2022-16684
[Federal Register Volume 87, Number 151 (Monday, August 8, 2022)]
[Proposed Rules]
[Pages 48092-48118]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-16684]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Notice of Proposed Order and Request for Comment on an
Application for a Capital Comparability Determination From the
Financial Services Agency of Japan
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed order and request for comment.
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SUMMARY: The Commodity Futures Trading Commission is soliciting public
comment on an application submitted by the Financial Services Agency of
Japan requesting that the Commission determine that registered swap
dealers organized and domiciled in Japan that are subject to, and
comply with, certain capital and financial reporting requirements in
Japan may comply with certain capital and financial reporting
requirements under the Commodity Exchange Act via compliance with
corresponding capital and financial reporting requirements of Japan.
The Commission also is soliciting public comment on a proposed order
providing for the conditional availability of substituted compliance in
connection with the application.
DATES: Comments must be received on or before October 7, 2022.
ADDRESSES: You may submit comments, identified by ``Japan Swap Dealer
Capital Comparability Determination'', by any of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select the
``Submit Comments'' link for this proposed order and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the Commission,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for Mail,
above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (``FOIA''), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Regulation 145.9.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to in this
release are found at 17 CFR chapter I, and are accessible on the
Commission's website at https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the proposed determination and order will be retained in
the public comment file and will be considered as required under the
Administrative Procedure Act and other applicable laws, and may be
accessible under the FOIA.
FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, 202-418-
5283, [email protected]; Thomas Smith, Deputy Director, 202-418-5495,
[email protected]; Rafael Martinez, Associate Director, 202-418-5462,
[email protected]; Joshua Beale, Associate Director, 202-418-5446,
[email protected]; Warren Gorlick, Associate Director, 202-418-5195,
[email protected]; Jennifer C.P. Bauer, Special Counsel, 202-418-5472,
[email protected]; Carmen Moncada-Terry, Special Counsel, 202-418-5795,
[email protected]; Liliya Bozhanova, Special Counsel, 202-418-
6232, [email protected]; Joo Hong, Risk Analyst, 202-418-6221,
[email protected]; Justin McPhee, Risk Analyst, 202-418-6223;
[email protected], Market Participants Division; Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION: The Commodity Futures Trading Commission
(``Commission'' or ``CFTC'') is soliciting public comment on an
application submitted by the Financial Services Agency of Japan
(``FSA''), dated September 30, 2021 (``FSA Application''), requesting
that the Commission determine that registered nonbank \2\ swap dealers
(``SDs'') organized and domiciled in Japan (``Japanese nonbank SDs'')
may satisfy certain capital and financial reporting requirements under
the Commodity Exchange Act (``CEA'') \3\ by being subject to and
complying with comparable capital and financial reporting requirements
under Japanese laws and regulations.\4\ The Commission also is
soliciting public comment on a proposed Commission Comparability
Determination order that would allow Japanese nonbank SDs, subject to
certain conditions, to comply with certain CFTC SD capital and
financial reporting requirements in the manner as set forth in the
proposed order.
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\2\ As discussed in Section I.A. below, the Commission has
capital jurisdiction over registered SDs that are not subject to the
regulation of a U.S. banking regulator (i.e., nonbank SDs).
\3\ 7 U.S.C. 1 et seq. The CEA may be accessed through the
Commission's website, www.cftc.gov.
\4\ See Letter from Yuji Yamashita, Deputy Commissioner for
International Affairs, Financial Services Agency of Japan, dated
September 30, 2021. The FSA Application is available on the
Commission's website at: https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
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I. Introduction
A. Regulatory Background--CFTC Capital, Margin, and Financial Reporting
Requirements for Swap Dealers and Major Swap Participants
Section 4s(e) of the CEA \5\ directs the Commission and
``prudential regulators'' \6\ to impose capital requirements on SDs and
major swap participants (``MSPs'') registered with the Commission.
Section 4s(e) of the CEA also directs the Commission and prudential
regulators to adopt regulations imposing initial and variation margin
requirements on swaps entered into by SDs and MSPs that are not cleared
by a registered derivatives clearing organization (``uncleared
swaps'').
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\5\ 7 U.S.C. 6s(e).
\6\ The term ``prudential regulators'' is defined in the CEA to
mean the Board of Governors of the Federal Reserve System (``Federal
Reserve Board''); the Office of the Comptroller of the Currency; the
Federal Deposit Insurance Corporation; the Farm Credit
Administration; and the Federal Housing Finance Agency. See 7 U.S.C.
1a(39).
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Section 4s(e) applies a bifurcated approach with respect to the
above Congressional directives, requiring each SD and MSP that is
subject to the regulation of a prudential regulator (``bank SD'' and
``bank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the applicable
prudential regulator, and requiring each SD and MSP that is not
[[Page 48093]]
subject to the regulation of a prudential regulator (``nonbank SD'' and
``nonbank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the Commission.\7\
Therefore, the Commission's authority to impose capital requirements
and margin requirements for uncleared swap transactions extends to
nonbank SDs and nonbank MSPs, including nonbanking subsidiaries of bank
holding companies regulated by the Federal Reserve Board.
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\7\ 7 U.S.C. 6s(e)(2).
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The prudential regulators implemented Section 4s(e) in 2015 by
amending existing capital requirements applicable to bank SDs and bank
MSPs to incorporate swap transactions into their respective bank
capital frameworks, and by adopting rules imposing initial and
variation margin requirements on bank SDs and bank MSPs that engage in
uncleared swap transactions.\8\ The Commission adopted final rules
imposing initial and variation margin obligations on nonbank SDs and
nonbank MSPs for uncleared swap transactions on January 6, 2016.\9\ The
Commission also approved final capital requirements for nonbank SDs and
nonbank MSPs on July 24, 2020, which were published in the Federal
Register on September 15, 2020 with a compliance date of October 6,
2021 (``CFTC Capital Rules'').\10\
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\8\ See Margin and Capital Requirements for Covered Swap
Entities, 80 FR 74840 (Nov. 30, 2015).
\9\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
\10\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 85 FR 57462 (Sept. 15, 2020).
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Section 4s(f) of the CEA addresses SD and MSP financial reporting
requirements.\11\ Section 4s(f) of the CEA authorizes the Commission to
adopt rules imposing financial condition reporting obligations on all
SDs and MSPs (i.e., nonbank SDs, nonbank MSPs, bank SDs, and bank
MSPs). Specifically, Section 4s(f)(1)(A) of the CEA provides, in
relevant part, that each registered SD and MSP must make financial
condition reports as required by regulations adopted by the
Commission.\12\ The Commission's financial reporting obligations were
adopted with the Commission's nonbank SD and nonbank MSP capital
requirements, and also had a compliance date of October 6, 2021 (``CFTC
Financial Reporting Rules'').\13\
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\11\ 7 U.S.C. 6s(f).
\12\ 7 U.S.C. 6s(f)(1)(A).
\13\ See 85 FR 57462.
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B. Commission Capital Comparability Determinations for Non-U.S. Nonbank
Swap Dealers and Non-U.S. Nonbank Major Swap Participants
Regulation 23.106 establishes a substituted compliance framework
whereby the Commission may determine that compliance by a non-U.S.
domiciled nonbank SD or non-U.S. domiciled nonbank MSP with its home
country's capital and financial reporting requirements will satisfy all
or parts of the CFTC Capital Rules and all or parts of the CFTC
Financial Reporting Rules (such a determination referred to as a
``Capital Comparability Determination'').\14\ The availability of such
substituted compliance is conditioned upon the Commission issuing a
determination that the relevant foreign jurisdiction's capital adequacy
and financial reporting requirements, and related financial
recordkeeping and reporting requirements, for non-U.S. nonbank SDs and/
or non-U.S. nonbank MSPs are comparable to the corresponding CFTC
Capital Rules and CFTC Financial Reporting Rules. The Commission will
issue a Capital Comparability Determination in the form of a Commission
order (``Capital Comparability Determination Order'').\15\
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\14\ 17 CFR 23.106. Regulation 23.106(a)(1) provides that a
request for a Capital Comparability Determination may be submitted
by a non-U.S. nonbank SD or non-US nonbank MSP, a trade association
or other similar group on behalf of its SD or MSP members, or a
foreign regulatory authority that has direct supervisory authority
over one or more non-US nonbank SDs or non-U.S. nonbank MSPs.
Commission regulations provide that any non-U.S. nonbank SD or non-
U.S. nonbank MSP that is dually-registered with the Commission as a
futures commission merchant (``FCM'') is subject to the capital
requirements of Regulation 1.17 and may not petition the Commission
for a Capital Comparability Determination. See 17 CFR 23.101(a)(5)
and (b)(4), respectively. Furthermore, non-U.S. bank SDs and non-
U.S. bank MSPs may not petition the Commission for a Capital
Comparability Determination with respect to their respective
financial reporting requirements under Regulation 23.105(p) (17 CFR
23.105(p)). Commission staff has issued, however, a time-limited no-
action letter stating the Market Participants Division will not
recommend enforcement action against a non-U.S. bank SD that files
with the Commission certain financial information that is provided
to its home country regulator in lieu of certain financial reports
required by Regulation 23.105(p). See CFTC Staff Letter 21-18,
issued on August 31, 2021.
\15\ 17 CFR 23.106(a)(3).
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The Commission's approach for conducting a comparability
determination with respect to the CFTC Capital Rules and the CFTC
Financial Reporting Rules is a principles-based, holistic approach that
focuses on whether the applicable foreign jurisdiction's capital and
financial reporting requirements achieve comparable outcomes to the
corresponding CFTC requirements.\16\ In this regard, the approach is
not a line-by-line assessment or comparison of a foreign jurisdiction's
regulatory requirements with the Commission's requirements.\17\ In
performing the analysis, the Commission recognizes that jurisdictions
may adopt differing approaches to achieving comparable outcomes, and
the Commission will focus on whether the foreign jurisdiction's capital
and financial reporting requirements are comparable to the Commission's
in purpose and effect, and not whether they are comparable in every
aspect or contain identical elements.
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\16\ 17 CFR 23.106(a)(3)(ii). See also 85 FR 57462 at 57521.
\17\ See 85 FR 57521.
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A person requesting a Capital Comparability Determination is
required to submit an application to the Commission containing: (i) a
description of the objectives of the relevant foreign jurisdiction's
capital adequacy and financial reporting requirements applicable to
entities that are subject to the CFTC Capital Rules and the CFTC
Financial Reporting Rules; (ii) a description (including specific legal
and regulatory provisions) of how the relevant foreign jurisdiction's
capital adequacy and financial reporting requirements address the
elements of the CFTC Capital Rules and CFTC Financial Reporting Rules,
including, at a minimum, the methodologies for establishing and
calculating capital adequacy requirements and whether such
methodologies comport with any international standards; and (iii) a
description of the ability of the relevant foreign regulatory authority
to supervise and enforce compliance with the relevant foreign
jurisdiction's capital adequacy and financial reporting requirements.
The applicant must also submit, upon request, such other information
and documentation as the Commission deems necessary to evaluate the
comparability of the capital adequacy and financial reporting
requirements of the foreign jurisdiction.\18\
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\18\ 17 CFR 23.106(a)(2).
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The Commission may consider all relevant factors in making a
Capital Comparability Determination, including: (i) the scope and
objectives of the relevant foreign jurisdiction's capital and financial
reporting requirements; (ii) whether the relevant foreign
jurisdiction's capital and financial reporting requirements achieve
comparable outcomes to the Commission's corresponding capital
[[Page 48094]]
requirements and financial reporting requirements; (iii) the ability of
the relevant foreign regulatory authority or authorities to supervise
and enforce compliance with the relevant foreign jurisdiction's capital
adequacy and financial reporting requirements; and (iv) any other facts
or circumstances the Commission deems relevant, including whether the
Commission and foreign regulatory authority or authorities have a
memorandum of understanding (``MOU'') or similar arrangement that would
facilitate supervisory cooperation.\19\
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\19\ See 17 CFR 23.106(a)(3) and 85 FR 57520-57522.
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In performing the comparability assessment for foreign nonbank SDs,
the Commission's review will include the extent to which the foreign
jurisdiction's requirements address: (i) the process of establishing
minimum capital requirements for nonbank SDs and how such process
addresses risk, including market risk and credit risk of the nonbank
SD's on-balance sheet and off-balance sheet exposures; (ii) the types
of equity and debt instruments that qualify as regulatory capital in
meeting minimum requirements; (iii) the financial reports and other
financial information submitted by a nonbank SD to its relevant
regulatory authority and whether such information provides the
regulatory authority with the means necessary to effectively monitor
the financial condition of the nonbank SD; and (iv) the regulatory
notices and other communications between a nonbank SD and its foreign
regulatory authority that address potential adverse financial or
operational issues that may impact the firm. With respect to the
ability of the relevant foreign regulatory authority to supervise and
enforce compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements, the Commission's review will include
a review of the foreign jurisdiction's surveillance program for
monitoring nonbank SDs' compliance with such capital adequacy and
financial reporting requirements, and the disciplinary process imposed
on firms that fail to comply with such requirements.
In performing the comparability assessment for foreign nonbank
MSPs,\20\ the Commission's review will include the extent to which the
foreign jurisdiction's requirements address: (1) the process of
establishing minimum capital requirements for nonbank MSPs and how such
process establishes a minimum level of capital to ensure the safety and
soundness of the nonbank MSP; (ii) the financial reports and other
financial information submitted by a nonbank MSP to its relevant
regulatory authority and whether such information provides the
regulatory authority with the means necessary to effectively monitor
the financial condition of the nonbank MSP; and (iii) the regulatory
notices and other communications between a nonbank MSP and its foreign
regulatory authority that address potential adverse financial or
operational issues that may impact the firm. With respect to the
ability of the relevant foreign regulatory authority to supervise and
enforce compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements, the Commission's review will include
a review of the foreign jurisdiction's surveillance program for
monitoring nonbank MSPs' compliance with such capital adequacy and
financial reporting requirements, and the disciplinary process imposed
on firms that fail to comply with such requirements.
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\20\ Regulation 23.101(b) requires a nonbank MSP to maintain
positive tangible net worth. There are no MSPs currently registered
with the Commission.
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Regulation 23.106 further provides that the Commission may impose
any terms or conditions that it deems appropriate in issuing a Capital
Comparability Determination.\21\ Any specific terms or conditions with
respect to capital adequacy or financial reporting requirements will be
set forth in the Commission's Capital Comparability Determination
Order. As a general condition to all Capital Comparability
Determination Orders, the Commission expects to require notification
from applicants of any material changes to information submitted by the
applicants in support of a comparability finding, including, but not
limited to, changes in the relevant foreign jurisdiction's supervisory
or regulatory regime.
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\21\ See 17 CFR 23.106(a)(5).
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The Commission's capital adequacy and financial reporting
requirements are designed to address and manage risks that arise from a
firm's operation as a SD and MSP. Given their functions, both sets of
requirements and rules must be applied on an entity-level basis
(meaning that the rules apply on a firm-wide basis, irrespective of the
type of transactions involved) in order to effectively address risk to
the firm as a whole. Therefore, in order to rely on a Capital
Comparability Determination, a nonbank SD or nonbank MSP domiciled in
the foreign jurisdiction and subject to supervision by the relevant
regulatory authority (or authorities) in the foreign jurisdiction must
file a notice with the Commission of its intent to comply with the
applicable capital adequacy and financial reporting requirements of the
foreign jurisdiction set forth in the Capital Comparability
Determination in lieu of all or parts of the CFTC Capital Rules and/or
CFTC Financial Reporting Rules.\22\ Notices must be filed
electronically with the Commission's Market Participants Division
(``MPD'').\23\ The filing of a notice by a non-U.S. nonbank SD or non-
U.S. nonbank MSP provides MPD staff, acting pursuant to authority
delegated by the Commission,\24\ with the opportunity to engage with
the firm and to obtain representations that it is subject to, and
complies with, the laws and regulations cited in the Capital
Comparability Determination and that it will comply with any listed
conditions. MPD will issue a letter under its delegated authority from
the Commission confirming that the non-U.S. nonbank SD or non-U.S.
nonbank MSP may comply with the foreign laws and regulations cited in
the Capital Comparability Determination in lieu of complying with the
CFTC Capital Rules and CFTC Financial Reporting Rules upon MPD's
determination that the firm is subject to and complies with such
foreign laws and regulations, is subject to the jurisdiction of the
applicable foreign regulatory authority (or authorities), and can meet
all of the conditions in the Capital Comparability Determination.
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\22\ 17 CFR 23.106(a)(4).
\23\ Notices must be filed in electronic form to the following
email address: [email protected].
\24\ See 17 CFR 140.91(a)(11).
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Each non-U.S. nonbank SD and/or non-U.S. nonbank MSP that receives,
in accordance with the applicable Commission Capital Comparability
Determination, confirmation from the Commission that it may comply with
a foreign jurisdiction's capital adequacy and/or financial reporting
requirements will be deemed by the Commission to be in compliance with
the corresponding CFTC Capital Rules and/or CFTC Financial Reporting
Rules.\25\ Accordingly, if a nonbank SD or nonbank MSP fails to comply
with the foreign jurisdiction's capital adequacy and/or financial
reporting requirements, the Commission may initiate an action for a
violation of the corresponding CFTC Capital Rules and/or CFTC Financial
Reporting Rules.\26\ In addition, a non-U.S. nonbank SD or
[[Page 48095]]
non-U.S. nonbank MSP that receives confirmation of its ability to use
substituted compliance remains subject to the Commission's examination
and enforcement authority.\27\
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\25\ 17 CFR 23.106(a)(4)(ii). Confirmation will be issued by MPD
under authority delegated by the Commission. See Regulation
140.91(a)(11) (17 CFR 140.91(a)(11)).
\26\ Id.
\27\ Id.
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The Commission will consider an application for a Capital
Comparability Determination to be a representation by the applicant
that the laws and regulations of the foreign jurisdiction that are
submitted in support of the application are finalized and in force,
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 relevant non-U.S. nonbank SDs and/or non-
U.S. nonbank MSPs domiciled in the foreign jurisdiction.\28\ A non-U.S.
nonbank SD or non-U.S. nonbank MSP that is not legally required to
comply with a foreign jurisdiction's laws or regulations determined to
be comparable in a Capital Comparability Determination may not
voluntarily comply with such laws or regulations in lieu of compliance
with the CFTC Capital Rules or the CFTC Financial Reporting Rules. Each
non-U.S. nonbank SD or non-U.S. nonbank MSP that seeks to rely on a
Capital Comparability Determination Order is responsible for
determining whether it is subject to the foreign laws and regulations
found comparable in the Order.
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\28\ The Commission has provided the FSA with an opportunity to
review for accuracy and completeness, and comment on, the
Commission's description of relevant Japanese laws and regulations
on which this proposed Capital Comparability Determination is based.
The Commission relies on this review and any corrections received
from the FSA in making its proposal. A comparability determination
based on an inaccurate description of foreign laws and regulations
may not be valid.
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C. Japan Financial Services Agency's Application for a Capital
Comparability Determination for Japanese-Domiciled Nonbank Swap Dealers
The FSA Application requests that the Commission issue a Capital
Comparability Determination finding that compliance with certain
designated capital requirements of Japan (the ``Japanese Capital
Rules'') and certain designated financial reporting requirements of
Japan (the ``Japanese Financial Reporting Rules'') by a Japanese
nonbank SD registered with the FSA as a Type I Financial Instruments
Business Operator (``FIBO'') satisfies corresponding CFTC Capital Rules
and CFTC Financial Reporting Rules applicable to a nonbank SD under
Sections 4s(e) and (f) of the CEA and Regulations 23.101 and
23.105.\29\ There are currently three Japanese nonbank SDs registered
with Commission, and the FSA has represented that each of the three
Japanese nonbank SDs are FSA-registered and regulated FIBOs.\30\ The
FSA Application requests that the Commission's Capital Comparability
Determination cover each of the three Japanese nonbank SDs and any
future Japanese registered and domiciled FIBOs that register with the
Commission as nonbank SDs.
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\29\ The FSA's application did not request a Capital
Comparability Determination with respect to nonbank MSPs as
currently there are no MSPs registered with the Commission and,
accordingly, no nonbank MSPs domiciled in Japan and registered with
the FSA. Accordingly, the Commission's Capital Comparability
Determination and proposed Order does not address nonbank MSPs.
\30\ FSA Application, pp. 4-5 (footnote 11).
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The FSA has represented that the capital adequacy and financial
reporting requirements for swap activities in Japan are governed by the
Japanese legal framework for financial regulation, which is mainly
composed of Acts, Cabinet Orders, Ministerial Orders, and FSA
Notices.\31\ With regard to the Japanese Capital Rules and the Japanese
Financial Reporting Rules, the Financial Instruments and Exchange Act
(Act No. 25 of 1948) (``FIEA'') and its related order, Cabinet Office
Order on Financial Instruments Business (Cabinet Office Order No. 52 of
2007) (``COO''), stipulate the prudential capital and financial
reporting requirements applicable to FIBOs, including Japanese nonbank
SDs.\32\ FIEA, COO, and related FSA Notices impose mandatory capital
and reporting requirements on FIBOs, including Japanese nonbank SDs.
Comprehensive Guidelines for Supervision of Financial Instruments
Business Operators, etc. (``Supervisory Guidelines for FIBO'') also
supplement the framework.\33\ The technical requirements for FIBOs,
including Japanese nonbank SDs, to calculate capital adequacy ratios
are specified in the FSA Notice No. 59 of 2007 (``Notice on Capital'')
in accordance with Article 177(8) and Article 178(1) of the COO.
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\31\ Id., p. 4.
\32\ Businesses categorized as Type I Financial Instruments
Business (Article 28(1) of the FIEA) can only be conducted by Type I
FIBOs registered under Article 29 of the FIEA. Type I Financial
Instruments Business includes market transactions of derivatives and
foreign market derivatives transactions pertaining to certain highly
liquid securities and over-the-counter transactions of derivatives.
