec. 23.600, and thus the Commission also has the authority to inquire
as to the adequacy of risk management covering uncleared swaps in non-
netting jurisdictions. In light of the limited scope of the difference
and APRA's heightened supervisory focus, the Commission finds for
purposes of Sec. 23.160 that APRA's margin rules are comparable in
outcome to the Commission's margin rules with respect to the treatment
of cross-border transactions with counterparties in non-netting
jurisdictions.
---------------------------------------------------------------------------
\205\ See Sec. 23.160(d).
\206\ See CPS 226, Paragraphs 68 and 69.
---------------------------------------------------------------------------
Further, the CFTC Cross-Border Margin Rule states that when a CSE
transacts in a jurisdiction where it cannot adhere to the CFTC Margin
Rule's custodial safekeeping requirements, the CSE must collect initial
margin in cash, and post and collect variation margin in cash, but is
not required to post initial margin.\207\ APRA's margin regime,
however, does not require APRA covered entities to post or collect
initial margin where either it or its counterparty cannot satisfy the
safekeeping requirements of Paragraph 25 of APRA's margin rules.\208\
APRA explained that this provision was intended to address APRA covered
entities operating in New Zealand, where the country's legal framework
prevents the giving or enforcing of rights with respect to margin
provided by way of security interest. APRA further stated that it
intends to monitor the use of this exemption and is engaged in ongoing
dialogue with New Zealand authorities. Given this explanation, the
Commission believes that the use of this exemption will be limited in
scope and continuously monitored by APRA. Accordingly, although the
Commission acknowledges that APRA's initial margin requirements in such
scenarios are less stringent than those of the CFTC, the Commission
finds that they
[[Page 12928]]
are nonetheless comparable in outcome for purposes of Sec. 23.160.
---------------------------------------------------------------------------
\207\ See Sec. 23.160(e).
\208\ See CPS 226, Paragraph 25, which states that initial
margin must be held so as to ensure that: (a) The margin collected
is promptly available to the collecting party in the event of the
posting party's default; and (b) the collected margin must be
subject to arrangements that protect the posting party to the extent
possible under applicable law in the event that the collecting party
enters insolvency or bankruptcy.
---------------------------------------------------------------------------
Having considered the similarities and differences described above,
the Commission finds that the cross-border aspects of APRA's margin
regime comparable in outcome to that of the Commission for purposes of
Sec. 23.160.
N. Supervision and Enforcement
The Commission has a long history of regulatory cooperation with
APRA, including cooperation in the regulation of registrants of the
Commission that are also APRA covered entities.\209\ As part of APRA's
ongoing prudential regulation and supervision of APRA covered entities,
it will take all measures necessary to ensure that APRA's margin rules
are implemented. Thus, the Commission finds that APRA has the necessary
powers to supervise, investigate, and discipline entities for
compliance with its margin requirements and recognizes APRA's ongoing
efforts to detect and deter violations of, and ensure compliance with,
the margin requirements applicable in Australia.
---------------------------------------------------------------------------
\209\ To facilitate this cooperation, the Commission has
concluded memoranda of understanding with APRA with respect to the
exchange of supervisory information. See the Commission's website at
http://www.cftc.gov/International/MemorandaofUnderstanding/index.htm.
---------------------------------------------------------------------------
V. Conclusion
As detailed above, the Commission has noted several differences
between the CFTC Margin Rule and APRA's margin rules. However, having
considered the scope and objectives of the margin requirements for non-
centrally cleared derivatives under the laws of Australia \210\ the
margin requirements in the broader context of APRA's prudential
oversight of risk management and capital requirements, whether such
margin requirements achieve comparable outcomes to the Commission's
corresponding margin requirements,\211\ the ability of APRA to
supervise and enforce compliance with the margin requirements for non-
centrally cleared derivatives under the laws of Australia,\212\ and the
reciprocal nature of comity in international regulation, the Commission
has determined that APRA's margin rules are comparable in outcome, for
purposes of Sec. 23.160, to the CFTC Margin Rule.
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\210\ See Sec. 23.160(c)(3)(i).
\211\ See Sec. 23.160(c)(3)(ii). As discussed herein, the
Commission's CFTC 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.
\212\ See Sec. 23.160(c)(3)(iii). See also Sec.
23.160(c)(3)(iv) (indicating the Commission would also consider any
other relevant facts and circumstances).
Issued in Washington, DC, on March 27, 2019, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Appendices to Comparability Determination for Australia: 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 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 I am pleased to announce that the Commission has issued a
decision concluding that the Australian margin rules are comparable
to the CFTC rules. As a result, Australian firms may rely on
compliance with Australian margin rules to satisfy CFTC
requirements.
In making this substituted compliance determination, Commission
staff has conducted a principles-based, holistic analysis that
focuses on regulatory outcomes rather than on a strict rule-by-rule
comparison. This means that market participants can rely on one set
of rules--in their totality--without fear that another jurisdiction
will seek to selectively impose an additional layer of regulatory
obligations.