\33\ In order to implement and reinforce the legal framework,
the FSA has developed and published supervisory guidelines. The
supervisory guidelines are meant for FSA staff, but are public
documents, which are expected to be followed by the applicable
financial institutions. Financial institutions are consulted in
connection with the establishment of, and any amendments to, the
supervisory guidelines. Supervision and enforcement are conducted
based on the supervisory guidelines.
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II. General Overview of CFTC and Japanese Nonbank Swap Dealer Capital
Rules
A. General Overview of CFTC Nonbank Swap Dealer Capital Rules
The CFTC Capital Rules provide nonbank SDs with three alternative
capital approaches: (i) the Tangible Net Worth Capital Approach (``TNW
Approach''); (ii) the Net Liquid Assets Capital Approach (``NLA
Approach''); and (iii) the Bank-Based Capital Approach (``Bank-Based
Approach'').\34\
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\34\ 17 CFR 23.101.
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Nonbank SDs that are ``predominantly engaged in non-financial
activities'' may elect the TNW Approach.\35\ The TNW Approach requires
a nonbank SD to maintain a level of ``tangible net worth'' \36\ equal
to or greater than the higher of: (i) $20 million plus the amount of
the nonbank SD's ``market risk exposure requirement'' \37\ and ``credit
risk exposure requirement'' \38\ associated with the nonbank SD's swap
[[Page 48096]]
and related hedge positions that are part of the nonbank SD's swap
dealing activities; (ii) eight percent of the nonbank SD's ``uncleared
swap margin'' amount; \39\ or (iii) the amount of capital required by a
registered futures association of which the nonbank SD is a member.\40\
The TNW Approach is intended to ensure the safety and soundness of a
qualifying nonbank SD by requiring the firm to maintain a minimum level
of tangible net worth that is based on the nonbank SD's swap dealing
activities to provide a sufficient level of capital to absorb losses
resulting from its swap dealing and other business activities.
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\35\ 17 CFR 23.101(a)(2). The term ``predominantly engaged in
non-financial activities'' is defined in Regulation 23.100 (17 CFR
23.100) and generally provides that: (i) the nonbank SD's, or its
parent entity's, annual gross financial revenues for either of the
previous two completed fiscal years represents less than 15 percent
of the nonbank SD's or the nonbank SD's parent's, annual gross
revenues for all operations (i.e., commercial and financial) for
such years, and (ii) the nonbank SD's, or its parent entity's, total
financial assets at the end of its two most recently completed
fiscal years represents less than 15 percent of the nonbank SD's, or
its parent's, total consolidated financial and nonfinancial assets
as of the end of such years.
\36\ The term ``tangible net worth'' is defined in Regulation
23.100 and generally means the net worth (i.e., assets less
liabilities) of a nonbank SD, computed in accordance with applicable
accounting principles, with assets further reduced by a nonbank SD's
recorded goodwill and other intangible assets.
\37\ The terms ``market risk exposure'' and ``market risk
exposure requirement'' are defined in Regulation 23.100 (17 CFR
23.100) and generally mean the risk of loss in a financial position
or portfolio of financial positions resulting from movements in
market prices and other factors. Market risk exposure is the sum of:
(i) general market risks including changes in the market value of a
particular asset that results from broad market movements, which may
include an additive for changes in market value under stressed
conditions; (ii) specific risk, which includes risks that affect the
market value of a specific instrument but do not materially alter
broad market conditions; (iii) incremental risk, which means the
risk of loss on a position that could result from the failure of an
obligor to make timely payments of principal and interest; and (iv)
comprehensive risk, which is the measure of all material price risks
of one or more portfolios of correlation trading positions.
\38\ The term ``credit risk exposure requirement'' is defined in
Regulation 23.100 (17 CFR 23.100) and generally reflects the amount
at risk if a counterparty defaults before the final settlement of a
swap transaction's cash flows.
\39\ The term ``uncleared swap margin'' is defined in Regulation
23.100 (17 CFR 23.100) to generally mean the amount of initial
margin that a nonbank SD would be required to collect from each
counterparty for each outstanding swap position of the nonbank SD. A
nonbank SD must include all swap positions in the calculation of the
uncleared swap margin amount, including swaps that are exempt or
excluded from the scope of the Commission's uncleared swap margin
regulations. A nonbank SD must compute the uncleared swap margin
amount in accordance with the Commission's margin rules for
uncleared swaps. See 17 CFR 23.154.
\40\ The National Futures Association (``NFA'') is currently the
only entity that is a registered futures association. The Commission
will refer to NFA in this document when referring to the
requirements or obligations of a registered futures association.
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The TNW approach requires a nonbank SD to compute its market risk
exposure requirement and credit risk exposure requirement using
standardized capital charges set forth in Securities and Exchange
Commission (``SEC'') Rule 18a-1 (17 CFR 240.18a-1) that are applicable
to entities registered with the SEC as security-based swap dealers
(``SBSDs'') or standardized capital charges set forth in CFTC
Regulation 1.17 applicable to entities registered as FCMs or entities
dually-registered as an FCM and nonbank SD.\41\ Nonbank SDs that have
received Commission or NFA approval pursuant to Regulation 23.102 may
use internal models to compute market risk and/or credit risk capital
charges in lieu of the SEC or CFTC standardized capital charges.\42\
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\41\ 17 CFR 23.101(a)(2)(ii)(A).
\42\ Id.
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A nonbank SD that elects the NLA Approach is required to maintain
``net capital'' in an amount that equals or exceeds the greater of: (i)
$20 million; (ii) 2 percent of the nonbank SD's uncleared swap margin
amount; or (iii) the amount of capital required by NFA.\43\ The NLA
Approach is intended to ensure the safety and soundness of a nonbank SD
by requiring the firm to maintain at all times at least one dollar of
highly liquid assets to cover each dollar of the nonbank SD's
liabilities.
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\43\ 17 CFR 23.101(a)(1)(ii)(A). ``Net capital'' consists of a
nonbank SD's highly liquid assets (subject to haircuts) less all of
the firm's liabilities, excluding certain qualified subordinated
debt. See 17 CFR 240.18a-1 for the calculation of ``net capital.''
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A nonbank SD is required to reduce the value of its highly liquid
assets by the market risk exposure requirement and/or the credit risk
exposure requirement in computing its net capital.\44\ A nonbank SD
that does not have Commission or NFA approval to use internal models
must compute its market risk exposure requirement and/or credit risk
exposure requirement using the standardized capital charges contained
in SEC Rule 18a-1 (17 CFR 240.18a-1) as modified by the Commission's
rule.\45\
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\44\ See 17 CFR 240.18a-1(c) and (d).
\45\ See 17 CFR 23.101(a)(1)(ii).
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A nonbank SD that has obtained Commission or NFA approval, may use
internal market risk and/or credit risk models to compute market risk
and/or credit risk capital charges in lieu of the standardized capital
charges.\46\ A nonbank SD that is approved to use internal market risk
and/or credit risk models is further required to maintain a minimum of
$100 million of ``tentative net capital.'' \47\
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\46\ See 17 CFR 23.102.
\47\ 17 CFR 23.101(a)(1)(ii)(A)(1). The term ``tentative net
capital'' is defined in Regulation 23.101(a)(1)(ii)(A)(1) by
reference to SEC Rule 18a-1 and generally means a nonbank SD's net
capital prior to deducting market risk and credit risk capital
charges.
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The Commission's NLA Approach is consistent with the SEC's SBSD
capital rule, and is based on the Commission's capital rule for FCMs
and the SEC's capital rule for securities broker-dealers (``BDs''). The
quantitative and qualitative requirements for NLA Approach internal
market and credit risk models are also consistent with the quantitative
and qualitative requirements of the Commission's Bank-Based Approach as
described below.
The Commission's Bank-Based Approach for computing regulatory
capital for nonbank SDs is based on certain capital requirements
imposed by the Federal Reserve Board for bank holding companies.\48\
The Bank-Based Approach also is consistent with the Basel Committee on
Banking Supervision's (``BCBS'') international framework for bank
capital requirements.\49\ The Bank-Based Approach requires a nonbank SD
to maintain regulatory capital equal to or in excess of each of the
following requirements: (i) $20 million of common equity tier 1
capital; (ii) an aggregate of common equity tier 1 capital, additional
tier 1 capital, and tier 2 capital (including qualifying subordinated
debt) equal to or greater than 8 percent of the nonbank SD's risk-
weighted assets (provided that common equity tier 1 capital comprises
at least 6.5 percent of the 8 percent minimum requirement); (iii) an
aggregate of common equity tier 1 capital, additional tier 1 capital,
and tier 2 capital equal to or greater than 8 percent of the nonbank
SD's uncleared swap margin amount; and (iv) an amount of capital
required by NFA.\50\ The Bank-Based Approach is intended to ensure that
the safety and soundness of a nonbank SD by requiring the firm to
maintain at all times qualifying capital in an amount sufficient to
absorb unexpected losses, expenses, decrease in firm assets, or
increases in firm liabilities without the firm becoming insolvent.
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\48\ See 17 CFR 23.101(a)(1)(i).
\49\ The BCBS is the primary global standard-setter for the
prudential regulation of banks and provides a forum for cooperation
on banking supervisory matters. Institutions represented on the BCBS
include the Federal Reserve Board, the European Central Bank,
Deutsche Bundesbank, Bank of England, Bank of France, Bank of Japan,
Banco de Mexico, and Bank of Canada.
\50\ 17 CFR 23.101(a)(1)(i).
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The terms used in the Commission's Bank-Based Approach are defined
by reference to regulations of the Federal Reserve Board.\51\
Specifically, the term ``common equity tier 1 capital'' is defined for
purposes of the CFTC Capital Rules to generally mean the sum of a
nonbank SD's common stock instruments and any related surpluses,
retained earnings, and accumulated other comprehensive income.\52\ The
term ``additional tier 1 capital'' is defined to include the nonbank
SD's common equity tier 1 capital and further includes such additional
equity instruments as preferred stock.\53\ The term ``tier 2 capital''
is defined to include certain types of instruments that include both
debt and equity characteristics (e.g., certain perpetual preferred
stock instruments and subordinated term debt instruments).\54\
Subordinated debt also must meet certain requirements to qualify as
tier 2 capital, including that the term of the subordinated debt
instrument is for a minimum of one year (with the exception of approved
revolving subordinated debt agreements which may have a maturity term
that is less than one year), and the debt instrument is an effective
subordination of the
[[Page 48097]]
rights of the lender to receive any payment, including accrued
interest, to other creditors.\55\
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\51\ Id. Regulation 23.101(a)(1)(i) references Federal Reserve
Board Rule 217.20 (12 CFR 217.20) for purposes of defining the terms
used in establishing the minimum capital requirements under the
Bank-Based Approach.
\52\ See 12 CFR 217.20(b).
\53\ See 12 CFR 217.20(c).
\54\ See 12 CFR 217.20(d).
\55\ The subordinated debt must meet the requirements set forth
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR
23.101(a)(1)(i)(B).
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Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are unencumbered and generally long-term or permanent forms of
capital that help ensure that a nonbank SD will be able to absorb
losses resulting from its operations and maintain confidence in the
nonbank SD as a going concern. In addition, in setting an equity ratio
requirement, this limits the amount of asset growth and leverage a
nonbank SD can incur, as a nonbank SD must fund its asset growth with a
certain percentage of regulatory capital.
A nonbank SD also must compute its risk-weighted assets using
standardized capital charges or, if approved, internal models. Risk-
weighting assets involves adjusting the notional or carrying value of
each asset based on the inherent risk of the asset. Less risky assets
are adjusted to lower values (i.e., have less risk-weight) than more
risky assets. As a result, nonbank SDs are required to hold lower
levels of regulatory capital for less risky assets and higher levels of
regulatory capital for riskier assets.
Nonbank SDs not approved to use internal models to risk-weight
their assets must compute market risk capital charges using the
standardized charges contained in CFTC Regulation 1.17 and SEC Rule
18a-1, and must compute their credit risk charges using the
standardized capital charges set forth in regulations of the Federal
Reserve Board for bank holding companies (Subpart D of 17 CFR part
217).\56\
---------------------------------------------------------------------------
\56\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the
term BHC risk-weighted assets in 17 CFR 23.100.
---------------------------------------------------------------------------
Standardized market risk charges are computed under CFTC Regulation
1.17 and SEC Rule 18a-1 by multiplying, as appropriate to the specific
asset schedule, the notional value or market value of the nonbank SD's
proprietary financial positions (such as swaps, security-based swaps,
futures, equities, and U.S. Treasuries) by fixed percentages set forth
in the Regulation or Rule.\57\ Standardized credit risk charges require
the nonbank SD to multiply on-balance sheet and off-balance sheet
exposures (such as receivables from counterparties, debt instruments,
and exposures from derivatives) by predefined percentages set forth in
the applicable Federal Reserve Board regulations contained in Subpart D
of 17 CFR part 217.
---------------------------------------------------------------------------
\57\ See 17 CFR 1.17(c)(5) and 17 CFR 240.15c3-1(c)(2).
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A nonbank SD also may apply to the Commission or NFA for approval
to use internal models to compute market risk exposure and/or credit
risk exposure for purposes of determining its total risk-weighted
assets.\58\ Nonbank SDs approved to use internal models for the
calculation of credit risk or market risk, or both, must follow the
model requirements set forth in Federal Reserve Board regulations for
bank holding companies (Subpart E and F, respectively, of 17 CFR part
217). Credit risk and market risk capital charges computed with
internal models require the estimation of potential losses, with a
certain degree of likelihood, within a specified time period, of a
portfolio of assets. Internal models allow for consideration of
potential co-movement of prices across assets in the portfolio, leading
to offsets of gains and losses. Internal credit risk models can also
further include estimation of the likelihood of default of
counterparties.
---------------------------------------------------------------------------
\58\ See 17 CFR 23.102.
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B. General Overview of Capital Rules for Japanese Nonbank SDs
The Japanese Capital Rules impose bank-like capital requirements on
a Japanese nonbank SD that are consistent with the BCBS framework for
international bank-based capital standards.\59\ The Japanese Capital
Rules are intended to require each Japanese nonbank SD to hold a
sufficient amount of qualifying equity and subordinated debt to absorb
decreases in the value of firm assets and to cover losses from its
activities, including possible counterparty defaults and margin
collateral shortfalls associated with its swap dealing activities,
without the firm becoming insolvent.
---------------------------------------------------------------------------
\59\ FSA Application, p. 9.
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The Japanese Capital Rules require each Japanese nonbank SD to hold
and maintain a ``capital adequacy amount'' equal to 120 percent or more
of the Japanese nonbank SD's ``risk equivalent amount.'' \60\ A
Japanese nonbank SD's ``capital adequacy amount'' is composed of the
firm's equity classified as ``Basic Items'' and ``Supplemental Items.''
\61\ Basic Items are composed of the firm's balance sheet capital
including: (i) issued and outstanding shares; (ii) the payment for an
application for new shares; (iii) the capital surplus; (iv) the earned
surplus; (v) the negative valuation difference on available-for-sale
securities; and (vi) the firm's own treasury stock.\62\ Supplemental
Items provide an additional layer of capital beyond Basic Items and are
composed of the positive valuation difference on available-for-sale
securities and certain subordinated debt instruments.\63\
---------------------------------------------------------------------------
\60\ Article 46-6(2) of the FIEA, Article 176 of the COO and
Section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the
Supervisory Guidelines for FIBO.
\61\ FSA Application, p. 14.
\62\ Article 176(1)(i) through (vi) of the COO.
\63\ Article 176(1)(vii) of the COO.
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A Japanese nonbank SD's capital adequacy amount must be composed of
at least 50 percent Basic Items, and limits are imposed on the
aggregate amount of subordinated debt that may be used to meet the
capital adequacy amount.\64\ Subordinated debt also must satisfy
specified conditions in order to be included in the Japanese nonbank
SD's capital. Specifically, the subordinated debt instrument must: (i)
contain special provisions subordinating the rights of the lender to
the payment of principal and interest; (ii) not be secured by the
Japanese nonbank SD; (iii) have a minimum original maturity of more
than five years for long term subordinated debt, and at least two years
for short term subordinated debt; (iv) provide that any early
redemption must be done voluntarily by the Japanese nonbank SD and must
be approved by the FSA; and (v) contain special provisions setting
forth that no interest payment shall be made to the lender if such
payment would result in the Japanese nonbank SD capital adequacy ratio
falling below certain thresholds.\65\
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\64\ The Japanese Capital Rules provide that the total amount of
Supplemental Items must be less than the total amount of the
Japanese nonbank SD's Basic Items. See Article 176(1)(vii) of the
COO.
\65\ Article 176(2) and (3) of the COO.
---------------------------------------------------------------------------
A Japanese nonbank SD's ``risk equivalent amount'' is calculated as
the sum of the firm's: (i) market risk equivalent amount, which is the
amount equivalent to possible risks which may accrue due to
fluctuations in the prices of securities and other proprietary assets
and transactions held; \66\ (ii) counterparty risk equivalent amount,
which is the amount equivalent to possible risks which may accrue due
to the default in performance of contracts by the counterparties to
transactions or any other reason; \67\ and (iii) basic risk equivalent
amount, which is the amount equivalent to possible risk which may
accrue in the ordinary course of
[[Page 48098]]
executing business, such as errors in business handling.\68\ The risk
equivalent amount is a method of risk-weighting the Japanese nonbank
SD's assets by adjusting the notional or carrying value of each asset
based on the inherent risk of the asset. Less risky assets have a lower
risk equivalent amount than assets with higher risk. As a result,
Japanese nonbank SDs are required to hold lower levels of regulatory
capital for assets with a lower risk equivalent amount and higher
levels of regulatory capital for assets with a higher level of risk
equivalent amount.
---------------------------------------------------------------------------
\66\ Article 178(1)(i) of the COO and Article 10 through 14 of
the Notice on Capital. The ``market risk equivalent amount''
corresponds to ``market risk'' in the BCBS and Bank-Based Approach
frameworks.
\67\ Article 178(1)(ii) of the COO and Article 15 through 15-7
of the Notice on Capital. The ``counterparty risk equivalent
amount'' corresponds to ``credit risk'' in the BCBS and Bank-Based
Approach frameworks.
\68\ Article 178(1)(iii) of the COO and Article 16 of the Notice
on Capital.
---------------------------------------------------------------------------
To calculate its risk equivalent amount, a Japanese nonbank SD
risk-weights its assets and exposures using specified standardized
weights or approved internal model-based methodologies. The Japanese
Capital Rules, including various ordinances, notices \69\ and
guidelines,\70\ set out quantitative and qualitative requirements that
internal models must meet in order to obtain and maintain approval.
Topics addressed by the quantitative and qualitative requirements
include model governance, validation, monitoring, and review.
---------------------------------------------------------------------------
\69\ Article 13 of the Notice on Capital.
\70\ Principles for Model Risk Management, Financial Services
Agency of Japan (November 12, 2021).
---------------------------------------------------------------------------
Modeled credit risk and market risk capital charges require the
estimation of potential losses, with a certain degree of likelihood,
within a specified time period, of a portfolio of assets.\71\ Internal
models allow for consideration of potential co-movement of prices
across assets in the portfolio, leading to offsets of gains and losses.
Internal credit risk models can also further include estimation of the
likelihood of default of counterparties.
---------------------------------------------------------------------------
\71\ The Japanese Capital Rules require Japanese nonbank SDs
with model approval for market risk to use a VaR model with a 99
percent, one-tailed confidence interval with (i) price changes
equivalent to a ten business-day movement in rates and prices, (ii)
effective historical observation periods of at least one year, and
(iii) at least monthly data set updates. See Article 13(3)(i), (ii),
and (iv) of the Notice on Capital. Japanese nonbank SDs approved to
use credit risk models are required to use specified formulas to
calculate the expected exposure at default of the counterparty. See
Article 15-2 of the Notice on Capital.
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III. Commission Analysis of the Comparability of the Japanese Capital
Rules and Japanese Financial Reporting Rules With the CFTC Capital
Rules and CFTC Financial Reporting Rules
The following section provides a description and comparative
analysis of the regulatory requirements of the Japanese Capital Rules
and Japanese Financial Reporting Rules to the CFTC Capital Rules and
CFTC Financial Reporting Rules. Immediately following a description of
the requirement(s) of the CFTC Capital Rules or the CFTC Financial
Reporting Rules for which a comparability determination was requested
by the FSA, the Commission provides a description of Japan's
corresponding laws, regulations, or rules. The Commission then provides
a comparative analysis of the Japanese Capital Rules or the Japanese
Financial Reporting Rules with the corresponding CFTC Capital Rules or
CFTC Financial Reporting Rules. The Commission identifies any material
differences between the respective rules.
The Commission performed this proposed Capital Comparability
Determination by assessing the comparability of the Japanese Capital
Rules for Japanese nonbank SDs as set forth in the FSA Application and
in the English language translation of certain Japanese laws and
regulations, with the Commission's Bank-Based Approach. For clarity,
the Commission did not assess the comparability of the Japanese Capital
Rules to the Commission's TNW Approach or NLA Approach as the
Commission understands that all Japanese nonbank SDs, as of the date of
the FSA Application, are subject to the current bank-based capital
approach of the Japanese Capital Rules. Accordingly, for clarity, when
the Commission makes a preliminary determination herein about the
comparability of the Japanese Capital Rules with the CFTC Capital
Rules, the determination pertains to the comparability of the Japanese
Capital Rules with the Bank-Based Approach under the CFTC Capital
Rules.
As described below, it is proposed that any material changes to the
Japanese Capital Rules will require notification to the Commission.
Therefore, if there are subsequent material changes to the Japanese
Capital Rules to include, for example, another capital approach,--the
Commission will review and assess the impact of such changes on the
Capital Comparability Determination Order as it is then in effect, and
may amend or supplement the Order.\72\
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\72\ The Commission also may amend or supplement the Order to
address any material changes to the CFTC Capital Rules and CFTC
Financial Reporting Rules that are adopted after a final Order is
issued.
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In addition, although the BCBS bank capital standards establish
minimum capital standards that are consistent with the requirements of
the Commission's Bank-Based Approach, the Commission notes that
consistency with the BCBS standards is not determinative of a finding
of comparability with the CFTC Capital Rules. In the Commission's view,
a foreign jurisdiction's consistency with the BCBS international bank
standards is an element in the Commission's comparability assessment,
but, in and of itself, it may not be sufficient to demonstrate
comparability with the CFTC Capital Rules without an assessment of the
individual elements of the foreign jurisdiction's capital framework.
Capital and financial reporting regimes are complex structures
comprised of a number of interrelated regulatory components.
Differences in how jurisdictions approach and implement these regimes
are expected, even among jurisdictions that base their requirements on
the principles and standards set forth in the BCBS international
framework. Therefore, the Commission's comparability determination
involves a detailed assessment of the relevant requirements of the
foreign jurisdiction and whether those requirements, viewed in the
aggregate, lead to an outcome that is comparable to the outcome of the
CFTC's corresponding requirements. Consistent with this approach, the
Commission has grouped the CFTC Capital Rules and the CFTC Financial
Reporting Rules into key categories that focus the analysis on whether
the Japanese capital and financial reporting requirements are
comparable to the Commission's requirements in purpose and effect, and
not whether the Japanese requirements meet every aspect or contain
identical elements as the Commission's requirements.
Specifically, as discussed in detail below, the Commission used the
following key categories in its review: (i) the quality of the equity
and debt instruments that qualify as regulatory capital, and the extent
to which the regulatory capital represents committed and permanent
capital that would be available to absorb unexpected losses or
counterparty defaults; (ii) the process of establishing minimum capital
requirements for a Japanese nonbank SD and how such process addresses
market risk and credit risk of the firm's on-balance sheet and off-
balance sheet exposures; (iii) the financial reports and other
financial information submitted by a Japanese nonbank SD to its
relevant regulatory authorities to effectively monitor the financial
condition of the firm; and (iv) the regulatory notices and other
communications between the Japanese nonbank SD and its relevant
regulatory authorities that detail
[[Page 48099]]
potential adverse financial or operational issues that may impact the
firm. The Commission also reviewed the manner in which compliance by a
Japanese nonbank SD with the Japanese Capital Rules and Japanese
Financial Reporting Rules is monitored and enforced. The Commission
invites public comment on all aspects of the FSA Application and on the
Commission's proposed Capital Comparability Determination discussed
below.
A. Regulatory Objectives of CFTC Capital Rules and CFTC Financial
Reporting Rules and Japanese Capital Rules and Japanese Financial
Reporting Rules
1. Regulatory Objectives of CFTC Capital Rules and CFTC Financial
Reporting Rules
The regulatory objectives of the CFTC Capital Rules and the CFTC
Financial Reporting Rules are to further the Congressional mandate to
ensure the safety and soundness of nonbank SDs to mitigate the greater
risk to nonbank SDs and the financial system arising from the use of
swaps that are not cleared.\73\ A primary function of the nonbank SD's
capital is to protect the solvency of the firm from decreases in the
value of firm assets and from losses, including losses resulting from
counterparty defaults and margin collateral failures, by requiring the
firm to maintain an appropriate level of capital, including qualifying
subordinated debt, to absorb such losses without becoming insolvent.
With respect to swap positions, capital and margin perform
complementary risk mitigation functions by protecting nonbank SDs,
containing the amount of risk in the financial system as a whole, and
reducing the potential for contagion arising from uncleared swaps.
---------------------------------------------------------------------------
\73\ See 7 U.S.C. 6s(e)(3)(A).
---------------------------------------------------------------------------
The objective of the CFTC Financial Reporting Rules is to provide
the Commission with the means to monitor and assess a nonbank SD's
financial condition, including the nonbank SD's compliance with minimum
capital requirements. The CFTC Financial Reporting Rules are designed
to provide the Commission and NFA, which along with the Commission
oversees nonbank SDs' compliance with Commission regulations, with a
comprehensive view of the financial health and activities of the
nonbank SD. The Commission's rules require nonbank SDs to file
financial information, including periodic unaudited and annual audited
financial statements, specific financial position information, and
notices of certain events that may indicate a potential financial or
operational issue that may adversely impact the nonbank SD's ability to
meet its obligations to counterparties and other creditors in the swaps
market, or impact the firm's solvency.
2. Regulatory Objective of Japanese Capital Rules and Japanese
Financial Reporting Rules
The regulatory objective of the Japanese Capital Rules is to ensure
the safety and soundness of FIBOs, including Japanese nonbank SDs. The
Japanese Capital Rules are designed to preserve the financial stability
and solvency of a Japanese nonbank SD by requiring the firm to maintain
a sufficient amount of qualifying equity and subordinated debt to
absorb decreases in the value of firm assets and to cover losses from
business activities, including counterparty defaults and margin
collateral shortfalls associated with the firm's swap dealing
activities. The Japanese Capital Rules also place an emphasis on high
quality equity, as a Japanese nonbank SD must maintain at least 50
percent of its minimum capital requirement in the form of Basic
Items.\74\ The Japanese Capital Rules further enhance a Japanese
nonbank SD's capital available to meet its minimum capital requirements
by requiring the firm to subtract the balance sheet carrying value of
its fixed assets from the firm's Basic Items in computing its minimum
capital.\75\
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\74\ The Japanese Capital Rules provide that the total amount of
Supplemental Items must be less than the total amount of the
Japanese nonbank SD's Basic Items. See Article 176(1)(vii) of the
COO.
\75\ Article 177 of the COO. The Japanese Capital Rules require
a Japanese nonbank SD to deduct fixed assets from the firm's Basic
Items to better ensure that the Japanese nonbank's regulatory
capital represents more liquid assets that may be promptly
liquidated at values comparable to carrying value to meet
obligations to creditors and to cover losses.
---------------------------------------------------------------------------
The objective of the Japanese Financial Reporting Rules is to
enable the FSA to assess the financial condition and safety and
soundness of Japanese nonbank SDs. The Japanese Financial Reporting
Rules aim to achieve this objective by requiring each Japanese nonbank
SD to provide financial reports and other financial position and
capital information to the FSA on a regular basis. The financial
reporting by a Japanese nonbank SD provides the FSA with information
necessary to effectively monitor the Japanese nonbank SD's overall
financial condition and its ability to meet its regulatory obligations
as a FIBO.
3. Commission Analysis
The Commission has reviewed the FSA Application and the relevant
Japanese laws and regulations, and has preliminarily determined that
the overall objectives of Japanese Capital Rules and CFTC Capital Rules
are comparable in that both sets of rules are intended to ensure the
safety and soundness of nonbank SDs by establishing a regulatory regime
that requires nonbank SDs to maintain a sufficient amount of qualifying
regulatory capital to absorb losses, including losses from swaps and
other trading activities, and to absorb decreases in the value of firm
assets without the nonbank SDs becoming insolvent. The Japanese Capital
Rules and CFTC Capital Rules are also based on, and consistent with,
the BCBS international bank capital framework, which was designed to
ensure that banking entities hold sufficient levels of capital to
absorb losses and decreases in the value of assets without the banks
becoming insolvent.
The Japanese Capital Rules are comparable in purpose and effect to
the CFTC Capital Rules in that both regulatory approaches compute the
minimum capital requirements based on the level of a nonbank SD's on-
balance sheet and off-balance sheet exposures, with the objective and
purpose of ensuring that the nonbank SD's capital is adequate to absorb
losses resulting from such exposures. The Japanese Capital Rules and
CFTC Capital Rules also provide for a comparable approach to the
calculation of on-balance sheet and off-balance sheet risk exposures
using standardized or internal model-based approaches that result in
comparable risk exposure amounts. The Japanese Capital Rules' and CFTC
Capital Rules' requirements for identifying and measuring on-balance
sheet and off-balance sheet exposures under standardized or internal
model-based approaches are also consistent with the requirements set
forth under the BCBS international bank capital framework for
identifying and measuring on-balance sheet and off-balance sheet
exposures.
The Japanese Capital Rules and CFTC Capital Rules further achieve
comparable outcomes and are comparable in purpose and effect in that
both limit the types of capital instruments that may qualify as
regulatory capital to cover the on-balance sheet and off-balance sheet
risk exposures to high quality equity capital and qualifying
subordinated debt instruments that meet conditions designed to ensure
that the holders of
[[Page 48100]]
the debt have effectively subordinated their claims to other creditors
of the nonbank SD. Both the Japanese Capital Rules and the CFTC Capital
Rules define high quality capital by the degree to which the capital
represents permanent capital that is contributed, or readily available
to a nonbank SD, on an unrestricted basis to absorb unexpected losses,
including losses from swaps trading and other activities, without the
nonbank SD becoming insolvent.
The Japanese Financial Reporting Rules are also comparable in
purpose and effect with the CFTC Financial Reporting Rules as both the
FSA and CFTC require nonbank SDs to file periodic financial reports,
including unaudited financial reports and an annual audited financial
report, detailing their financial operations and demonstrating their
compliance with minimum capital requirements. In addition to providing
the CFTC and FSA with information necessary to comprehensively assess
the financial condition of a nonbank SD on an ongoing basis, the
financial reports further provide the CFTC and FSA with information
regarding potential changes in a nonbank SD's risk profile by
disclosing changes in account balances reported over a period of time.
Such changes in account balances may indicate that the nonbank SD has
entered into new lines of business, has increased its activity in an
existing line of business relative to other activities, or has
terminated a previous line of business.
The prompt and effective monitoring of the financial condition of
nonbank SDs through the receipt and review of periodic financial
reports supports the Commission and FSA in meeting their respective
objectives of ensuring the safety and soundness of nonbank SDs. In this
connection, the early identification of potential financial issues
provides the Commission and FSA with an opportunity to address such
issues with the nonbank SD before they develop to a state where the
financial condition of the firm is impaired such that it may no longer
hold a sufficient amount of qualifying regulatory capital to absorb
decreases in the value of firm assets or cover losses from its business
activities, including the firm's swap dealing activities and
obligations to swap counterparties.
The Commission invites public comment on its analysis above,
including comment on the FSA Application and relevant Japanese laws and
regulations.
B. Nonbank Swap Dealer Qualifying Capital
1. CFTC Capital Rules: Qualifying Capital Under Bank-Based Approach
The CFTC Capital Rules require a nonbank SD electing the Bank-Based
Approach to maintain regulatory capital in the form of common equity
tier 1 capital, additional tier 1 capital, and tier 2 capital in
amounts that meet certain stated minimum requirements set forth in
Regulation 23.101.\76\ Common equity tier 1 capital, additional tier 1
capital, and tier 2 capital are composed of certain defined forms of
equity of the nonbank SD, including common stock, retained earnings,
and qualifying subordinated debt.\77\ The Commission's requirement for
a nonbank SD to maintain a minimum amount of defined qualifying capital
and subordinated debt is intended to ensure that the firm maintains a
sufficient amount of regulatory capital to absorb decreases in the
value of the firm's assets and to cover losses resulting from the
firm's swap dealing and other activities, without the firm becoming
insolvent.
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\76\ See 17 CFR 23.101(a)(1)(i).
\77\ The terms ``common equity tier 1 capital,'' ``additional
tier 1 capital,'' and ``tier 2 capital'' are defined in the bank
holding company regulations of the Federal Reserve Board. See 12 CFR
217.20.
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Common equity tier 1 capital is generally composed of an entity's
common stock instruments and any related surpluses, retained earnings,
and accumulated other comprehensive income, and is a more conservative
or permanent form of capital than additional tier 1 and tier 2
capital.\78\ Additional tier 1 capital is generally composed of equity
instruments such as preferred stock and certain hybrid securities that
may be converted to common stock if triggering events occur.\79\ Total
tier 1 capital is composed of common equity tier 1 capital and further
includes additional tier 1 capital.\80\ Tier 2 capital includes certain
types of instruments that include both debt and equity characteristics
such as qualifying subordinated debt.\81\
---------------------------------------------------------------------------
\78\ 12 CFR 217.20.
\79\ Id.
\80\ Id.
\81\ Id.
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Subordinated debt must meet certain conditions to qualify as tier 2
capital under the CFTC Capital Rules. Specifically, subordinated debt
instruments must have a term of at least one year (with the exception
of approved revolving subordinated debt agreements which may have a
maturity term that is less than one year), and contain terms that
effectively subordinate the rights of lenders to receive any payments,
including accrued interest, to other creditors of the firm.\82\
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\82\ The subordinated debt must meet the requirements set forth
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR
23.101(a)(1)(i)(B).
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Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are permitted to be included in a nonbank SD's regulatory
capital and used to meet the firm's minimum capital requirement due to
their characteristics of being permanent forms of capital that are
subordinate to the claims of other creditors, which ensures that a
nonbank SD will have this regulatory capital to absorb decreases in the
value of the firm's assets and losses from business activities,
including swap dealing activities, without the firm becoming insolvent.
2. Japanese Capital Rules: Qualifying Capital
The Japanese Capital Rules require each Japanese nonbank SD to
maintain a ``capital adequacy amount'' (i.e., Basic Items and
Supplemental Items) that equals or exceeds 120 percent of the firm's
``risk equivalent amount,'' which is the sum of the firm's market risk,
credit risk, and basic risk.\83\ Basic Items are composed of the
Japanese nonbank SD's balance sheet capital including: issued and
outstanding shares; (ii) the payment for an application for new shares;
(iii) the capital surplus; (iv) the earned surplus; (v) the negative
valuation difference on available-for-sale securities; and (vi) the
firm's own treasury stock.\84\ Supplemental Items include the positive
valuation difference on available-for-sale securities and certain
subordinated debt instruments.\85\ Subordinated debt instruments also
must meet certain conditions to qualify as Supplemental Items under the
Japanese Capital Rules, including containing appropriate provisions
subordinating the rights of the lender to the payment of principal and
interest to other creditors of the Japanese nonbank SD.\86\ The
Japanese Capital Rules also provide that a minimum of 50 percent of a
Japanese nonbank SD's capital adequacy amount must be composed of Basic
Items.\87\
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\83\ See Article 46-6-2 of the FIEA, Article 176 of the COO and
Section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the
Supervisory Guidelines for FIBO.
\84\ See Article 176(1)(i) through (vi) of the COO.
\85\ See Article 176(1)(vii) of the COO.
\86\ Article 176(2) and (3) of the COO.
\87\ FSA Application, pp. 14-15.
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The Japanese Capital Rules further require a Japanese nonbank SD,
in computing its capital adequacy amount, to deduct the balance sheet
carrying
[[Page 48101]]
value of fixed assets from its Basic Items.\88\ The deduction of the
carrying value of fixed assets is a conservative approach to the
computation of a Japanese nonbank SD's capital adequacy amount as it
excludes the value of non-liquid fixed assets from the firm's total
Basic Items. The deduction of the carrying value of fixed assets from a
Japanese nonbank SD's Basic Items reduces the amount of regulatory
capital that the firm may recognize in meeting its capital
requirements, and places an emphasis on the Japanese nonbank SD
maintaining liquid assets to meet its minimum capital requirement to
absorb business losses and decreases in the value of firm assets, and
to satisfy financial obligations to counterparties and creditors.\89\
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\88\ See Article 177 of the COO for a breakdown of the fixed
assets to be deducted from the Basic Items.
\89\ The Japanese Capital Rules require a Japanese nonbank SD to
deduct illiquid fixed assets from its regulatory capital to better
ensure that the firm's regulatory capital reflects assets that may
be more promptly liquidated at values comparable to carrying values
to meet losses. As discussed infra, under the CFTC Capital Rules,
fixed assets are not deducted from regulatory capital, and are
included in the nonbank SD's risk weighted assets.
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3. Commission Analysis
The Commission has reviewed the FSA Application and the relevant
Japanese laws and regulations, and has preliminarily determined that
the Japanese Capital Rules are comparable in purpose and effect to CFTC
Capital Rules with regard to the types and characteristics of a nonbank
SD's equity that qualifies as regulatory capital in meeting its minimum
requirements. The Japanese Capital Rules and the CFTC Capital Rules for
nonbank SDs both require a nonbank SD to maintain a quantity of high-
quality and permanent capital that, based on the firm's activities and
on-balance sheet and off-balance sheet exposures, is sufficient to
absorb losses and decreases in the value of the firm's assets without
resulting in the firm becoming insolvent.
The Japanese Capital Rules and the CFTC Capital Rules permit
nonbank SDs to recognize comparable forms of equity capital and
qualifying subordinated debt instruments toward meeting minimum capital
requirements, with both the Japanese Capital Rules and the CFTC Capital
Rules placing an emphasis on high quality equity capital instruments.
In this regard, the types and characteristics of the equity instruments
included in Basic Items under the Japanese Capital Rules are comparable
to the types and characteristics of equity instruments comprising
common equity tier 1 capital and additional tier 1 capital under the
CFTC Capital Rules. Specifically, the Japanese Capital Rules' Basic
Items and the CFTC Capital Rules' common equity tier 1 capital and
additional tier 1 capital are comparable in that these forms of equity
capital have similar characteristics (e.g., the equity must be in the
form of high-quality, committed, and permanent capital) and these forms
of capital represent contributed equity capital that generally has no
priority to the distribution of firm assets or income with respect to
other shareholders or creditors of the firm, which allows a nonbank SD
to use this equity to absorb decreases in the value of firm assets and
cover losses from business activities, including the firm's swap
dealing activities.
Supplemental Items under the Japanese Capital Rules are also
comparable to tier 2 capital under the CFTC Capital Rules.
Specifically, the qualifying conditions imposed on subordinated debt
instruments are comparable under the Japanese Capital Rules and the
CFTC Capital Rules and ensure that the debt has qualities that support
its recognition by a nonbank SD as equity for capital purposes,
including that the debt lenders have effectively subordinated their
claims for repayment on the debt to other creditors of the nonbank SD.
Qualifying subordinated debt under the Japanese Capital Rules and CFTC
Capital Rules also must contain provisions limiting or restricting
repayment of the subordinated loans if such repayments result in the
nonbank SD's equity falling below certain defined thresholds. These
terms and conditions provide assurances that the subordinated debt is
appropriate to be recognized as regulatory capital available to a
nonbank SD to meet its obligations and to absorb business losses and
decreases in the value of firm assets.
The Japanese Capital Rules differ from the CFTC Capital Rules,
however, in that the Japanese Capital Rules require Japanese nonbank
SDs to exclude the carrying value of fixed assets from the sum of the
Basic Items in computing the capital adequacy amount. The CFTC Capital
Rules do not require a nonbank SD to exclude fixed assets from the
firm's common equity tier 1 capital or additional tier 1 capital. The
deduction of the carrying value of fixed assets is a stricter capital
standard as it imposes an obligation on Japanese nonbank SDs to meet
minimum regulatory capital requirements with assets that are more
liquid than fixed assets.
Having reviewed the FSA Application and the relevant Japanese laws
and regulations, the Commission has made a preliminary determination
that the Japanese Capital Rules and CFTC Capital Rules impose
comparable requirements on Japanese nonbank SDs with respect to the
types and characteristics of equity capital that must be used to meet
minimum regulatory capital requirements. The Commission invites public
comment on its analysis above, including comment on the FSA Application
and relevant Japanese laws and regulations.
C. Nonbank Swap Dealer Minimum Capital Requirement
1. CFTC Capital Rules: Nonbank SD Minimum Capital Requirement
The CFTC Capital Rules require a nonbank SD electing the Bank-Based
Approach to maintain regulatory capital that satisfies each of the
following criteria: (i) an amount of common equity tier 1 capital of at
least $20 million; (ii) an aggregate of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital in an amount equal to or
in excess of 8 percent of the nonbank SD's uncleared swap margin
amount: (iii) an aggregate amount of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital equal to or greater than
8 percent of the nonbank SD's total risk-weighted assets, provided that
common equity tier 1 capital comprises at least 6.5 percent of the 8
percent; and (iv) the amount of capital required by the NFA.\90\
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\90\ See 17 CFR 23.101(a)(1)(i). NFA has not adopted a separate
capital requirement for a nonbank SD.
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Prong (i) above requires each nonbank SD electing the Bank-Based
Approach to maintain a minimum of $20 million of common equity tier 1
capital in order to operate as a nonbank SD. The requirement that each
nonbank SD electing the CFTC Bank-Based Approach maintain a minimum of
$20 million of common equity tier 1 capital is also consistent with the
minimum capital requirement for nonbank SDs electing the NLA Approach
and the TNW Approach.\91\ The Commission adopted this minimum
requirement as it believed that the role a nonbank SD performs in the
financial markets by engaging in swap dealing activities warranted a
minimum level of capital, stated as a fixed dollar amount that does not
fluctuate with the level of the firm's
[[Page 48102]]
dealing activities, to help ensure that the firm meets its financial
commitments to swap counterparties and creditors without the firm
becoming insolvent.\92\
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\91\ Nonbank SDs electing the NLA Approach are subject to a
minimum capital requirement that includes a fixed minimum dollar
amount of net capital of $20 million. See 17 CFR
23.101(a)(1)(ii)(A)(1). Nonbank SDs electing the TNW Approach are
required to maintain levels of tangible net worth that equals or
exceeds $20 million plus the amount of the nonbank SDs' market risk
and credit risk associated with the firms' dealing activities. See
17 CFR 23.101(a)(2)(ii)(A).
\92\ See, e.g., 85 FR 57492.
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Prong (ii) above is a minimum capital requirement that is based on
the amount of uncleared margin for swap transactions entered into by
the nonbank SD and is computed on a counterparty by counterparty basis.