This comparability determination is another example of how the
Commission is committed to showing deference to foreign
jurisdictions that have comparable regulatory and supervisory
regimes. Such an approach is essential to ensuring strong and stable
derivatives markets that support economic growth both within the
United States and around the globe.
Appendix 3--Statement of Commissioner Brian D. Quintenz
I support the issuance of the Margin Comparability Determination
for Australia (Determination). As I have noted previously, in order
to avoid market fragmentation and an unworkable, complex patchwork
of cross-border regulations, the Commission must apply a holistic,
outcomes-based approach to substituted compliance. The Commission
should assess comparability by determining if the totality of a
legal regime's regulations, guidance, and supervisory approach
achieve comparable outcomes to the CFTC's regime, instead of
engaging in a rule-by-rule analysis for identical requirements.
I support today's Determination which applies such a holistic
approach and respects the sovereignty of another jurisdiction to
implement important G-20 reforms, such as margin, as it deems
appropriate. Moreover, the Australian Prudential Regulation
Authority (APRA) has already found CFTC margin regulations to be
comparable to its own, so I am pleased that the determination
adopted by the Commission today appropriately reciprocates that
finding.
The outcomes-based approach of today's Determination
appropriately accounts for modest regulatory differences between the
CFTC and Australian margin regimes. For example, although CFTC rules
require initial margin to be segregated at a third party custodian,
the Australian framework allows initial margin to be segregated at a
third party custodian or held in some other bankruptcy-remote
manner, such as the use of a trust account. The end result of both
custodial arrangements is the same, however, because in the event of
bankruptcy, the posting party's assets are protected. The
Determination today recognizes that other regimes can achieve the
same overarching policy goals as the CFTC's regulations, although
they do so by different means.
Like the recently amended Comparability Determination for Japan
regarding margin for uncleared swaps, the Determination before us
today also 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 an Australian
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. In light of these safeguards, I do not
believe that the Determination today will result in systemic risk
being ``backdoored'' into the United States.
Since the Commission first began issuing comparability
determinations in 2013, we have made substantial progress toward
formalizing cooperative arrangements with our international
counterparts through supervisory Memorandums of Understanding
(``MOUs''). MOUs facilitate information sharing and cooperation
between regulators with a shared interest in supervising cross-
border firms. Importantly, we have an active MOU with APRA and I
know we will continue to coordinate closely to ensure appropriate
oversight over our respective regulated entities.\1\ Through
deference and engagement, the Commission can work alongside other
regulators to ensure a well-regulated, liquid, global swaps market.
---------------------------------------------------------------------------
\1\ Memorandum of Understanding, Cooperation and the Exchange of
Information Related to the Supervision of Covered Firms (April 13,
2015), https://www.cftc.gov/idc/groups/public/@internationalaffairs/documents/file/cftc-apra-supervisorymou041320.pdf.
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Appendix 4--Statement of Commissioner Dan M. Berkovitz
I support today's Comparability Determination for Australia:
Margin Requirements for Uncleared Swaps for Swap Dealers and Major
Swap Participants (``Australia Determination'').
The Commission's regulations governing margin requirements for
uncleared swaps (``CFTC Margin Rules'') help mitigate risks
[[Page 12929]]
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.
---------------------------------------------------------------------------
\1\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
---------------------------------------------------------------------------
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 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.
---------------------------------------------------------------------------
\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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
The Australia Determination finds the margin requirements for
uncleared swaps under Australian laws, regulations, standards, and
other materials comparable in outcome to the CFTC's Margin Rules.
The CFTC staff engaged with staff of the Australian Prudential
Regulation Authority (``APRA''), and evaluated prudential standards
and other materials provided by APRA to develop an understanding of
APRA's regulatory objectives, the products and entities subject to
margin requirements, the treatment of inter-affiliate swaps, and
other aspects of APRA's margin rules. The in-depth analysis outlined
in today's Australia Determination reflects a holistic understanding
by the Commission of APRA's margin rules and its prudential
oversight practices. The analysis also observes that the CFTC Margin
Rules and APRA's margin requirements for uncleared swaps are not
identical. In a number of instances, APRA's specific requirements
are not as comprehensive as the CFTC's Margin Rules. However, the
determination explains how mitigating factors--such as certain of
APRA's risk management requirements and differences in the size of
the two countries' swap markets and of the market participants in
them--support a determination that the two systems of regulation
have similar outcomes.
For example, unlike the CFTC Margin Rule, APRA only requires
that variation margin be exchanged between counterparties whose
average notional amount of uncleared swaps exceeds a certain
threshold. However, as noted in the determination, Australia's non-
centrally cleared swaps market is highly concentrated in large
entities that exceed that threshold, and the large majority of
transactions would therefore be subject to variation margin.
Furthermore, as noted in the determination, if an Australian 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 under our rules. This reduces the potential for
risks from swap activities overseas finding their way to the United
States.
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. 2019-06319 Filed 4-2-19; 8:45 am]
BILLING CODE 6351-01-P