The requirement for a nonbank SD to maintain minimum capital equal to 8
percent of the firm's uncleared swap margin provides a capital floor
based on a measure of the risk and volume of the swap positions, and
the number of counterparties and the complexity of operations, of the
nonbank SD. The intent of the minimum capital requirement based on a
percentage of the nonbank SD's uncleared swap margin was to establish a
minimum capital requirement that would help ensure that the nonbank SD
meets all of its obligations as a SD to market participants, and to
cover potential operational risk, legal risk and liquidity risk in
addition to the risks associated with its trading portfolio.\93\
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\93\ See, 85 FR 57462.
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Prong (iii) above is a minimum capital requirement that is based on
the Federal Reserve Board's capital requirements for bank holding
companies and is consistent with the BCBS international capital
adequacy framework for banking institutions. As noted above, a nonbank
SD under prong (iii) must maintain an aggregate of common equity tier 1
capital, additional tier 1 capital, and tier 2 capital in an amount
equal to or greater than 8 percent of the nonbank SD's total risk-
weighted assets, with common equity tier 1 capital comprising at least
6.5 percent of the 8 percent. Risk-weighted assets are a nonbank SD's
on-balance sheet and off-balance sheet exposures, including proprietary
swap, security-based swap, equity, and futures positions, weighted
according to risk. The Bank-Based Approach requires each nonbank SD to
maintain regulatory capital in an amount that equals or exceeds 8
percent of the firm's total risk-weighted assets to help ensure that
the nonbank SD's level of capital is sufficient to absorb decreases in
the value of the firm's assets and unexpected losses resulting from
business activities, including uncollateralized defaults from swap
counterparties, without the nonbank SD becoming insolvent.
A nonbank SD must compute its risk-weighted assets using
standardized market risk and/or credit risk charges, unless the nonbank
SD has been approved by the Commission or NFA to use internal
models.\94\ For standardized market risk charges, the Commission adopts
by reference the standardized market risk charges set forth in
Regulation 1.17 for FCMs and SEC Rule 18a-1 for nonbank SBSDs.\95\ The
standardized market risk charges under Regulation 1.17 and SEC Rule
18a-1 are calculated as a percentage of the market value or notional
value of the nonbank SD's marketable securities and derivatives
positions, with the percentages applied to the market value or notional
value increasing as the expected or anticipated risk of the positions
increases.\96\ As stated above, the nonbank SD must maintain qualifying
capital in an amount that equals or exceeds 8 percent of the firm's
total market risk-weighted assets.\97\
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\94\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the
term BHC equivalent risk-weighted assets in 17 CFR 23.100.
\95\ See paragraph (3) of the definition of the term BHC
equivalent risk-weighted assets in 17 CFR 23.100.
\96\ See 17 CFR 1.17(c)(5) and 17 CFR 240.18a-1(c)(1).
\97\ See 17 CFR 23.100 (definition of BHC equivalent risk-
weighted assets). As noted, a nonbank SD is required to maintain
qualifying capital (i.e., an aggregate of common equity tier 1
capital, additional tier 1 capital, and tier 2 capital) in an amount
that exceeds 8 percent of its market risk-weighted assets and
credit-risk-weighted assets. The regulations, however, require the
nonbank SD to effectively maintain qualifying capital in excess of
100 percent of is market risk-weighted assets by requiring the
nonbank SD to multiply its market-risk weighted assets by a factor
of 12.5.
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With respect to standardized credit risk charges for exposures from
non-derivatives positions, a nonbank SD computes its on-balance sheet
and off-balance sheet exposures in accordance with the standardized
credit risk charges adopted by the Federal Reserve Board and set forth
in Subpart D of 12 CFR 217.\98\ Standardized credit risk charges are
computed by multiplying the amount of the exposure by defined
counterparty credit risk factors that range from 0 percent to 150
percent.\99\ A nonbank SD with off-balance sheet exposures is required
to calculate a credit risk charge by multiplying each exposure by a
credit conversion factor that ranges from 0 percent to 100 percent,
depending on the type of exposure.\100\
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\98\ See 23.101(a)(1)(i)(B) and paragraph (1) of the definition
of the term BHC equivalent risk-weighted assets in 17 CFR 23.100.
\99\ See 17 CFR 217.32. Lower credit risk factors are assigned
to entities with lower credit risk and higher credit risk factors
are assigned to entities with higher credit risk. For example, a
credit risk factor of 0% is applied to exposures to the U.S.
government, the Federal Reserve Bank, and U.S. government agencies
(see 12 CFR 217.32(a)(1)), and a credit risk factor of 100% is
assigned to an exposure to foreign sovereigns that are not members
of the Organization of Economic Co-operation and Development (see 12
CFR 217.32(a)(2)).
\100\ See 17 CFR 217.33.
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A nonbank SD may compute standardized credit risk charges for
derivatives positions, including uncleared swaps and non-cleared
security-based swaps, using either the current exposure method
(``CEM'') or the standardized approach for measuring counterparty
credit risk (``SA-CCR'').\101\ Both CEM and SA-CCR are non-model,
rules-based, approaches to calculating counterparty credit risk for
derivatives positions. Credit risk under CEM is the sum of: (i) the
current exposure (i.e., the positive mark-to-market) of the derivatives
contract; and (ii) the potential future exposure, which is calculated
as the product of the notional principal amount of the derivatives
contract multiplied by a standard credit risk conversion factor set
forth in the rules of the Federal Reserve Board.\102\ Credit risk under
SA-CCR is defined as the exposure at default amount of a derivatives
contract, which is computed as the sum of: (i) the replacement costs of
the contract (i.e., the positive mark-to market); and (ii) the
potential future exposure of the contract multiplied by a factor of
1.4.\103\
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\101\ See 17 CFR 217.34. See also, Regulation 23.100 (17 CFR
23.100) defining the term BHC risk-weighted assets, which provides
that a nonbank SD that does not have model approval may use either
CEM or SA-CCR to compute its exposures for over-the-counter
derivative contracts without regard to the status of its affiliate
entities to use CEM or SA-CCR under the Federal Reserve Board's
capital rules.
\102\ See 12 CFR 217.34.
\103\ See 12 CFR 217.132(c).
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A nonbank SD also may obtain approval from the Commission or NFA to
use internal models to compute market risk and/or credit risk charges
in lieu of the standardized charges. A nonbank SD seeking approval to
use an internal model is required to submit an application to the
Commission or NFA.\104\ The application is required to include, among
other things, a list of categories of positions that the nonbank SD
holds in its proprietary accounts and a brief description of the
methods that the nonbank SD will use to calculate deductions for market
risk and/or credit risk charges for such positions, as well as a
description of the mathematical models used to compute market risk and
credit risk charges.
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\104\ See 17 CFR 23.102(c).
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A nonbank SD approved by the Commission or NFA to use internal
models to compute market risk is required to comply with Subpart F of
the Federal Reserve Board's Part 217
[[Page 48103]]
regulations (``Subpart F'').\105\ Subpart F is based on models that are
consistent with the BCBS Basel 2.5 capital framework.\106\ The
Commission's qualitative and quantitative requirements for internal
capital models also are comparable to the SEC's existing internal
capital model requirements for broker-dealers in securities and
SBSDs,\107\ which are also broadly based on the BCBS Basel 2.5 capital
framework.
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\105\ See paragraph (4) of the definition of BHC equivalent
risk-weighted assets in 17 CFR 23.100.
\106\ Compare 17 CFR 23.100 (providing for a nonbank SD that is
approved to use internal models to calculate market and credit risk
to calculate its RWAs using Subparts E and F of 12 CFR part 217),
Subpart F of 12 CFR, 17 CFR 23.101(a)(1)(ii) (providing for an SD
that elects the Net Liquid Assets Approach to calculate its net
capital in accordance with Rule 18a-1), and 17 CFR 23.102(a), with
Basel Committee on Banking Supervision, Revisions to the Basel II
Market Risk Framework (2011), https://www.bis.org/publ/bcbs193.pdf
(describing the revised internal model approach under Basel 2.5).
\107\ The SEC internal model requirements for SBSDs are listed
in 17 CFR 240.18a-1(d). See also SEC FOCUS Report Part II,
Computation of Net Capital (Filer Authorized to Use Models)
(providing for inclusion of a market risk exposure section for Basel
2.5 firms).
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A nonbank SD approved to use internal models to compute credit risk
is required to perform such computation in accordance with Subpart E of
the Federal Reserve Board's Part 217 regulations.\108\ These internal
credit risk modeling requirements are also based on the Basel 2.5
capital framework and the Basel 3 capital framework.
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\108\ 12 CFR 217 Subpart E.
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Under the Basel 2.5 capital framework, nonbank SDs have flexibility
in developing their internal models, but must follow certain minimum
standards. Internal market risk and credit risk models must follow a
Value at Risk (``VaR'') structure to compute, on a daily basis, a 99th
percentile, one-tailed confidence interval for the potential losses
resulting from an instantaneous price shock equivalent to a 10-day
movement in prices (unless a different time-frame is specifically
indicated). The simulation of this price shock must be based on a
historical observation period of minimum length of one year, but there
is flexibility on the method used to render simulations, such as
variance-covariance matrices, historical simulations, or Monte Carlo.
The Commission and the Basel standards for internal models also
have requirements on the selection of appropriate risk factors as well
as on data quality and update frequency.\109\ One specific concern is
that internal models must capture the non-linear price characteristics
of options positions, including but not limited to, relevant
volatilities at different maturities.\110\
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\109\ See 17 CFR Appendix A to Subpart E of Part 23(i)(2)(iii),
and Basel Committee on Banking Supervision, Revisions to the Basel
II Market Risk Framework (2011), paragraph 718(Lxxvi)(e), available
at: https://www.bis.org/publ/bcbs193.pdf.
\110\ The Commission's requirement is set forth in paragraph
(i)(2)(iv)(A) of Appendix A to Subpart E of 17 CFR part 23. See
also, Basel Committee on Banking Supervision, Revisions to the Basel
II Market Risk Framework (2011), paragraph 718(Lxxvi)(h), available
at: https://www.bis.org/publ/bcbs193.pdf.
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In addition, BCBS standards for market risk models include a series
of additive components for risks for which the broad VaR is ill-suited
or that may need targeted calculation. These include the calculation of
a Stressed VaR measure (with the same specifications as the VaR, but
calibrated to historical data from a continuous 12-month period of
significant financial stress relevant to the firm's portfolio); a
Specific Risk measure (which includes the effect of a specific
instrument); an Incremental Risk measure (which addresses changes in
the credit rating of a specific obligor which may appear as a reference
in an asset); and a Comprehensive Risk measure (which addresses risk of
correlation trading positions).
2. Japanese Capital Rules: Japanese Nonbank Swap Dealer Minimum Capital
Requirements
The Japanese Capital Rules impose bank-like capital requirements on
a Japanese nonbank SD that, consistent with the BCBS international bank
capital framework, require the Japanese nonbank SD to hold a sufficient
amount of qualifying equity capital and subordinated debt to absorb
decreases in the value of a firm assets and to cover losses from its
business activities, including the firm's swap dealing activities,
without the firm becoming insolvent. Specifically, the Japanese Capital
Rules require each Japanese nonbank SD to maintain a ``capital adequacy
amount'' that equals or exceeds 120 percent of the firm's ``risk
equivalent amount.'' \111\ The ``capital adequacy amount'' is
calculated as the Japanese nonbank SD's qualifying balance sheet equity
capital in the form of Basic Items and Supplemental Items. The Japanese
Capital Rules further require that at least 50 percent of the Japanese
nonbank SD's capital used to meet the 120 percent minimum requirement
must be composed of Basic Items, and any subordinated debt included in
Supplemental Items must meet regulatory requirements designed to ensure
that the debt is adequately subordinated to claims of other potential
creditors of the firm.\112\
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\111\ Article 46-6(2) of the FIEA, Article 176 of the COO and
Section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the
Supervisory Guidelines for FIBO.
\112\ Article 176(1)(vii) of the COO.
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The Japanese nonbank SD's ``risk equivalent amount'' is calculated
as the sum of the: (i) market risk equivalent amount; (ii) counterparty
risk equivalent amount; and (iii) basic risk equivalent amount.\113\
Comparable to nonbank SDs under the CFTC Bank-Based Approach, the
Japanese Capital Rules require Japanese nonbank SDs to compute market
risk and/or credit risk using a standardized approach or, if approved
to use internal models, market risk and/or credit risk models. The
basic risk equivalent amount is computed as an amount equal to 25
percent of the Japanese nonbank SD's defined annual operating expenses,
and is intended to provide a capital cushion to cover risks that may
accrue in the course of executing ordinary business operations, such as
error in business transactions.\114\
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\113\ Article 46-6(2) of the FIEA, Article 176 of the COO and
Section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the
Supervisory Guidelines for FIBO.
\114\ Article 178(1)(iii) of the COO and Article 16 of the
Notice on Capital.
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For standardized market risk charges, the Japanese Capital Rules
require a Japanese nonbank SD to calculate a market risk equivalent
amount to reflect possible decreases in value of the firm's financial
positions including equity risk, interest rate risk, foreign exchange
risk, commodity risk, crypto asset risk, and option risk.\115\ The
market risk equivalent amount is calculated by the Japanese nonbank SD
by multiplying specified market risk charges set forth in the Japanese
Capital Rules by the notional or market value of the relevant assets
and positions. A Japanese nonbank SD is further required to include the
full value of its market risk equivalent amount in its aggregate risk
equivalent amount, which effectively requires the Japanese nonbank SD
to hold qualifying equity capital and subordinated debt in an amount
that equals or exceeds 120 percent of the market risk equivalent
amount.
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\115\ FSA Notice No. 59 of 2007, Chapter III, Section 2, Article
4.
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With respect to credit risk for non-derivatives positions, the
Japanese Capital Rules require a Japanese nonbank SD to calculate its
standardized counterparty risk equivalent amount by multiplying its
exposure under a given transaction by the specific risk weight
applicable to the counterparty under the provisions of the
[[Page 48104]]
Japanese Capital Rules. In this regard, the Japanese Capital Rules
impose risk-weights ranging from 0 percent to 25 percent on exposures
to governmental financial institutions, non-governmental financial
institutions, general corporations, and individuals.\116\ For certain
exposures, credit ratings are used to determine the percentage of the
counterparty credit risk exposure and, if no credit ratings are
available, the Japanese nonbank SD generally applies a 25 percent risk-
weight.
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\116\ Article 15(3) of the Notice on Capital.
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A Japanese nonbank SD is required to include the full amount of the
counterparty risk equivalent in its aggregate risk equivalent amount.
Therefore, a Japanese nonbank SD is effectively required to maintain a
capital adequacy amount that is equal to or in excess of 120 percent of
its credit risk equivalent amount.
With respect to credit risk for derivatives positions, the Japanese
Capital Rules require a Japanese nonbank SD that is not approved to use
credit risk models to calculate its exposure using the CEM, which is
one of the standardized methods that a nonbank SD may use to calculate
its credit risk exposure under a derivatives transaction pursuant to
the Commission's Bank-Based Approach.\117\ Under the CEM, a Japanese
nonbank SD calculates its exposures for over-the-counter derivatives
using a standardized rules-based approach, and is required to hold an
amount of qualifying capital that equals or exceeds 120 percent of the
aggregate derivatives exposures.
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\117\ See 17 CFR 23.101(a)(1)(i) and supra, note 78.
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Japanese nonbank SDs may use internal models approved by the FSA to
calculate their market risk equivalent amount and/or counterparty risk
equivalent amount in lieu of the standardized charges. Japanese Capital
Rules set out qualitative and quantitative requirements \118\ that
internal models must meet in order to be approved for use. The Japanese
Capital Rules also require Japanese nonbank SDs to satisfy qualitative
and quantitative requirements in order to continue to use models after
obtaining the initial approval. These qualitative and quantitative
requirements address: the effective review and assessment of models
during development, validation, and periodic examinations;
identification of key assumptions and limitations; and management of
model risk. In this regard, Japanese nonbank SDs approved to use
internal models for capital purposes are subject to principles for
model risk management.\119\ The principles lay out practices for
nonbank SDs, covering model governance, model risk rating,
documentation, testing, monitoring, independent validation, controls of
vendor products and external resources, and internal audit. The ongoing
monitoring includes frequent tests, such as stress testing, backtesting
and benchmarking. The FSA periodically confirms that firms using models
are adhering to the conditions set.
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\118\ Article 13 of the Notice on Capital.
\119\ Principles for Model Risk Management, Financial Services
Agency (November 12, 2021). The principles are available at: https://www.fsa.go.jp/en/news/2021/2021112en.html.
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The internal market risk model-based methodology contained in the
Japanese Capital Rules is based on the Basel 2.5 standard,\120\ and
requires a Japanese nonbank SD to use a VaR model with a 99 percent,
one-tailed confidence level with: (i) price changes equivalent to a 10
business-day movement in rates and prices; (ii) effective historical
observation periods of at least one year; and (iii) at least monthly
data set updates.\121\ The Japanese Capital Rules require a Japanese
nonbank SD using approved internal models for market risk to calculate
a stressed VaR, specific risk, incremental risk, and comprehensive risk
of correlation trading.\122\
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\120\ Compare Article 1 through 14-11 of the Notice on Capital
with Revisions to the Basel II Market Risk Framework.
\121\ Article 13(3)(i), (ii) and (iv) of the Notice on Capital.
\122\ Article 13-2 and 14-9 of the Notice on Capital.
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The Japanese Capital Rules' internal credit risk model-based
methodology is also based on the Basel 2.5 standard. The Japanese
Capital Rules allow for the estimation of expected exposure, as a
measure of potential future exposure, based on VaR techniques as well,
with adjustments to the period of risk, as appropriate to the asset and
counterparty.\123\ Credit risk models may include internal ratings
based on the estimation of default probabilities, consistent with the
Basel framework and subject to the same model risk management
guidelines.
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\123\ FSA Notice 15.2-2.
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3. Commission Analysis
The Commission has reviewed the FSA Application and the relevant
Japanese laws and regulations, and has preliminarily determined that
the Japanese Capital Rules are comparable in purpose and effect to CFTC
Capital Rules with regard to the establishment of a nonbank SD's
minimum capital requirement and the calculation of the nonbank SD's
amount of regulatory capital. Although there are differences in the
minimum capital requirements and calculation of regulatory capital
between the Japanese Capital Rules and the CFTC Capital Rules, as
discussed below, the Commission preliminarily believes that the
Japanese Capital Rules and CFTC Capital Rules are designed to ensure
the safety and soundness of a nonbank SD and, subject to the proposed
condition discussed below, will achieve comparable outcomes by
requiring the firm to maintain a minimum level of qualifying regulatory
capital and subordinated debt to absorb losses from the firm's business
activities, including its swap dealing activities, and decreases in the
value of the firm's assets, without the nonbank SD becoming insolvent.
The CFTC Capital Rules require a nonbank SD electing the Bank-Based
Approach to maintain regulatory capital in an amount that meets or
exceeds each of the following requirements: (i) $20 million of common
equity tier 1 capital; (ii) 8 percent of the nonbank SD's uncleared
swap margin amount; (iii) 8 percent of the nonbank SD's risk-weighted
assets (with common equity tier 1 capital comprising at least 6.5
percent of the 8 percent);and (iv) the amount of capital required by
NFA.\124\ The Japanese Capital Rules require a Japanese nonbank SD to
maintain regulatory capital in an amount equal to or in excess of 9.6
percent of the market risk, credit risk, and operational risk of the
firm.\125\
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\124\ 17 CFR 23.101(a)(1)(i). NFA has not adopted additional
capital requirements for nonbank SDs and, therefore, an analysis of
the comparability of this element of the CFTC Capital Rules with the
Japanese Capital Rules is not applicable.
\125\ The Japanese Capital Rules require a Japanese nonbank SD
to maintain a capital adequacy amount that equals or exceeds 120
percent of its risk-weighted assets. Adjusting the Japanese Capital
Rules approach to be consistent with the CFTC Capital Rules approach
results in a Japanese nonbank SD having an effective minimum capital
requirement of 9.6 percent of its risk weighted assets.
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The Japanese Capital Rules differ from the CFTC Capital Rules in
that the Japanese Capital Rules do not impose a capital requirement on
Japanese nonbank SDs based on a minimum dollar amount or based on a
percentage of the margin for uncleared swap transactions. However, the
approach for conducting a Capital Comparability Determination is a
principles-based, holistic approach that focuses on whether the
applicable foreign jurisdiction's capital requirements achieve
comparable outcomes to the corresponding CFTC requirements for nonbank
SDs.\126\ The focus of the comparability determination is on
[[Page 48105]]
whether the foreign jurisdiction's capital requirements are comparable
to the Commission's in purpose and effect, and not on whether the
foreign jurisdiction's capital requirements are comparable in every
aspect or contain identical elements based on a line-by-line assessment
or comparison of the foreign jurisdiction's regulatory requirements
with the Commission's regulatory requirements.\127\
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\126\ 17 CFR 23.106(a)(3)(ii). See also 85 FR 57520 at 57521.
\127\ Id.
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Based on a principles-based assessment, the Commission
preliminarily believes, subject to the proposed condition below, and
further subject to its consideration of public comments to the proposed
Capital Comparability Determination and Order, that the purpose and
effect of the Japanese Capital Rules and the CFTC Capital Rules are
comparable. In this connection, the Japanese Capital Rules and CFTC
Capital rules are both designed to require a nonbank SD to maintain a
sufficient amount of qualifying regulatory capital and subordinated
debt to absorb losses resulting from the firm's business activities,
and decreases in the value of firm assets, without the nonbank SD
becoming insolvent. As discussed below, the Commission specifically
seeks public comment on the question of whether requirements under the
Japanese Capital Rules are comparable in purpose and effect to the
Commission's requirement for a nonbank SD to hold regulatory capital
equal to or greater than 8 percent of its uncleared swap margin amount.
The Commission preliminarily believes that the Japanese Capital
Rules and CFTC Capital Rules impose a comparable approach by requiring
a nonbank SD to maintain qualifying equity capital and qualifying
subordinated debt in an amount that equals or exceeds the nonbank SD's
risk-weighted assets, which are composed of the aggregate of the firm's
market risk and credit risk charges. The Japanese Capital Rules,
however, require a Japanese nonbank SD to maintain a higher percentage
of regulatory capital relative to the firm's risk-weighted assets than
the CFTC Capital Rules require. Specifically, the Japanese Capital
Rules require a Japanese nonbank SD to maintain regulatory capital
equal to or greater than 9.6 percent of the firm's risk-weighted
assets.\128\
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\128\ As previously noted, the Japanese Capital Rules require a
Japanese nonbank SD to maintain a capital adequacy amount that
equals or exceeds 120 percent of its risk-weighted assets. For
purposes of comparison of the two rules, the Japanese Capital Rules
effectively require a Japanese nonbank SD to maintain an effective
minimum capital ratio of 9.6 percent of the firm's risk-weighted
assets and the CFTC Capital Rules require a nonbank SD to maintain a
minimum capital ratio of 8 percent of the firm's risk-weighted
assets.
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Furthermore, the Japanese Capital Rules add operational risk to the
market risk and credit risk charges in setting the minimum capital
requirements whereas the CFTC Capital Rules sets operational risk as a
separate minimum capital requirement from the market risk and credit
risk calculation of the risk weighted assets.\129\ Specifically, as
noted above, under the Japanese Capital Rules the basic risk equivalent
amount is computed as an amount equal to 25 percent of the Japanese
nonbank SD's defined annual operating expenses, and is intended to
provide a capital cushion to cover risks that may accrue in the course
of executing ordinary business operations, such as error in business
transactions.\130\ In addition, the Japanese Capital Rules require a
Japanese nonbank SD to deduct the carrying value of fixed assets from
its Basic Items in computing its regulatory capital, which promotes a
degree of liquidity into the Japanese nonbank SD's regulatory capital.
The Commission preliminarily believes the inclusion of an operational
risk charge with the market risk and credit risk charges, and the
deduction of the carrying value of fixed assets from regulatory
capital, will achieve a comparable outcome to the Commission's
requirement for nonbank SDs to hold regulatory capital in excess of 8
percent of its uncleared swap margin amount. The Commission
specifically seeks public comment below on the comparability of this
Commission requirement with the Japanese requirements designed to
address operational risk.
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\129\ In establishing the requirement that a nonbank SD must
maintain a level of regulatory capital in excess of 8 percent of the
uncleared swap margin amount associated with the firm's swap
transactions, the Commission stated that the intent of the uncleared
swap margin amount was to establish a method of developing a minimum
amount of capital for a nonbank SD to meet all of its obligations as
a SD to market participants, and to cover potential operational
risk, legal risk and liquidity risk, and not just the risks of its
trading portfolio. See, 85 FR 57462 at 57485.
\130\ Article 178(1)(iii) of the COO and Article 16 of the
Notice on Capital. The basic risk equivalent amount is calculated as
25 percent of certain defined operating expenses incurred by the
Japanese nonbank SD over a 12-month period, and includes general
expenses, selling expenses, and financial expenses.
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The calculation of market risk charges and credit risk charges is
also comparable under the Japanese Capital Rules and the CFTC Capital
Rules. Both regimes require a nonbank SD to use standardized approaches
to compute market and credit risk, unless the firms are approved to use
internal models. The standardized approaches follow the same structure
that is now the common global standard: allocating assets to categories
according to risk and assigning each a risk weight; allocating
counterparties to categories according to risk assessments and
assigning each a risk factor; calculating gross exposures based on the
valuation of assets; calculating a net exposure allowing offsets
following well defined procedures and subject to clear limitations;
adjusting the net exposure by the market risk weights; and finally, for
credit risk exposures, multiplying the sum of net exposures to each
counterparty by the corresponding risk factor. After reviewing the
standardized risk weights contained in the Japanese Capital Rules and
the CFTC Capital Rules, the Commission preliminarily believes that the
resulting risk charges are comparable for corresponding categories of
instruments and credit exposures.
Internal market risk and credit risk models under the Japanese
Capital Rules and the CFTC Capital Rules are based on the BCBS
framework and contain comparable quantitative and qualitative
requirements covering the same risks, including comparable model risk
management requirements. As both rule sets address the same types of
risk, with similar allowed methodologies, calibrated to similar risk
levels and under similar controls, the Commission preliminarily
believes that these requirements are comparable, as they produce
similar market and credit risk charges for comparable exposures. Market
risk charges increase capital requirements, or conversely are deducted
from available capital, in full amount. Credit risk charges increase
capital requirements, or conversely are deducted from available
capital, with an adjustment. This adjustment to credit risk charges is
applied in the CFTC Capital Rules as a final multiplication of credit
risk weights by 8 percent, while the Japanese Capital Rules apply a
comparable adjustment directly via the counterparty risk weights. The
Japanese Capital Rules and the CFTC Capital Rules contain comparable
requirements for the management of model risk, which depend on a series
of controls, including the independence of validation, ongoing
monitoring and audit. The ongoing monitoring includes frequent tests,
such as stress testing, backtesting and benchmarking.
The Japanese Capital Rules differ from the CFTC Capital Rules in
that the Japanese Capital Rules do not contain a requirement that each
Japanese nonbank
[[Page 48106]]
SD maintain a fixed amount of regulatory capital. As noted previously,
the requirement in the CFTC Capital Rules for a non-bank SD to maintain
a minimum of $20 million of common equity tier 1 capital is intended to
ensure that each nonbank SD maintains a level of capital, without
regard to the firm's level of dealing activities, sufficient to meet
its obligations to swap market participants given the firm's status as
a registered SD.
The Commission preliminarily believes that each CFTC-registered
nonbank SD should maintain a minimum level of regulatory capital to
help ensure that it satisfies its regulatory obligations and meets is
financial commitments to swap counterparties and creditors without the
firm becoming insolvent. Therefore, the Commission is proposing to
condition the proposed Capital Comparability Determination Order to
require each Japanese nonbank SD to maintain a minimum level of
regulatory capital in the form of Basic Items, as defined in Article
176 of the COO. Specifically, the proposed condition would require each
Japanese nonbank SD to maintain at all times regulatory capital in the
form of Basic Items in an amount denominated in yen that is equivalent
to or greater than $20 million in U.S. dollars. The Commission is also
proposing that a Japanese nonbank SD may convert the yen-denominated
amount of its Basic Items to the U.S. dollar equivalent based on a
commercially reasonable and observed exchange rate.
Having compared the minimum capital requirements and the
calculation of regulatory capital under the Japanese Capital Rules for
Japanese nonbank SDs with the corresponding minimum capital
requirements and calculation of regulatory capital under the CFTC's
Capital Rules for nonbank SDs, the Commission preliminarily finds that,
subject to the proposed condition discussed above, the minimum capital
requirements and calculation of regulatory capital are comparable. The
Commission invites public comment on its analysis above, including
comment on the FSA Application and Japanese laws and regulations, and
the Commission's preliminary determination that the Japanese Capital
Rules and the CFTC Capital Rules are comparable in purpose and effect
and achieve comparable outcomes with respect to the minimum regulatory
capital requirements and the calculation of regulatory capital for
nonbank SDs.
The Commission also specifically seeks public comment on the
question of whether the requirement under the Japanese Capital Rules
for a Japanese nonbank SD to hold qualifying capital in an amount equal
to 25 percent of its defined annual operating expenses is sufficiently
comparable in purpose and effect to the CFTC's requirement for a
nonbank SD to hold qualifying capital in amount equal to at least 8
percent of the nonbank SD's uncleared swap margin amount.
The Commission further requests comment on the proposed condition
that each Japanese nonbank SD maintains a minimum level of regulatory
capital in the form of yen-denominated Basic Items (as defined in
Article 176 of the COO) that equals or exceeds the equivalent of $20
million U.S. dollars. Lastly, the Commission requests comment on the
proposed requirement that a Japanese nonbank SD determine the amount of
yen-denominated Basic Items it holds in U.S. dollars by using a
commercially reasonable and observed yen/U.S. dollar exchange rate.
D. Nonbank Swap Dealer Financial Reporting Requirements
1. CFTC Financial Recordkeeping and Reporting Rules for Nonbank Swap
Dealers
The CFTC Financial Reporting Rules impose financial recordkeeping
and reporting requirements on nonbank SDs. In this regard, the CFTC
Financial Reporting Rules require each nonbank SD to prepare and keep
current ledgers or similar records summarizing each transaction
affecting the nonbank SD's asset, liability, income, expense, and
capital accounts.\131\ The nonbank SD's ledgers and similar records
must be prepared in accordance with generally accepted accounting
principles as adopted in the United States (``U.S. GAAP''), except that
if the nonbank SD is not otherwise required to prepare financial
statements in accordance with U.S. GAAP, the nonbank SD may prepare and
maintain its accounting records in accordance with International
Financial Reporting Standards (``IFRS'') issued by the International
Accounting Standards Board.\132\
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\131\ 17 CFR 23.105(b).
\132\ Id.
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The CFTC Financial Reporting Rules also require each nonbank SD to
prepare and file with the Commission and NFA periodic unaudited and
annual audited financial statements.\133\ A nonbank SD that elects the
TNW Approach is required to file unaudited financial statements within
17 business days of the close of each fiscal quarter, and its annual
audited financial statements within 90 days of its fiscal year-
end.\134\ A nonbank SD that elects either the NLA Approach or the Bank-
Based Approach is required to file unaudited financial statements
within 17 business days of the end of each month, and its annual
audited financial statements within 60 days of the end of its fiscal
year.\135\
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\133\ 17 CFR 23.105(d) and (e).
\134\ 17 CFR 23.105(d)(1) and (e)(1).
\135\ Id.
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The CFTC Financial Reporting Rules further provide that a nonbank
SD's unaudited financial statements must include: (i) a statement of
financial condition; (ii) a statement of income/loss; (iii) a statement
of changes in liabilities subordinated to claims of general creditors;
(iv) a statement of changes in ownership equity; (v) a statement
demonstrating compliance with, and calculation of, the applicable
regulatory minimum capital requirement; and (vi) such further material
information necessary to make the required statements not
misleading.\136\ The annual audited financial statements must include:
(i) a statement of financial condition; (ii) a statement of income/
loss; (iii) a statement of cash flows; (iv) a statement of changes in
liabilities subordinated to claims of general creditors; (v) a
statement of changes in ownership equity; (vi) a statement
demonstrating the calculation of, and compliance with, the applicable
regulatory minimum capital requirement; (vii) appropriate footnote
disclosures; and (vii) a reconciliation of any material differences
between the annual audited financial statements and the unaudited
financial statements prepared as of the nonbank SD's year-end
date.\137\
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\136\ 17 CFR 23.105(d)(2).
\137\ 17 CFR 23.105(e)(4).
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A nonbank SD that has obtained approval from the Commission or NFA
to use internal capital models also must submit certain model metrics,
such as aggregate VaR and counterparty credit risk information, each
month to the Commission and NFA.\138\ A nonbank SD also is required to
provide the Commission and NFA with a detailed list of financial
positions reported at fair market value as part of its monthly
unaudited financial statements.\139\ Each nonbank SD is also required
to provide information to the Commission and NFA regarding its
counterparty credit concentration for the 15 largest exposures in
derivatives, a summary of its derivatives exposures by internal credit
ratings, and the geographic
[[Page 48107]]
distribution of derivatives exposures for the 10 largest
countries.\140\
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\138\ 17 CFR 23.105(k) and (l) and Appendix B to Subpart E of
Part 23.
\139\ 17 CFR 23.105(l) and Appendix B to Subpart E of Part 23.
\140\ 17 CFR 23.105(l) in Schedules 2, 3, and 4, respectively.
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The CFTC Financial Reporting Rules also require a nonbank SD to
attach to each unaudited and audited financial report an oath or
affirmation that to the best knowledge and belief of the individual
making the affirmation the information contained in the financial
report is true and correct.\141\ The individual making the oath or
affirmation must be a duly authorized officer if the nonbank SD is a
corporation, or one of the persons specified in the regulation for
business organizations that are not corporations.\142\
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\141\ 17 CFR 23.105(f).
\142\ Id.
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The CFTC Financial Reporting Rules further require a nonbank SD to
make certain financial information publicly available by posting the
information on its public website.\143\ Specifically, a nonbank SD must
post on its website a statement of financial condition and a statement
detailing the amount of the nonbank SD's regulatory capital and the
minimum regulatory capital requirement based on its audited financial
statements and based on its unaudited financial statements that are as
of a date that is six months after the nonbank SD's audited financial
statements.\144\ Such public disclosure is required to be made within
10 business days of the filing of the audited financial statements with
the Commission, and within 30 calendar days of the filing of the
unaudited financial statements required with the Commission.\145\ A
nonbank SD also must obtain written approval from NFA to change the
date of its fiscal year-end for financial reporting.\146\
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\143\ 17 CFR 23.105(i).
\144\ Id.
\145\ Id.
\146\ 17 CFR 23.105(g).
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The CFTC Financial Reporting Rules also require a nonbank SD to
provide the Commission and NFA with information regarding the
custodianship of margin for uncleared swap transactions (``Margin
Report'').\147\ The Margin Report must contain: (i) the name and
address of each custodian holding initial margin or variation margin
that is required for uncleared swaps subject to the CFTC margin rules
(``uncleared margin rules''), on behalf of the nonbank SD or its swap
counterparties; (ii) the amount of initial and variation margin
required by the uncleared margin rules held by each custodian on behalf
of the nonbank SD and on behalf its swap counterparties; and (iii) the
aggregate amount of initial margin that the nonbank SD is required to
collect from, or post with, swap counterparties for uncleared swap
transactions subject to the uncleared margin rules.\148\ The Commission
requires this information in order to monitor the use of custodians by
nonbank SDs and their swap counterparties. Such information assists the
Commission in monitoring the safety and soundness of a nonbank SD by
monitoring whether the firm is current with its swap counterparties
with respect to the posting and collecting of margin required by the
uncleared margin rules. By requiring the nonbank SD to report the
required amount of margin to be posted and collected, and the amount of
margin that is actually posted and collected, the Commission could
identify potential issues with the margin practices and compliance by
nonbank SDs that may hinder the ability of the firm to meet its
obligations to market participants. The Margin Report also allows the
Commission to identify custodians used by nonbank SDs and their
counterparties, which may permit the Commission to assess potential
market issues, including a concentration of custodial services by a
limited number of banks.
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\147\ 17 CFR 23.105(m).
\148\ Id.
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2. Japanese Nonbank Swap Dealer Financial Reporting Requirements
The Japanese Financial Reporting Rules impose financial reporting
requirements on FIBOs, including Japanese nonbank SDs. Specifically,
the Japanese Financial Reporting Rules require each of the Japanese
nonbank SDs to submit monthly monitoring survey reports (``Monthly
Monitoring Reports'') to the FSA.\149\ The Monthly Monitoring Reports
are required to report on the Japanese nonbank SD's balance sheet,
profit and loss statement, capital adequacy ratio, market risk,
counterparty risk and liquidity risk.\150\ The Monthly Monitoring
Reports are typically submitted by the Japanese nonbank SDs within 2-3
weeks of the end of each month.\151\
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\149\ See II-1-4 (General Supervisory Processes) of the
Supervisory Guidelines for FIBO, which directs the FSA (and other
supervisors) as part of its offsite monitoring to require FIBOs
(including the Japanese nonbank SDs) to submit a monitoring survey
report regarding the following matters: capital adequacy ratio,
status of business operations and accounting (including a balance
sheet and profit and loss statement), status of segregated
management of customer assets, market risk, counterparty risk,
operational risk, and liquidity risk. The FSA has, pursuant to
Article 56-2(1) of the FIEA, ordered the Japanese nonbank SDs to
submit monthly monitoring reports to the FSA.
\150\ Id.
\151\ There are various types of reports which are required of
the Japanese nonbank SDs under ``Reporting orders'' issued by the
FSA in accordance with Article 56-2(1) of the FIEA. Some reports are
required to be submitted on monthly basis, whereas other reports are
required to be submitted on a quarterly basis, semi-annual basis, or
annual basis. In terms of the filing due dates of those reports, the
FSA typically does not set a specific deadline and instead requests
all reports to be submitted ``without delay.'' In case of monthly
reports, the normal practice is for firms to submit such reports
within 2 to 3 weeks from the prior month-end.
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Each Japanese nonbank SD is also required to submit a business
report to the Commissioner of the FSA within three months of the end of
the firm's fiscal year (``Annual Business Report'').\152\ The Annual
Business Report must include a balance sheet, profit and loss
statement, statement of changes in shareholders' equity, balance of
subordinated debt and statement of capital adequacy ratio.\153\
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\152\ Article 46-3(1) of the FIEA and Article 172 of the COO.
\153\ Appended Forms No.12 of the COO.
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Furthermore, each Japanese nonbank SD is required to prepare
financial statements and business reports every business year pursuant
to the Japanese Companies Act (Act No. 86 of 2005). The financial
statements include a balance sheet, profit and loss statement, and
statement of changes in shareholders' equity, and are required to be
audited by an accounting auditor (``Annual Audited Financial
Report'').\154\ The Annual Audited Financial Report must be submitted
to and approved by the shareholders' meeting within 3 months of the
Japanese nonbank SD's fiscal year-end.\155\
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\154\ Article 328(1) and (2) and Article 435(2) and 436(2)(i) of
the Companies Act, and Article 59 of Rules of Corporate Accounting
(Ordinance of the Ministry of Justice No. 13 of 2006). The audit
requirement applies to a ``Large Company,'' which is defined by
Article 2(vi) of the Companies Act as a stock company that satisfies
any of the following requirements: (a) that the amount of stated
capital in the balance sheet as of the end of the firm's most recent
business year is JPY 500 million or more; or (b) that the total sum
of the liabilities section of the balance sheet as of the end of the
firm's most recent business year is JPY 20 billion or more. The FSA
has represented that each of the Japanese nonbank SDs is a Large
Company under the Companies Act, and is subject to the audit
requirement for its financial statements. See FSA Application p. 18.
\155\ Id.
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3. Commission Analysis
The Commission has reviewed the FSA Application and the relevant
Japanese laws and regulations, and has preliminarily determined that
the financial reporting requirements of the Japanese Financial
Reporting Rules, subject to the conditions specified
[[Page 48108]]
below, are comparable to CFTC Financial Reporting Rules in purpose and
effect as they are intended to provide the FSA and Commission,
respectively, with financial information to monitor and assess the
financial condition of nonbank SDs and their ongoing ability to absorb
decreases in the value of firm assets and to cover losses from business
activities, including swap dealing activities, without the firm
becoming insolvent.
The Japanese Financial Reporting Rules require Japanese nonbank SDs
to file financial reports with the FSA that are comparable with respect
to the content of the financial reporting and the frequency of the
submission of the financial reports with the requirements for nonbank
SDs under the CFTC Financial Reporting Rules. In this regard, the
Japanese Financial Reporting Rules require Japanese nonbank SDs to
prepare and submit reports that include statements of financial
condition, statements of profit and loss, and statements of capital
adequacy that are comparable to the statements required of nonbank SDs
under Regulation 23.105 of the CFTC Financial Reporting Rules.
Accordingly, the Commission has preliminarily determined that a
Japanese nonbank SD may comply with the financial reporting
requirements contained in Commission Regulation 23.105 by complying
with the corresponding Japanese Financial Reporting Rules, subject to
the conditions set forth below.\156\
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\156\ A Japanese nonbank SD that qualifies and elects to seek
substituted compliance with Japanese Capital Rules must also seek
substituted compliance with the Japanese Financial Reporting Rules.
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Such substituted compliance is proposed to be conditioned upon a
Japanese nonbank SD providing the Commission and NFA with copies of its
Monthly Monitoring Report and Annual Business Report filed with the FSA
pursuant to Article 56-2(1) and Article 46-3(1), respectively, of the
FIEA. It is proposed that a Japanese nonbank SD also must provide the
Commission and NFA with a copy of its Annual Audited Financial Report
that is required to be prepared pursuant to Article 453(2) of the
Companies Act. The Monthly Monitoring Report, Annual Business Report,
and Annual Audited Financial Report must be translated into the English
language.\157\ The Monthly Monitoring Report and the Annual Business
Report must have balances converted from yen to U.S. dollars. The
Commission, however, recognizes that the requirement to translate
accounts denominated in yen to U.S. dollars on the audited financial
statements may impact the opinion provided by the public accountant.
The Commission is therefore proposing to accept the Annual Audited
Financial Report denominated in yen, provided that the report is
translated into the English language.
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\157\ The translation of audited financial statements into the
English language is not required to be subject to the audit of the
public accountants. The Monthly Monitoring Report and Annual
Business Report must convert balances into U.S. dollars. A Japanese
nonbank SD must report the exchange rate that it used to convert
balances from yen to U.S. dollars to the Commission and NFA as part
of the financial reporting.
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The Commission also is proposing to condition the Capital
Comparability Determination Order below on the Japanese nonbank SD
filing (i) its Annual Business Report with the Commission and NFA
within 15 business days of the earlier of the date the report is filed
with the FSA or the date that the report is required to be filed with
the FSA; (ii) its Annual Audited Financial Statement with the
Commission and NFA within 15 business days of the approval of the
report at the Japanese nonbank SD's shareholder meeting; and (iii) its
Monthly Monitoring Report within 15 business days of the earlier of the
date the report is filed with the FSA or 35 calendar days after the
month-end reporting date.\158\ The Commission preliminarily believes
that these proposed filing dates provide sufficient time for the
respective reports to be translated into the English language and
balances converted from yen to U.S. dollars, where applicable.
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\158\ As previously noted, the FSA does not set a specific
filing date for Monthly Monitoring Reports, electing to instead
require firms to file such reports ``without delay.'' The Commission
proposes to establish a due that that is no later than 35 calendar
days from the reporting date in order to set a definitive filing
date that also provides Japanese nonbank SDs with sufficient time to
translate the reports into English and convert balances to U.S.
dollars.
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The filing of English language financial reports by a Japanese
nonbank SD with the Commission and NFA is necessary as financial
reporting is a critical and central component of the Commission's and
NFA's ability to assess the safety and soundness of registered nonbank
SDs as required under Section 4s(e) of the CEA. Although the Commission
is proposing to permit Japanese nonbank SDs to comply with the form and
content requirements for the financial reports set forth in the
Japanese Financial Reporting Rules, the receipt of English language
financial reports that have balances converted to U.S. dollars (with
the exception of the Annual Audited Financial Report) is necessary for
the Commission to effectively monitor the ongoing financial condition
of all nonbank SDs, including Japanese nonbank SDs, to help ensure
their safety and soundness and ability to meet their financial
obligations to customers, counterparties, and general market
participants.
The Commission preliminarily believes that its proposed approach of
requiring Japanese nonbank SDs to provide the Commission and NFA with
copies of the Monthly Monitoring Reports, Annual Business Reports, and
Annual Audited Financial Reports that the firms currently file with the
FSA or otherwise prepare strikes an appropriate balance of ensuring
that the Commission and NFA receive the financial reporting necessary
for the effective monitoring of the financial condition of the nonbank
SDs, while also recognizing the appropriateness of providing
substituted compliance based on the existing FSA financial reporting
requirements and regulatory structure.
The Commission is also proposing to condition the Capital
Comparability Determination Order on Japanese nonbank SDs filing the
aggregate securities, commodities, and swap positions information set
forth in Schedule 1 of Appendix B to Subpart E of Part 23 on a monthly
basis with the Commission and NFA.\159\ Schedule 1 provides the
Commission and NFA with detailed information regarding the financial
positions that a nonbank SD holds as of the end of each month,
including the firm's swaps positions, which will allow the Commission
and NFA to monitor the types of investments and other activities that
the firm engages in and will enhance the Commission's and NFA's ability
to monitor the safety and soundness of the firm.
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\159\ Schedule 1 of Appendix B to Subpart E of Part 23 includes
a nonbank SD's holding of U.S. Treasury securities, U.S. government
agency debt securities, foreign debt and equity securities, money
market instruments, corporate obligations, spot commodities, and
cleared and uncleared swaps, security-based swaps, and mixed swaps
in addition to other position information.
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The Commission is also proposing to condition the Capital
Comparability Determination Order on a Japanese nonbank SD submitting
with each Monthly Monitoring Report, Annual Business Report, and Annual
Audited Financial Report, as well as the applicable Schedule 1, a
statement by an authorized representative or representatives of the
Japanese nonbank SD that to the best knowledge and belief of the
person(s) the information contained in the respective report is true
[[Page 48109]]
and correct, including the translation of the report into the English
language and conversion of balances in the reports to U.S. dollars. The
statement by the authorized representative or representatives of the
Japanese nonbank SD is in lieu of the oath or affirmation required of
nonbank SDs under Regulation 23.105(f),\160\ and is intended to ensure
that reports filed with the Commission and NFA are prepared and
submitted by firm personnel with knowledge of the financial reporting
of the firm who can attest to the accuracy of the reporting and
translation.
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\160\ 17 CFR 23.105(f).
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The Commission is further proposing to condition the Capital
Comparability Determination Order on a Japanese nonbank SD filing the
Margin Report specified in Regulation 23.105(m) with the Commission and
NFA. The Margin Report contains: (i) the name and address of each
custodian holding initial margin or variation margin required by the
uncleared margin rules on behalf of the nonbank SD or its swap
counterparties; (ii) the amount of initial and variation margin
required by the uncleared margin rules held by each custodian on behalf
of the nonbank SD and on behalf its swap counterparties; and (iii) the
aggregate amount of initial margin required by the uncleared margin
rules that the nonbank SD is required to collect from, or post to, swap
counterparties for uncleared swap transactions.\161\
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\161\ 17 CFR 23.105(m).
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The Commission believes that receiving this margin information from
Japanese nonbank SDs will assist in the Commission's assessment of the
safety and soundness of the Japanese nonbank SDs. Specifically, the
Margin Report will provide the Commission with information regarding a
Japanese nonbank SD's swap book, the extent to which it has
uncollateralized exposures to counterparties or has not met its
financial obligations to counterparties. This information, along with
the list of custodians holding both the firm's and counterparties'
swaps collateral, will assist the Commission in assessing and
monitoring potential financial impacts to the nonbank SD resulting from
defaults on its swap transactions. The Commission is further proposing
to require a Japanese nonbank SD to file its Margin Report at the same
time that the Japanese nonbank SD files its Monthly Monitoring Report,
and to require the Margin Report to be prepared in the English language
with balances reported in U.S. dollars.
The Commission is not proposing to require a Japanese nonbank SD
that has been approved by FSA to use capital models to file the monthly
model metric information contained in Regulation 23.105(k) with the
Commission or NFA.\162\ Regulation 23.105(k) requires a nonbank SD that
has obtained approval from the Commission or NFA to use internal
capital models to submit to the Commission and NFA each month
information regarding its risk exposures, including VaR and credit risk
exposure information when applicable. The model metrics are intended to
provide the Commission and NFA with information that would assist with
the ongoing oversight and assessment of internal market risk and credit
risk models that have been approved for use by a nonbank SD. The
Commission preliminarily believes, however, that the receipt by the
Commission and NFA of model metrics set forth in Regulation 23.105(k)
from Japanese nonbank SDs is not necessary as the initial approval and
the ongoing assessment of the performance of a Japanese nonbank SD's
models will be performed by the FSA as part of its oversight function.
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\162\ 17 CFR 23.105(k).
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The Commission also is proposing not to require a Japanese nonbank
SD to file the monthly counterparty credit exposure information
specified in Regulation 23.105(l) and Schedules 2, 3, and 4 of Appendix
B to Subpart E of Part 23 with the Commission or NFA. Regulation
23.105(l) requires each nonbank SD to provide information to the
Commission and NFA regarding its counterparty credit concentration for
the 15 largest exposures in derivatives, a summary of its derivatives
exposures by internal credit ratings, and the geographic distribution
of derivatives exposures for the 10 largest countries in Schedules 2,
3, and 4, respectively. The Commission preliminarily believes that,
under a substituted compliance regime, the FSA is best positioned to
monitor a Japanese nonbank SD's credit exposures, which may be
comprised of credit exposures to primarily other Japanese
counterparties, as part of the FSA's overall monitoring of the
financial condition of the firm.
Furthermore, the Commission, in making the preliminary
determination to not require a Japanese nonbank SD to file the model
metrics and counterparty exposures required by Regulations 23.105(k)
and (l), respectively, recognizes that NFA's current risk monitoring
program requires each bank SD and each nonbank SD, including each
Japanese nonbank SD, to file risk metrics addressing market risk and
credit risk with NFA on a monthly basis. This information includes: (i)
monthly VaR for interest rates, credit, foreign exchange, equities,
commodities, and total VaR; (ii) total stressed VaR; (iii) interest
rate, credit spread, foreign exchange market, and commodity
sensitivities; (iv) total swaps current exposure both before and after
offsetting against collateral held by the firm; and (v) a list of the
15 largest swaps counterparty current exposures.\163\ While there are
differences between the information filed with the NFA and the
information required under Regulations 23.105(k) and (l), the NFA risk
metrics provide a level of information that allows NFA to identify SDs
that may pose heightened risk and to allocate appropriate NFA
regulatory oversight resources. The Commission preliminarily believes
that the proposed financial reporting set forth as conditions in the
proposed Capital Comparability Determination Order, and the risk metric
and counterparty exposure information required to be reported by
nonbank SDs (including Japanese nonbank SDs) under NFA rules, provide
the appropriate balance of recognizing the comparability of the
Japanese Financial Reporting Rules to the CFTC Financial Reporting
Rules while also ensuring that the Commission and NFA receive
sufficient data to monitor and assess the overall financial condition
of nonbank Japanese SDs.
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\163\ See NFA Financial Requirements, Section 17--Swap Dealer
and Major Swap Participant Reporting Requirements, and Notice to
Members--Monthly Risk Data Reporting for Swap Dealers (May 30,
2017).
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The Commission invites public comment on its analysis above,
including comment on the FSA Application and relevant Japanese
Financial Reporting Rules. The Commission also invites comment on the
proposed conditions listed above. The Commission recognizes that while
the Monthly Monitoring Reports, Annual Business Reports, and Annual
Audited Financial Reports contain financial information regarding a
Japanese nonbank SD that is comparable to the financial information
required of nonbank SDs under Regulation 23.105 (such as statements of
financial condition, statements of income, and statements demonstrating
compliance with capital requirements), the reports also contain
financial information that exceeds the requirements of regulation
23.105 (such as information regarding the holding of customer funds
under Japanese laws). The Commission requests comment on the scope of
the financial information that Japanese nonbank SDs should be required
to file
[[Page 48110]]
with the Commission and NFA. Should the Commission limit the financial
information required of Japanese nonbank SDs to the types of financial
information required of nonbank SDs under regulation 23.105?
The Commission also invites comment on its proposal not to require
Japanese nonbank SDs to submit to the Commission and NFA the
information set forth in Regulations 23.105(k) and (l). Are there
specific elements of the data required under Regulations 23.105(k) and
(l) that the Commission should require of Japanese nonbank SDs for
purposes of monitoring model performance?
The Commission requests comment on the proposed filing dates for
the reports and information specified above. Specifically, do the
proposed filing dates provide sufficient time for Japanese nonbank SDs
to prepare the reports, translate the reports into English, and, where
required, convert balances into U.S. dollars? If not, what period of
time should the Commission consider imposing on one or more of the
reports?
The Commission also specifically requests comment regarding the
setting of compliance dates for the reporting conditions that the
proposed Capital Comparability Determination Order would impose on
Japanese nonbank SDs. In this connection, if the Commission were to
require Japanese nonbank SDs to file the Margin Report as set forth in
the proposed Order below, how much time would Japanese nonbank SDs need
to develop new systems or processes to capture information that is
required? Would Japanese nonbank SDs need a period of time to develop
any systems or processes to meet any other reporting conditions in the
proposed Capital Comparability Determination Order? If so, what would
be an appropriate amount of time for a Japanese nonbank SD to develop
and implement such systems or processes?
E. Notice Requirements
1. CFTC Nonbank SD Notice Reporting Requirements
The CFTC Financial Reporting Rules require nonbank SDs to provide
the Commission and NFA with written notice of certain defined
events.\164\ The notice provisions are intended to provide the
Commission and NFA with an opportunity to assess whether the
information contained in the written notices indicates the existence of
actual or potential financial and/or operational issues at a nonbank
SD, and, when necessary, allows the Commission and NFA to engage the
nonbank SD in an effort to minimize potential adverse impacts on swap
counterparties and the larger swaps market. The notice provisions are
part of the Commission's overall program for helping to ensure the
safety and soundness of nonbank SDs and the swaps markets in general.
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\164\ 17 CFR 23.105(c).
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The CFTC Financial Reporting Rules require a nonbank SD to provide
written notice within specified timeframes if the firm is: (i)
undercapitalized; (ii) fails to maintain capital at a level that is in
excess of 120 percent of its minimum capital requirement; or (iii)
fails to maintain current books and records.\165\ A nonbank SD is also
required to provide written notice if the firm experiences a 30 percent
or more decrease in excess regulatory capital from its most recent
financial report filed with the Commission.\166\ A nonbank SD also is
required to provide notice if the firm fails to post or collect initial
margin for uncleared swap and non-cleared security-based swap
transactions or exchange variation margin for uncleared swap or non-
cleared security-based swap transactions as required by the
Commission's uncleared swaps margin rules or the SEC's non-cleared
security-based swaps margin rules, respectively, if the aggregate is
equal to or greater than: (i) 25 percent of the nonbank SD's required
capital under Regulation 23.101 calculated for a single counterparty or
group of counterparties that are under common ownership or control; or
(ii) 50 percent of the nonbank SD's required capital under Regulation
23.101 calculated for all of the firm's counterparties.\167\
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\165\ 17 CFR 23.105(c)(1), (2), and (3).
\166\ 17 CFR 23.105(c)(4).
\167\ 17 CFR 23.105(c)(7).
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The CFTC Financial Reporting Rules further require a nonbank SD to
provide advance notice of an intention to withdraw capital by an equity
holder that would exceed 30 percent of the firm's excess regulatory
capital.\168\ Finally, a nonbank SD that is dually-registered with the
SEC as an SBSD or major security-based swap participant (``MSBSP'')
must file a copy of any notice with the Commission and NFA that the
SBSD or MSBSP is required to file with the SEC under SEC Rule 18a-8 (17
CFR 240.18a-8).\169\ SEC Rule 18a-8 requires SBSDs and MSBSPs to
provide written notice to the SEC for comparable reporting events as
the CFTC Capital Rules in Regulation 23.105(c), including if a SBSD or
MSBSP is undercapitalized or fails to maintain current books and
records.
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\168\ 17 CFR 23.105(c)(5).
\169\ 17 CFR 23.105(c)(6).
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2. Japanese Nonbank Swap Dealer Notice Requirements
The FSA maintains a system of notice reporting requirements
(``Early Warning System'') that is designed to provide the FSA with
notice of, and an opportunity to react to, potential financial and/or
operational issues with a Japanese nonbank SD prior to the firm falling
below the FSA's minimum capital requirements. Specifically, each
Japanese nonbank SD is required to submit an immediate notification to
the FSA if its capital adequacy ratio falls below 140 percent.\170\ The
Japanese nonbank SD's notification submitted to the FSA must be
accompanied by a Plan Regarding Specific Voluntary Measures to Be Taken
in Order to Maintain the Capital Adequacy Ratio, which is expected to
include concrete measures that the firm will take to maintain a capital
adequacy ratio above 140 percent.\171\ The FSA also has the authority
to examine the future outlook on the Japanese nonbank SD's capital
adequacy ratio through hearings and to urge the firm to make voluntary
improvement efforts. \172\
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\170\ The notification is required to be filed pursuant to
Article 179 of the COO. As noted in section C.2 above, each Japanese
nonbank SD is required to maintain a minimum capital adequacy ratio
of 120 percent.
\171\ Id.
\172\ IV-2-2 (Supervisory Response to Cases of Financial
Instruments Business Operators' Capital Adequacy Ratio Falling Below
Prescribed Level) (1) of the Supervisory Guidelines for FIBO.
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A Japanese nonbank SD also must submit an immediate notification
and a Plan Regarding Specific Voluntary Measures to Be Taken in Order
to Improve the Capital Adequacy Ratio (the ``Plan'') to the FSA if the
firm's capital adequacy ratio falls below the minimum capital adequacy
ratio of 120 percent.\173\ The FSA reviews the Plan and, when
necessary, identifies the specific method by which a Japanese nonbank
SD must bring its capital adequacy ratio back above the prescribed
minimum level and the estimated date of the recovery. In situations
where the Japanese nonbank SD fails to maintain the minimum level of
regulatory capital, the FSA will also examine other aspects of the
firm's operations, including the status of segregated management of
customer assets and fund-raising. If the FSA finds it to be necessary
and appropriate in the public interest or for the protection of
investors, the Commissioner of the FSA may order a change of business
[[Page 48111]]
methods, order assets to be deposited, or issue orders with respect to
matters that are otherwise necessary from a supervisory
perspective.\174\
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\173\ Article 179 of the COO.
\174\ Article 53(1) of the FIEA. IV-2-2 (Supervisory Response to
Cases of Financial Instruments Business Operators' Capital Adequacy
Ratio Falling Below Prescribed Level) (3) of the Supervisory
Guidelines for FIBO indicates four examples of the order: (i) To
draft and implement measures (including the drafting of specifics
and the implementation schedule) to bring the capital adequacy ratio
back above the legally prescribed level and maintain the ratio above
that level on a permanent basis; (ii) To implement measures to
ensure the protection of investors in preparation for an unexpected
event, through appropriate management of securities and cash and
careful management of fund-raising; (iii) To avoid activities that
could lead to wasteful use of corporate assets; and (iv) To compile
the projections of the balance sheet and fund-raising status on a
daily basis and the projection of the capital adequacy ratio in ways
to reflect the specific measures to be implemented, in order to
bring the capital adequacy ratio back above the legally prescribed
level.
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If a Japanese nonbank SD's capital adequacy ratio falls below 100
percent, the Commissioner of the FSA may order the suspension of all or
part of the firm's business activities for a period not to exceed three
months if the FSA deems such action to be necessary and appropriate for
the public interest or for the protection of investors.\175\ If the
Japanese nonbank SDs capital adequacy ratio does not exceed 100
percent, and the FSA determines that the firm's capital adequacy ratio
status is not likely to recover, the Commissioner of the FSA may
rescind the registration of the firm.\176\
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\175\ Article 53(2) of the FIEA.
\176\ Article 53(3) of the FIEA.
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In addition to the above measures, the FSA may order a Japanese
nonbank SD to change its business methods or to otherwise take measures
that are necessary for improving its business operations or the state
of its assets if the FSA finds such action necessary and appropriate in
the public interest or for the protection of investors.\177\ Finally,
the Prime Minister of Japan may rescind the registration of a Japanese
nonbank SD, or order the suspension of all or a part of its business
activities for a period of no longer than six months, if the Japanese
nonbank SD violates a disposition by a government agency,\178\ or is
likely to become insolvent due to the state of its business and
assets.\179\
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\177\ Article 51 of the FIEA.
\178\ Article 52(1)(vii) of the FIEA.
\179\ Article 52(1)(viii) of the FIEA.
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3. Commission Analysis
The Commission has reviewed the FSA Application and the relevant
Japanese laws and regulations, and has preliminarily determined that
the Japanese Financial Reporting Rules related to notice provisions,
subject to the conditions specified below, are comparable to the notice
provisions of the CFTC Financial Reporting Rules in purpose and effect
as each regulator's requirements are intended to provide the FSA and
Commission with prompt notice of potential or actual financial or
operational issues at a nonbank SD that may impact its ability to
continue to meet its financial obligations to swap counterparties and
other creditors, or otherwise impair its safety and soundness. The
Commission is therefore proposing to issue a Capital Comparability
Determination Order providing that a Japanese nonbank SD may comply
with the notice provisions required under Japanese laws and regulations
in lieu of certain notice provisions required of nonbank SDs under
Regulation 23.105(c), subject to the conditions set forth below.
The Japanese Financial Reporting Rules require a Japanese nonbank
SD to provide notice to the FSA if the firm experiences a reduction of
its regulatory capital that exceeds certain predefined limits
(``Japanese Early Warning Notices''). As noted above, pursuant to the
Japanese Early Warning Notices, a Japanese nonbank SD is required to
provide the FSA with notices if its regulatory capital falls below: (i)
140 percent; or (ii) 120 percent of its minimum capital requirement.
The Japanese Early Warning Notices are also required to contain
information regarding actions that the Japanese nonbank SD will take to
ensure that the firm is properly capitalized.
The Commission has preliminarily determined that these Japanese
Early Warning Notices achieve comparable outcomes to CFTC notice
provisions contained in Regulation 23.105(c)(1) and (2) that require a
nonbank SD to provide notice to the Commission and to NFA if a nonbank
SD fails to meet its minimum capital requirement or if the firm's
regulatory capital falls below 120 percent of its minimum capital
requirement. These notice provisions set forth in the Japanese
Financial Reporting Rules and the CFTC Financial Reporting Rules are
further comparable in purpose and effect in that the provisions are
intended to alert the FSA and Commission/NFA, respectively, of
potential financial or operational issues that could have an adverse
impact on the safety and soundness of a nonbank SD, including the
nonbank SD's ability to meet its financial obligations to customers,
counterparties, creditors, and general market participants. The notices
are also intended to provide an opportunity for the applicable
regulator to monitor a nonbank SD's financial condition and operations
to ensure that the firm takes appropriate actions to maintain, or to
regain, compliance with its minimum capital requirements.
The Japanese Financial Reporting Rules differ from the CFTC
Financial Reporting Rules in certain respects. Specifically, unlike the
CFTC Financial Reporting Rules, the Japanese Financial Reporting Rules
do not contain explicit requirements for a Japanese nonbank SD to
notify the FSA if the firm fails to maintain current books and records,
experiences a decrease in capital over levels previously reported, or
fails to collect or post initial margin or variation margin for
uncleared swap transactions with swap counterparties that exceed
certain threshold levels.\180\ The Japanese Financial Reporting Rules
also do not require a Japanese nonbank SD to provide the FSA with
advance notice of capital withdrawals initiated by equity holders that
exceed defined amounts or percentages of the firm's excess regulatory
capital.\181\
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\180\ See 17 CFR 23.105(c)(3), (4), and (7).
\181\ See 17 CFR 23.105(c)(5), which requires a nonbank SD to
provide written notice to the Commission and NFA two business days
prior to the withdrawal of capital by action of the equity holders
if the amount of the withdrawal exceeds 30 percent of the nonbank
SD's excess regulatory capital.
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The Commission is proposing to condition the Capital Comparability
Determination Order on a Japanese nonbank SD providing the Commission
and NFA with notice if the firm fails to make or to keep current books
and records required by the FSA. For avoidance of doubt, in this
context the Commission believes that books and records would include
current ledgers or other similar records which show or summarize, with
appropriate references to supporting documents, each transaction
affecting the Japanese nonbank SD's asset, liability, income, expense
and capital accounts in accordance with the accounting principles
accepted by the FSA.\182\ The Commission preliminarily believes that
the maintenance of current books and records is a fundamental and
essential component of operating as a registered nonbank SD and that
the failure to comply with such a requirement may indicate an inability
of the firm to promptly and accurately record transactions and to
ensure compliance with regulatory requirements, including regulatory
capital requirements. Therefore, the proposed Order below is
conditioned on a Japanese nonbank SD providing the Commission and NFA
with a written notice within 24 hours if
[[Page 48112]]
the firm fails to maintain on a current basis the books and records
required by the FSA.
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\182\ For comparison, see 17 CFR 23.105(b), which similarly
defines the term `Current books and records' as used in the context
of Commission's requirements.
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The Commission is also proposing to condition the Capital
Comparability Determination Order on a Japanese nonbank SD providing
the Commission and NFA with a written notice within 24 hours of the
firm filing a notice with the FSA pursuant to Article 179(3) of the COO
that the firm's regulatory capital has fallen below 140 percent of its
minimum requirement. It is proposed that a Japanese nonbank SD also
must provide the Commission and NFA with written notice within 24 hours
of filing a notice with the FSA that the firm's regulatory capital has
fallen below 120 percent of its minimum requirement.
The requirement for a nonbank SD to file notice with the Commission
and NFA of a decrease of excess regulatory capital below defined levels
is a central component of the Commission's and NFA's oversight program
for nonbank SDs.\183\ Therefore, the Commission preliminarily believes
that it is necessary for the Commission and NFA to receive notice from
a Japanese nonbank SD that the firm has filed a regulatory notice with
the FSA that its capital level has decreased below 140 percent or 120
percent of its minimum regulatory capital requirement. The notice must
be filed by the Japanese nonbank SD within 24 hours of the filing of
the notice with the FSA, and the Commission expects that, upon the
receipt of a notice, Commission staff and NFA staff will engage with
staff of the FSA to obtain an understanding of the facts that led to
the filing of the notice and will discuss with the FSA its plan for any
ongoing monitoring of the Japanese nonbank SD. Therefore, the
Commission's proposal would not require the Japanese nonbank SD to file
copies of its recovery plan that is filed with the FSA with the
Commission or NFA. To the extent the Commission needs further
information from the Japanese nonbank SD, the Commission expects to
request such information as part of its assessment of the notice and
its discussions with the FSA.
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\183\ See Regulation 23.105(c)(4) which requires a nonbank SD to
file notice with the Commission and NFA if it experiences a decrease
in excess capital of 30 percent or more from the excess capital
reported in its last financial filing with the Commission.
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The proposed Capital Comparability Determination Order also
requires a Japanese nonbank SD to file notice with the Commission and
NFA if: (i) a single counterparty, or group of counterparties under
common ownership or control, fails to post required initial margin or
pay required variation margin on uncleared swap and non-cleared
security-based swap positions that, in the aggregate, exceeds 25
percent of the Japanese nonbank SD's minimum capital requirement; (ii)
counterparties fail to post required initial margin or pay required
variation margin to the Japanese nonbank SD for uncleared swap and non-
cleared security-based swap positions that, in the aggregate, exceed 50
percent of the Japanese nonbank SD's minimum capital requirement; (iii)
a Japanese nonbank SD fails to post required initial margin or pay
required variation margin for uncleared swap and non-cleared security-
based swap positions to a single counterparty or group of
counterparties under common ownership and control that, in the
aggregate, exceeds 25 percent of the Japanese nonbank SD's minimum
capital requirement; and (iv) a Japanese nonbank SD fails to post
required initial margin or pay required variation margin to
counterparties for uncleared swap and non-cleared security-based swap
positions that, in the aggregate, exceeds 50 percent of the Japanese
nonbank SD's minimum capital requirement. The Commission is proposing
to require this notice so that, in the event that such a notice is
filed, it and NFA may commence communication with the Japanese nonbank
SD and the FSA in order to obtain an understanding of the facts that
led to the failure to exchange material amounts of initial margin or
variation margin in accordance with the applicable margin rules, and to
assess whether there is a concern regarding the financial condition of
the firm that may impair its ability to meet its financial obligations
to customers, counterparties, creditors, and general market
participants, or otherwise adversely impact the firm's safety and
soundness.
The proposed Capital Comparability Determination Order does not
require a Japanese nonbank SD to file notices with the Commission
concerning withdrawals of capital or changes in capital levels as such
information will be reflected in the financial statement reporting
filed with the Commission and NFA as conditions of the order, and
because the Japanese nonbank SD's capital levels are monitored by the
FSA, which the Commission preliminarily believes renders the separate
reporting to the Commission superfluous.
The proposed Capital Comparability Determination Order requires a
Japanese nonbank SD to file any notices required under the Order with
the Commission and NFA in English and, where applicable, with any
balances reported in U.S. dollars. Each notice required by the proposed
Capital Comparability Determination Order must be filed in accordance
with instructions issued by the Commission or NFA.
The Commission invites public comment on its analysis above,
including comment on the FSA Application and relevant Japanese
Financial Reporting Rules. The Commission also invites comment on the
proposed conditions to the Capital Comparability Determination Order
that are listed above.
The Commission requests comment on the timeframes set forth in the
proposed conditions for Japanese nonbank SDs to file notices with the
Commission and NFA. In this regard, the proposed conditions would
require Japanese nonbank SDs to file certain written notices with the
Commission within 24 hours of the occurrence of a reportable event or
of being alerted to a reportable event by the FSA. These notices would
have to be translated into English prior to being filed with the
Commission and NFA. The Commission request comment on the issues
Japanese nonbank SDs may face meeting the filing requirements given
time-zone difference and translation issues. The Commission also
requests specific comment regarding the setting of compliance dates for
the notice reporting conditions that the proposed Capital Comparability
Determination Order would impose on Japanese nonbank SDs.
F. Supervision and Enforcement
1. Commission and NFA Supervision and Enforcement of Nonbank SDs
The Commission and NFA conduct ongoing supervision of nonbank SDs
to assess their compliance with the CEA, Commission regulations, and
NFA rules by reviewing financial reports, notices, risk exposure
reports, and other filings that nonbank SDs are required to file with
the Commission and NFA. The Commission and NFA also conduct periodic
examinations as part of their supervision of nonbank SDs, including
routine onsite examinations of nonbank SDs' books, records, and
operations to ensure compliance with CFTC and NFA requirements.\184\
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\184\ Section 17(p)(2) of the CEA (7 U.S.C. 21(p)(2)) requires
NFA as a registered futures association to establish minimum capital
and financial requirements for nonbank SDs and to implement a
program to audit and enforce compliance with such requirements.
Section 17(p)(2) further provides that NFA's capital and financial
requirements may not be less stringent than the capital and
financial requirements imposed by the Commission.
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As noted in section D.1 above, financial reports filed by a nonbank
SD provide the Commission and NFA with information necessary to ensure
the
[[Page 48113]]
firm's compliance with minimum capital requirements and to assess the
firm's overall safety and soundness and its ability to meet its
financial obligations to customers, counterparties, creditors, and
general market participants. A nonbank SD is also required to provide
written notice to the Commission and NFA if certain defined events
occur, including that the firm is undercapitalized or maintains a level
of capital that is less than 120 percent of the firm's minimum capital
requirements.\185\ The notice provisions, as stated in section E.1
above, are intended to provide the Commission and NFA with information
of potential issues at a nonbank SD that may impact the firm's ability
to maintain compliance with the CEA and Commission regulations. The
Commission and NFA also have the authority to require a nonbank SD to
provide any additional financial and/or operational information on a
daily basis or at such other times as the Commission or NFA may specify
to monitor the safety and soundness of the firm.\186\
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\185\ See 17 CFR 23.105(c).
\186\ See 17 CFR 23.105(h).
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The Commission also has authority to take disciplinary actions
against a nonbank SD for failing to comply with the CEA and Commission
regulations. Section 4b-1(a) of the CEA provides the Commission with
exclusive authority to enforce the capital requirements imposed on
nonbank SDs adopted under Section 4s(e) of the CEA.
2. FSA Supervision and Enforcement of Japanese Nonbank SDs
The FSA has supervision, audit, and investigation authority with
respect to Japanese nonbank SDs, including the authority to require
such firms to provide all necessary information for FSA to carry out
its supervisory responsibilities.\187\ Specifically, the FSA has the
authority to require Japanese nonbank SDs to submit documents to the
FSA and to conduct onsite inspections at the business offices of the
Japanese nonbank SDs.\188\
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\187\ FSA Application, p. 16.
\188\ Article 56-2 of the FIEA.
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The FSA also monitors the capital adequacy ratios of Japanese
nonbank SDs through supervisory measures on an ongoing basis. The
monitoring includes a system of notice requirements, discussed in
section E.2 above, that obligate Japanese nonbank SDs to provide notice
to the FSA if certain triggering conditions are met. The FSA also has a
variety of measures in place to address actual cases of a Japanese
nonbank SD's failure to maintain its required level of minimum capital.
Specifically, a Japanese nonbank SD is required to submit a
notification and an action plan to the FSA if the Japanese nonbank SD's
capital adequacy ratio falls below 120 percent.\189\ The FSA will
review the plan and, when necessary, identify the specific method by
which the Japanese nonbank SD is required to bring its capital adequacy
ratio back above the prescribed minimum level. The FSA also may order a
Japanese nonbank SD to change its business methods, order assets to be
deposited, or issue orders with respect to matters that are otherwise
necessary from a supervisory perspective, if the FSA finds it in the
public interest or for the protection of customers to take such
actions.\190\ Furthermore, a Japanese nonbank SD may have all or parts
of its business suspended for a period of no more than six months or
have its registration revoked if the firm violates certain laws or
regulations in connection with the financial instruments business or
services,\191\ or if the firm is likely to become insolvent.\192\
Finally, a Japanese nonbank SD is subject to fines and other possible
actions if it fails to submit documents that are required by law to be
filed with the FSA.\193\
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\189\ Article 53(2) of the FIEA.
\190\ Id.
\191\ Article 52(1)(vii) of the FIEA.
\192\ Article 52(1)(viii) of the FIEA.
\193\ Article 198-6 of the FIEA.
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3. Commission Analysis
The Commission has a long history of regulatory cooperation with
the FSA. In this connection, the Commission and FSA entered into a
Memorandum of Cooperation (``MOC'') with regard to the cooperation and
the exchange of information in the supervision and oversight of
regulated entities that operate on a cross-border basis in both the
U.S. and Japan (``Cross-Border Covered Entities''), including nonbank
SDs registered with the Commission and FIBOs registered with the
FSA.\194\ Pursuant to the MOC, the Commission and FSA expressed an
intent to consult regularly, as appropriate, regarding: (i) general
supervisory issues, including regulatory, oversight, or other related
developments; (ii) issues relevant to the operations, activities, and
regulation of Cross-Border Covered Entities; and (iii) any other areas
of mutual supervisory interest, and to meet periodically to discuss
their respective functions and regulatory oversight programs.\195\ The
MOC further provides for the Commission and FSA to inform each other of
certain events, including any material events that could adversely
impact the financial or operational stability of a Cross-Border Covered
Entity, and provides a procedure for the Commission or FSA to conduct
on-site examinations in, respectively, Japan or the U.S.\196\ Pursuant
to the terms of the MOC, the Commission intends to communicate and
consult with the FSA regarding the supervision of the financial and
operational condition of Japanese nonbank SDs.
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\194\ Memorandum of Cooperation Related to the Supervision of
Cross-Border Covered Entities (Mar. 10, 2014). See the Commission's
website at https://www.cftc.gov/International/MemorandaofUnderstanding/index.htm.
\195\ MOC, paragraphs 19 and 26.
\196\ MOC, paragraphs 22 and 29. Event-triggered notification in
paragraph 22 of the MOC includes any known adverse material change
in the ownership, operating environment, operations, financial
resources, management, or systems and controls of a Cross-Border
Covered Entity, and the failure of a Cross-Border Covered Entity to
satisfy any of its requirements for continued authorization or
registration where that failure could have a material adverse effect
in the jurisdiction of Commission or FSA.
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In addition, as discussed above, as part of FSA's ongoing
prudential regulation and supervision of FSA regulated entities, it is
able to take all measures necessary to ensure that FSA's capital,
financial and reporting rules are implemented.\197\ Thus, the
Commission preliminarily finds that FSA has the necessary powers and
ability to supervise and enforce Japanese nonbank SDs' compliance with
Japanese capital adequacy and financial reporting requirements.\198\
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\197\ FSA Application, pp 19-20.
\198\ In addition, both the Commission and the FSA are
signatories to the IOSCO Multilateral Memorandum of Understanding
Concerning Consultation and Cooperation and the Exchange of
Information (revised May 2012), which covers primarily information
sharing in the context of enforcement matters.
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The Commission invites public comment on its analysis above,
including comment on the FSA Application and relevant Japanese laws and
regulations.
IV. Proposed Capital Comparability Determination Order
A. Commission's Proposed Comparability Determination
The Commission's preliminary view, based on the FSA's Application
and the Commission's review of applicable Japanese laws and
regulations, is that the Japanese Capital Rules and the Japanese
Financial Reporting Rules, subject to the conditions set forth in the
proposed Capital Comparability Determination Order below, achieve
comparable outcomes and are comparable in purpose and effect to the
[[Page 48114]]
CFTC Capital Rules and CFTC Financial Reporting Rules. In reaching this
preliminary conclusion, the Commission recognizes that there are
certain differences between the Japanese Capital Rules and CFTC Capital
Rules and certain differences between the Japanese Financial Reporting
Rules and the CFTC Financial Reporting Rules. The proposed Capital
Comparability Determination Order is subject to proposed conditions
that are preliminarily deemed necessary to promote consistency in
regulatory outcomes, or to reflect the scope of substituted compliance
that would be available notwithstanding certain differences. In the
Commission's preliminary view, the differences between the two rule
sets would not be inconsistent with providing a substituted compliance
framework for Japanese nonbank SDs subject to the conditions specified
in the proposed Order below.
Furthermore, the proposed Capital Comparability Determination Order
is limited to the comparison of the Japanese Capital Rules to the Bank-
Based Approach under the CFTC Capital Rules. As noted previously, the
FSA has not requested, and the Commission has not performed, a
comparison of the Japanese Capital Rules to the Commission's NAL
Approach or TNW Approach.
B. Proposed Capital Comparability Determination Order
The Commission invites comments on all aspects of the FSA
Application, relevant Japanese laws and regulations, the Commission's
preliminary views expressed above, the question of whether requirements
under the Japanese Capital Rules are comparable in purpose and effect
to the Commission's requirement for a nonbank SD to hold regulatory
capital equal to or greater than 8 percent of its uncleared swap margin
amount, and the Commission's proposed Capital Comparability
Determination Order, including the proposed conditions included in the
proposed Order, set forth below.
Proposed Order Providing Conditional Capital Comparability
Determination for Japanese Nonbank Swap Dealers
It is hereby determined and ordered, pursuant to Commodity Futures
Trading Commission (``CFTC'' or ``Commission'') Regulation 23.106 (17
CFR 23.106) under the Commodity Exchange Act (``CEA'') (7 U.S.C. 1 et
seq.) that a swap dealer (``SD'') organized and domiciled in Japan and
subject to the Commission's capital and financial reporting
requirements under Sections 4s(e) and (f) of the CEA (7 U.S.C. 6s(e)
and (f)) may satisfy the capital requirements under Section 4s(e) of
the CEA and CFTC Regulation 23.101(a)(1)(i) (17 CFR 23.101(a)(1)(i))
(``CFTC Capital Rules''), and the financial reporting rules under
Section 4s(f) of the CEA and Commission Regulation 23.105 (17 CFR
23.105) (``CFTC Financial Reporting Rules''), by complying with certain
specified Japanese laws and regulations cited below and otherwise
complying with the following conditions, as amended or superseded from
time to time:
(1) The SD is not subject to regulation by a prudential regulator
defined in section 1a(39) of the CEA (7 U.S.C. 1a(39));
(2) The SD is organized under the laws of Japan and is domiciled in
Japan (a ``Japanese nonbank SD'');
(3) The Japanese nonbank SD is registered as a Type I Financial
Instruments Business Operator (``FIBO'') with the Japan Financial
Services Agency;
(4) The Japanese nonbank SD is subject to and complies with:
Articles 28(1), 29, 46-3, 46-6(2), 52(1), 53(1) through (3), 56-2, and
198-6 of the Financial Instruments and Exchange Act (Act No. 25 of
1948); Section II-1-4 (General Supervisory Processes), Section IV-2-1
(Preciseness of Capital Adequacy Ratio), and Section IV-2-2
(Supervisory Response to Cases of Financial Instruments Business
Operators' Capital Adequacy Ratio Falling Below Prescribed Level) of
the Comprehensive Guidelines for Supervision of Financial Instruments
Business Operators; Articles 172, 176, 177(8), 178(1), 179(3), and
Appended Forms No. 12 of the Cabinet Office Order on Financial
Instruments Business (Cabinet Office Order No. 52 of 2007); Articles 1
through 17 of the Financial Services Agency Notice No. 59 of 2007;
Articles 2(vi), 328(1) and (2), 435(2), and 436(2)(i) of the Japanese
Companies Act (Act No. 86 of 2005); and Article 59 of the Rules of
Corporate Accounting (Ordinance of the Ministry of Justice No. 13 of
2006) (collectively, the ``Japanese Capital Rules and Japanese
Financial Reporting Rules'');
(5) The Japanese nonbank SD maintains at all times an amount of
regulatory capital in the form of Basic Items, as defined in Article
176 of the Cabinet Office Order No. 52 of 2007, equal to or in excess
of the equivalent of $20 million in United States dollars (``U.S.
dollars''). The Japanese nonbank SD shall use a commercially reasonable
and observed yen/U.S. dollar exchange rate to convert the value of the
yen-denominated Basic Items to U.S. dollars;
(6) The Japanese nonbank SD has filed with the Commission a notice
stating its intention to comply with the applicable Japanese Capital
Rules and Japanese Financial Reporting Rules in lieu of the CFTC
Capital Rules and the CFTC Financial Reporting Rules. The notice of
intent must include the Japanese nonbank SD's representation that the
firm is organized and domiciled in Japan; is a registered FIBO; and is
subject to, and complies with, the Japanese Capital Rules and Japanese
Financial Reporting Rules. The Japanese nonbank SD may not rely on this
Capital Comparability Determination Order until it receives
confirmation from Commission staff, acting pursuant to authority
delegated by the Commission, that the Japanese nonbank SD may comply
with the applicable Japanese Capital Rules and Japanese Financial
Reporting Rules in lieu of the CFTC Capital Rules and CFTC Financial
Reporting Rules. Each notice filed pursuant to this condition must be
prepared in the English language and submitted to the Commission via
email to the following address: [email protected];
(7) The Japanese nonbank SD prepares and keeps current ledgers and
other similar records in accordance with accounting principles required
by the Financial Services Agency;
(8) The Japanese nonbank SD files with the Commission and with the
National Futures Association (``NFA'') a copy of its Monthly Monitoring
Report that is required to be filed with the Financial Services Agency
pursuant to Article 56-2(1) of the Financial Instruments and Exchange
Act. The Monthly Monitoring Report must be translated into the English
language and balances must be converted to U.S. dollars. The Monthly
Monitoring Report must be filed with the Commission and NFA within 15
business days of the date the Monthly Monitoring Report is filed with
the Financial Services Agency or 35 days after the month-end reporting
date, whichever is earlier;
(9) The Japanese nonbank SD files with the Commission and with NFA
a copy of its Annual Business Report that is required to be filed with
the Financial Services Agency in accordance with Article 46-3(1) of the
Financial Instruments and Exchange Act and Article 172 of the Cabinet
Office Order on Financial Instruments Business. The Annual Business
Report must be translated into the English language and balances must
be converted to U.S. dollars. The Annual Business Report must be filed
with the Commission and
[[Page 48115]]
NFA within 15 business days of the earlier of the date the Annual
Business Report is filed with the Financial Services Agency or the date
that the Annual Business Report is required to be filed with the
Financial Services Agency.
(10) The Japanese nonbank SD files with the Commission and with NFA
a copy of its Annual Audited Financial Report that is required to be
prepared pursuant to Article 435(2) of the Japanese Companies Act (Act
No. 86 of 2005). The Annual Audited Financial Report must be translated
into the English language and balances may be reported in yen. The
Annual Audited Financial Report must be filed with the Commission and
NFA within 15 business days of approval of the report at the
shareholders' meeting of the Japanese nonbank SD;
(11) The Japanese nonbank SD files Schedule 1 of Appendix B to
Subpart E of Part 23 of the CFTC's regulations (17 CFR 23 Subpart E--
Appendix B) with the Commission and NFA on a monthly basis. Schedule 1
must be prepared in the English language with balances reported in U.S.
dollars and must be filed with the Commission and NFA with the Japanese
nonbank SD's Monthly Monitoring Report;
(12) The Japanese nonbank SD submits with each Monthly Monitoring
Report, Schedule 1, Margin Report, Annual Business Report, and Annual
Audited Financial Report a statement by an authorized representative or
representatives of the Japanese nonbank SD that to the best knowledge
and belief of the representative or representatives the information
contained in the report, including as applicable the translation of the
report into the English language and conversion of balances in the
report to U.S. dollars, is true and correct. The statement must be
prepared in the English language;
(13) The Japanese nonbank SD files a margin report containing the
information specified in CFTC Regulation 23.105(m) (17 CFR 23.105(m))
with the Commission and with NFA on a monthly basis. The margin report
must be prepared in the English language with balances reported in U.S.
dollars and must be filed with the Commission and NFA with the Japanese
nonbank SD's Monthly Monitoring Report;
(14) The Japanese nonbank SD files a notice with the Commission and
NFA within 24 hours of being informed by the Financial Services Agency
that the firm is not in compliance with any component of the Japanese
Capital Rules or Japanese Financial Reporting Rules. The notice must be
prepared in the English language;
(15) The Japanese nonbank SD files a notice within 24 hours with
the Commission and NFA if it fails to maintain regulatory capital in
the form of Basic Items, as defined in Article 176 of the Cabinet
Office Order No. 52 of 2007, equal to or in excess of the U.S. dollar
equivalent of $20 million using a commercially reasonable and observed
yen/U.S. dollar exchange rate. The notice must be prepared in the
English language;
(16) The Japanese nonbank SD provides the Commission and NFA with
notice within 24 hours of filing a notice with the Financial Services
Agency pursuant to Article 179 of the Cabinet Office Order on Financial
Instruments Business that the firm's capital adequacy ratio has fallen
below the early warning level of 140 percent. The notice filed with the
Commission and NFA must be prepared in the English language;
(17) The Japanese nonbank SD provides the Commission and NFA with
notice within 24 hours of filing a notice with the Financial Services
Agency pursuant to Article 179 of the Cabinet Office Order on Financial
Instruments Business that the firm's capital adequacy ratio has fallen
below 120 percent. The notice filed with the Commission and NFA must be
prepared in the English language;
(18) The Japanese nonbank SD files a notice with the Commission and
NFA within 24 hours if it fails to make or keep current the financial
books and records required by the Financial Services Agency. The notice
must be prepared in the English language;
(19) The Japanese nonbank SD files a notice with the Commission and
NFA within 24 hours of the occurrence of any of the following: (i) a
single counterparty, or group of counterparties under common ownership
or control, fails to post required initial margin or pay required
variation margin on uncleared swap and non-cleared security-based swap
positions that, in the aggregate, exceeds 25 percent of the Japanese
nonbank SD's minimum capital requirement; (ii) counterparties fail to
post required initial margin or pay required variation margin to the
Japanese nonbank SD for uncleared swap and non-cleared security-based
swap positions that, in the aggregate, exceeds 50 percent of the
Japanese nonbank SD's minimum capital requirement; (iii) the Japanese
nonbank SD fails to post required initial margin or pay required
variation margin for uncleared swap and non-cleared security-based swap
positions to a single counterparty or group of counterparties under
common ownership and control that, in the aggregate, exceeds 25 percent
of the Japanese nonbank SD's minimum capital requirement; or (iv) the
Japanese nonbank SD fails to post required initial margin or pay
required variation margin to counterparties for uncleared swap and non-
cleared security-based swap positions that, in the aggregate, exceeds
50 percent of the Japanese nonbank SD's minimum capital requirement.
The notice must be prepared in the English language;
(20) The Japanese nonbank SD files a notice with the Commission and
NFA of a change in its fiscal year-end approved or permitted to go into
effect by the Financial Services Agency. The notice required by this
paragraph will satisfy the requirement for a nonbank SD to obtain the
approval of NFA for a change in fiscal year-end under CFTC Regulation
23.105(g) (17 CFR 23.105(g)). The notice of change in fiscal year-end
must be prepared in the English language and filed with the Commission
and NFA at least 15 business days prior to the effective date of the
Japanese nonbank SD's change in fiscal year-end;
(21) The Financial Services Agency notifies the Commission of any
material changes to the information submitted in its application,
including, but not limited to, material changes to the Japanese Capital
Rules or Japanese Financial Reporting Rules imposed on Japanese nonbank
SDs, the Financial Services Agency's supervisory authority or
supervisory regime over Japanese nonbank SDs, and proposed or final
material changes to the Japanese Capital Rules or Japanese Financial
Reporting Rules as they apply to Japanese nonbank SDs; and
(22) Unless otherwise noted in the conditions above, the reports,
notices, and other statements required to be filed by the Japanese
nonbank SD with the Commission and NFA pursuant to the conditions of
this Capital Comparability Determination Order must be submitted
electronically to the Commission and NFA in accordance with
instructions provided by the Commission or NFA.
Issued in Washington, DC, on July 29, 2022, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
[[Page 48116]]
Appendices to Notice of Proposed Order and Request for Comment on an
Application for a Capital Comparability Determination From the
Financial Services Agency of Japan--Commission Voting Summary,
Chairman's Statement, and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Behnam and Commissioners Johnson,
Goldsmith Romero, and Mersinger voted in the affirmative.
Commissioner Pham voted to concur. No Commissioner voted in the
negative.
Appendix 2--Statement of Support of Chairman Rostin Behnam
As CFTC provisionally-registered swap dealers (SDs) operate and
manage risk globally, the Commission's supervisory framework must
acknowledge the realities of multi-jurisdictional operations. I
support the Commission's proposed order and request for comment on
its preliminary determination that nonbank \1\ swap dealers (SDs)
organized and domiciled in Japan are subject to, and comply with,
capital and financial reporting requirements in Japan that are
comparable to certain capital and financial reporting requirements
under the Commodity Exchange Act and the Commission's regulations
(Capital Comparability Determination), subject to certain
conditions.
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\1\ The Commission has capital jurisdiction over registered SDs
that are not subject to the regulation of a U.S. banking regulator
(i.e., nonbank SDs). 7 U.S.C. 6s(e)(1).
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Today's preliminary Capital Comparability Determination is the
first such order proposed by the Commission since adopting its
regulatory substituted compliance framework for non-U.S. domiciled
nonbank SDs in July 2020.\2\ The Commission is proposing this order
in response to an application submitted by the Financial Services
Agency of Japan (FSA), which has direct supervisory authority over
the three Japanese nonbank SDs that are provisionally-registered
with the Commission.
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\2\ See 85 FR 57462, 57520 (Sept. 15, 2020). Regulation 23.106
also sets forth the Commission's substituted compliance requirements
for major swap participants; however, there are not any registered
with the Commission.
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The Commission's principles-based approach to the proposed
determination focuses on whether the FSA's capital and financial
reporting requirements achieve comparable outcomes to the
corresponding CFTC requirements.\3\ Specifically, the Commission has
also considered the scope and objectives of FSA's capital adequacy
and financial reporting requirements; the ability of FSA to
supervise and enforce compliance with its capital and financial
reporting requirements; and other facts or circumstances the
Commission has deemed relevant for this application.
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\3\ 17 CFR 23.106(a)(3)(ii). See also 85 FR 57462 at 57521.
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Throughout its analysis, the Commission recognized that
jurisdictions may adopt unique approaches to achieving comparable
outcomes, and the Commission has focused on how the FSA's capital
and financial reporting requirements are comparable to its own in
purpose and effect, rather than whether each are comparable in every
particular aspect or contain identical elements. In this regard, the
approach was not a line-by-line assessment or comparison of FSA's
regulatory requirements with the Commission's requirements.\4\
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\4\ See 85 FR 57462, 57521.
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Consistent with the Commission's authority to issue a Capital
Comparability Determination with terms and conditions it deems
appropriate, today's proposed order contains 22 conditions. These
conditions aim to ensure that the proposed order, if finalized,
would only apply to Japanese nonbank SDs that are eligible for
substituted compliance and that these Japanese nonbank SDs comply
with FSA's capital and financial reporting requirements as well as
certain additional capital, margin, position, financial reporting,
required recordkeeping, and regulatory notice requirements.
If the Commission, upon consideration of the comments received,
determines to issue a favorable comparability determination, an
eligible Japanese nonbank SD would be required to file a notice of
its intent to comply with FSA's capital adequacy and financial
reporting rules in lieu of the Commission's requirements.\5\ The
Commission (or the Market Participants Division through delegated
authority) would then be obligated to confirm to the Japanese
nonbank SD that it may comply with the foreign jurisdiction's rules
as well as any conditions that would be adopted as part of the final
determination, and that, by doing so, it would be deemed to be in
compliance with the Commission's corresponding capital adequacy and
financial reporting requirements.
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\5\ See 17 CFR 23.106(a)(4).
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I believe it is important to note that today's proposed Capital
Comparability Determination, if finalized, would not compromise the
Commission's capital and financial reporting requirements. Instead,
it recognizes the global nature of the swap markets with dually-
registered SDs that operate in multiple jurisdictions that mandate
prudent capital and financial reporting requirements. A capital and
financial reporting comparability determination order of this kind
is not a compromise or deference to a foreign regulatory authority.
The Commission would retain its enforcement authority and
examinations authority as well as obtain all financial and event
specific reporting to maintain direct oversight of nonbank SDs
located in Japan.
While the CFTC and the FSA have a pre-existing memorandum of
understanding (MOU) in place, it is important to note that an MOU or
a similar agreement is not necessary for the Commission and the
National Futures Association to monitor these firms' compliance with
the conditions of a capital comparability determination.
I look forward to the public's submission of comments and
feedback on this proposed determination and order.
I wish to again thank the hardworking staff in the Market
Participants Division for all of their efforts towards bringing us
here today.
Appendix 3--Statement of Support of Commissioner Kristin N. Johnson
I support the Commission's issuance of the proposed capital
comparability order for comment (Proposed Order). I commend staff's
hard work on this matter and their meticulous review of the capital
and financial reporting requirements in Japan, as well as their
outstanding cooperation with the Financial Services Agency of Japan
(JFSA). I also appreciate the JFSA's sustained and meaningful
engagement of Commission staff during the entirety of the review
process.
The Commission's capital and financial reporting requirements
are critical to ensuring the safety and soundness of our regulated
swap dealers.\1\ Ensuring necessary levels of capital, as well as
accurate and timely reporting about financial conditions, helps to
protect swap dealers and the broader financial markets ecosystem
from shocks, thereby ensuring resiliency.
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\1\ See 7 U.S.C. 6s(e); 17 CFR subpart E.
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Prior to the adoption of the CFTC's final rules regarding swap
dealer capital which published in the Federal Register on September
15, 2020,\2\ with a compliance date of October 6, 2021,\3\ the
Commission had issued interpretive guidance allowing for substituted
compliance determinations to be made with respect to other
components of the Commission's swap dealer requirements. Under that
guidance, the Commission has issued comparability determinations
relating to market participants operating in several jurisdictions
including the EU, Australia, Canada, Hong Kong, Switzerland, and,
notably, Japan.\4\ The Proposed Order before the Commission is,
however, the first capital comparability determination.
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\2\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 85 FR 57462 (Sept. 15, 2020) (CFTC Capital Rules).
\3\ Id. at 57462.
\4\ The Commission has issued comparability determinations for
certain entity-level requirements (Australia, Canada, EU, Hong Kong,
Japan, Switzerland), certain transaction-level requirements (EU,
Japan), and margin requirements for uncleared swaps (EU, Japan). See
CFTC, Comparability Determinations for Substituted Compliance
Purposes, https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
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When the Commission initially issued interpretive guidance, many
jurisdictions had not yet implemented swaps reforms addressing risk
management failures that precipitated the 2008 financial crisis.
Today, many jurisdictions have made great strides to adopt effective
regulatory regimes, mitigating the systemic risks that previously
pervaded global markets. The current procedure for regulatory
capital and financial reporting requirements set forth in regulation
23.106 permits foreign nonbank swap dealers, a trade association on
behalf of one or more foreign nonbank swap dealers, or a foreign
regulatory authority with jurisdiction over a foreign nonbank swap
dealer (as the JFSA has done) to file an application for substituted
compliance. The Proposed Order, if
[[Page 48117]]
approved, will allow registered nonbank swap dealers organized and
domiciled in Japan to satisfy certain capital and financial
reporting requirements under the Commodity Exchange Act \5\ by being
subject to and complying with comparable capital and financial
reporting requirements under Japanese laws and regulations.
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\5\ 7 U.S.C. 1 et seq.
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I support acknowledging market participants' compliance with the
regulations of foreign jurisdictions when the requirements lead to
an outcome that is comparable to the outcome of complying with the
CFTC's corresponding requirements. Substituted compliance must not,
however, be confused with deference. To the contrary, the swap
dealers that qualify for substituted compliance under regulation
23.106 must be Commission registrants. The Proposed Order, if
approved, would continue to ensure that relevant Japan-based swap
dealers are subject to the Commission's examination and enforcement
authority over the firms.
Capital requirements play a critical role in fostering the
safety and soundness of financial markets. As indicated in the
Commodity Exchange Act, capital requirements protect market
participants against risks such as counterparty default.\6\ Robust
capital requirements enable individual market participants to absorb
losses, meet their obligations, and successfully navigate challenges
that may threaten their integrity or trigger systemic risk concerns.
As a result, the Commission must be measured in applying its
framework for capital comparability determinations. I look forward
to reviewing the public comments on this proposed determination.
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\6\ 7 U.S.C. 6s(e).
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Appendix 4--Statement of Support of Commissioner Christy Goldsmith
Romero
I support the Commission's efforts for strong capital
requirements and financial reporting to help ensure the safety and
soundness of swap dealers whose activities could affect U.S.
markets, including through this proposed Capital Comparability
Determination for Japan. The proposal promotes financial stability,
and the benefits of global harmonization with a like-minded
regulator for the global swaps markets. Thank you to the staff for
their hard work, and for their thoughtful engagement with me and my
office on changes to improve the proposal.
The 2008 Financial Crisis and TARP Capital Injections
A key cause of the financial crisis was the failure of bank
regulators to require financial institutions to have high quality
capital in a sufficient amount to serve as a buffer against risk.
This included the lack of capital requirements that would ensure
that financial institutions that were swap dealers, and other major
participants in swaps markets, had adequate capital to absorb
losses. The devastating result of this undercapitalization swept
rapidly through the highly interconnected financial system. The
default or margin failure of one counterparty triggered another, and
then another--which led to a short-term liquidity crisis. Risk and
losses also cascaded from subsidiaries and affiliates to bank parent
companies and/or bank holding companies, including across borders.
The financial contagion was not limited to major players in the
markets. The entire economy suffered, with Main Street bearing the
consequences of Wall Street. The federal government made
unprecedented capital injections of hundreds of billions of taxpayer
dollars into more than 700 financial institutions through the
Troubled Asset Relief Program (``TARP''). For the last decade, I
served as the Special Inspector General for TARP (``SIGTARP''),
providing oversight over TARP programs. I have testified before
Congress and reported publicly on lessons learned from inadequate
capital requirements pre-crisis, and the need for strong levels of
high-quality capital to lower systemic risk in the financial system.
The Dodd Frank Act's Capital Requirements for Swap Dealers
Swap dealer capital requirements are one of the most critical
reforms in the Dodd-Frank Act for derivatives markets. These reforms
led the CFTC to allow nonbank swap dealers to use a capital
framework similar to what prudential banking regulators apply to
banks.\1\
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\1\ This bank-based approach is consistent with the Basel
Committee on Banking Supervision's international framework for bank
capital requirements.
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Capital protects the solvency of the swap dealer from unexpected
losses such as counterparty defaults and margin collateral failures.
Capital requirements are aimed at ensuring a swap dealer has the
ability to absorb losses and they prevent market disruption by
helping to ensure that swap dealers continue to perform their
critical function to provide liquidity and market making. Capital
along with margin requirements for uncleared swaps reduces the
potential for contagion, thereby lowering systemic risk in the
financial system, and promoting financial stability.
The CFTC's First Substituted Compliance Determination for Capital
Requirements
The global nature of the financial crisis also highlighted the
need for the CFTC to coordinate with foreign regulators as swap
activities in a foreign jurisdiction may have an impact here in the
United States. For example, risk of a foreign subsidiary can flow to
their U.S. parent company.
The CFTC's ``substituted compliance'' framework leverages a
second regulator, a like-minded foreign regulator that has rules,
supervision and enforcement that are comparable in purpose and
effect to the CFTC's. Under this global harmonization, the CFTC
would allow a non-U.S. entity to be deemed in compliance with CFTC
requirements if the non-U.S. entity complied with the foreign
regulator's comparable rules.
I am mindful that this proposal is the first of its kind--the
first substituted compliance determination for the CFTC's capital
rules. Therefore, we should proceed carefully, as we are
establishing precedent.
The proposal today is for nonbank swap dealers that are
domiciled in Japan, where we have a Memorandum of Cooperation and a
long history of cooperation with the Japanese Financial Services
Agency.\2\ Currently, this proposal would apply to Japanese
affiliates of Bank of America, Morgan Stanley and Goldman Sachs--
three systemically important institutions and three of the largest
TARP recipients having collectively received $60 billion in TARP
capital injections. Therefore, it is vital that the CFTC ensures
that these swap dealers have adequate amounts of high-quality
capital. Public comment will be helpful on whether the CFTC is
correct in its preliminary determinations of comparability.
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\2\ As noted in the proposal, in making a Capital Comparability
Determination the Commission may consider any facts or circumstances
it deems relevant, including whether the relevant foreign regulatory
authority has a memorandum of understanding or similar arrangement
with the Commission that would facilitate supervisory cooperation.
See 17 CFR 23.106(a)(3)(iv).
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I highlight, and express my appreciation for, the involvement of
the Japanese Financial Services Agency in this process. CFTC staff's
engagement with our regulatory counterparts in Japan has helped to
ensure the accuracy of the staff's assessment of Japanese capital
and financial reporting requirements, along with supervisory and
enforcement programs.\3\
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\3\ The Commission may consider all relevant factors in making a
Capital Comparability Determination, including the ability of the
relevant foreign regulatory authority to supervise and enforce
compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements. See 17 CFR 23.106(a)(3)(iii). The
proposal also makes a preliminary determination that the Japanese
financial reporting rules are conditionally comparable in purpose
and effect with the CFTC's financial reporting rules.
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Substituted compliance does not require an all or nothing
determination. The CFTC may continue to require compliance with
certain of its rules, and impose any terms or conditions that it
deems appropriate.\4\
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\4\ See 17 CFR 23.106(a)(5).
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The CFTC proposes to continue to require that Japanese nonbank
swap dealers comply with the CFTC's $20 million capital requirement,
as Japan has no minimum requirement.\5\ I strongly support retaining
the $20 million capital requirement. However, the CFTC is not
requiring compliance with our requirement that the $20 million be in
the form of common equity tier 1 capital--one of the strongest forms
of capital. Instead, the proposal would allow the $20 million
requirement to be satisfied with types of capital defined in a
category called ``Basic Items'' under Japanese regulation. I look
forward to commenters' response on whether allowing the $20 million
capital requirement to be satisfied with this category of ``Basic
Items'' is comparable in purpose and effect to the CFTC's
requirement that only common equity tier 1 capital be included in
the $20 million.
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\5\ Japanese capital requirements are consistent with Basel bank
capital standards, similar to the CFTC.
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Japan also does not have a minimum requirement for capital that
is tied to the
[[Page 48118]]
margin for uncleared swaps entered into by the nonbank swap dealer.
The CFTC requires an aggregate of common equity tier 1 capital,
additional tier 1 capital and tier 2 capital equal to or greater
than 8 percent of the nonbank swap dealer's uncleared swap margin
amount. I look forward to commenters' response on the question as to
whether Japan's capital requirement in an amount equal to 25% of
operating expenses is comparable in purpose and effect to the CFTC's
capital requirement equal to 8% of the uncleared swap margin amount.
It is a priority for me to ensure that the CFTC guards against
complacency with post-crisis reforms, particularly after market
stresses from the pandemic and geopolitical events. We should
remember that our capital rules serve as critical pillars of Dodd-
Frank reforms to help ensure the safety and soundness of financial
institutions, and to protect the market from serious risks and
contagion. The CFTC has a duty to ensure that our comparability
assessment is sound, and that the foreign regulator is like-minded
in not only rules but in their approach, supervision and
enforcement. Substituted compliance must leave U.S. markets and our
economy at no greater risk than full compliance with our rules.
Appendix 5--Concurring Statement of Commissioner Caroline D. Pham
I respectfully concur with the notice of proposed order and
request for comment on an application for a capital comparability
determination submitted by the Financial Services Agency (FSA) of
Japan.
First, I want to recognize the staff's work as each of my fellow
Commissioners has done because this is not easy--not only for this
rulemaking, but also, generally speaking, swap dealer oversight is
an incredibly complex regulatory regime. I also appreciate your
commitment to providing substituted compliance.
In addition, in my past work in Japan and with their financial
sector, I have enjoyed working with the FSA for many years, and I
appreciate their thoughtful and robust oversight of their regulated
firms. I also want to say that my thoughts and heart are with the
people of Japan regarding the tragic loss of Prime Minister Shinzo
Abe.
As I mentioned in my opening statement, the CFTC should take an
outcomes-based approach to substituted compliance that appropriately
balances and recognizes the nature of cross-border regulation of
global markets and firms, and that preserves access for U.S. persons
to other markets.\1\ I appreciate the Chairman's remarks and I
welcome comments, particularly on operational issues with additional
reporting requirements given the time difference, language
translation, conversion to USD, local governance and regulatory
requirements, and differences in financial reporting.
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\1\ See Statement of Dissent by Commissioner Scott D. O'Malia on
Comparability Determinations for Australia, Canada, the European
Union, Hong Kong, Japan, and Switzerland: Certain Entity and
Transaction-Level Requirements (Dec. 20, 2013).
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I urge a pragmatic approach with sufficient time to implement
conditions before any compliance date, and I appreciate the thought
that the staff have been putting into that. I speak from my past
experience as a global head of swap dealer compliance who had to
implement global regulatory reforms. I'll also note that in a
crisis, such as during the early days of the COVID-19 pandemic,
there was timely and effective engagement between and amongst CFTC
registrants and U.S. regulators. I have been on many calls and
spoken to many regulators all over the world, not only during COVID-
19, but also during times of market disruption or potentially
material events.
There is a difference between a phone call and a formal written
notice, and that's just one example of the conditions in this
proposal. So, I appreciate receiving comments on this and any other
operational issues and the careful consideration by the staff and
the Commission of how to take a practical approach to achieving
appropriate oversight and mitigation of risk to the United States
and to our markets.
[FR Doc. 2022-16684 Filed 8-5-22; 8:45 am]
BILLING CODE 6351-01-P