2019-06424
Federal Register, Volume 84 Issue 64 (Wednesday, April 3, 2019)
[Federal Register Volume 84, Number 64 (Wednesday, April 3, 2019)]
[Rules and Regulations]
[Pages 12894-12906]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-06424]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AE78
Segregation of Assets Held as Collateral in Uncleared Swap
Transactions
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is amending selected provisions of its regulations to
simplify certain requirements for swap dealers (``SDs'') and major swap
participants (``MSPs'') concerning notification of counterparties of
their right to segregate initial margin for uncleared swaps, and to
modify requirements for the handling of segregated initial margin.
DATES: Effective May 3, 2019.
FOR FURTHER INFORMATION CONTACT: Matthew Kulkin, Director, 202-418-
5213, [email protected]; or Christopher Cummings, Special Counsel, 202-
418-5445, [email protected], Division of Swap Dealer and Intermediary
Oversight, Commodity Futures Trading Commission, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Existing Requirements
1. Statutory Basis and Regulatory Background
2. Subpart L as Originally Adopted
B. Factors Considered by the Commission
II. Final Rule, Summary of Comments, and Commission Response
A. Regulation 23.700--Definitions
B. Regulation 23.701--Notification of Right to Segregation
C. Regulation 23.702--Requirements for Segregated Initial Margin
D. Regulation 23.703--Investment of Segregated Initial Margin
E. Regulation 23.704--Requirements for Non-Segregated Margin
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. Background
2. Modification of Collection 3038-0075
C. Cost-Benefit Considerations
1. Background
2. Regulations 23.700, 23.701, 23.702, and 23.703--Notification
of Right to Initial Margin Segregation
D. Antitrust Considerations
I. Introduction
A. Existing Requirements
1. Statutory Basis and Regulatory Background
Subpart L of part 23 of the Commission's regulations (``Segregation
of Assets Held as Collateral in Uncleared Swap Transactions,''
consisting of Regulations 23.700 through 23.704) was published in the
Federal Register on November 6, 2013 and became effective on January 6,
2014.\1\ Subpart L implements the requirements for segregation of
initial margin for uncleared swap transactions set forth in section
4s(l) of the Commodity Exchange Act (``CEA'' or the ``Act'').\2\
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\1\ See 78 FR 66621 (Nov. 6, 2013).
\2\ 7 U.S.C. 6s(l) (2012 and Supp. 2015). Like the Commission's
regulations, the CEA can be accessed through the Commission's
website.
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CEA section 4s(l) addresses segregation of initial margin held as
collateral in certain uncleared swap transactions. The section applies
only where a swap between a counterparty and an SD or MSP is not
submitted for clearing to a derivatives clearing organization
(``DCO''). It requires that an SD or MSP notify the counterparty of the
SD or MSP at the beginning of a swap transaction that the counterparty
has the right to require segregation of the funds or other property
supplied to margin, guarantee, or secure the obligations of the
counterparty. Such funds or property are to be segregated in a separate
account from the SD's or MSP's assets. The separate account must be
held by an independent third-party custodian and must be designated as
a segregated account for the counterparty. CEA section 4s(l) does not
preclude the counterparty and the SD or MSP from agreeing to their own
terms regarding investment of initial margin (subject to any
regulations adopted by the Commission) or allocation of gains or losses
from such investment. If the counterparty elects not to require
segregation of margin, the SD or MSP is required to report quarterly to
the counterparty that the SD's or MSP's back office procedures relating
to margin and collateral are in compliance with the agreement between
the counterparty and the SD or MSP.
In November 2015, the 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
(collectively, ``Prudential Regulators'') adopted margin requirements
for swaps entered into by SDs and MSPs that they regulate (``Prudential
Regulator Margin Rules'').\3\ In January 2016, the Commission adopted
margin requirements for certain uncleared swaps which requirements are
applicable to SDs and MSPs for which there is no prudential regulator
(``CFTC Margin Rule'').\4\ The CFTC Margin Rule and the Prudential
Regulator Margin
[[Page 12895]]
Rules established initial and variation margin requirements for SDs and
MSPs.\5\
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\3\ See Margin and Capital Requirements for Covered Swap
Entities, 80 FR 74840 (Nov. 30, 2015).
\4\ Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants, 81 FR 636 (Jan. 6, 2016). The CFTC Margin
Rule, which became effective April 1, 2016, is codified in part 23
of the Commission's regulations. 17 CFR 23.150 through 23.159,
23.161. The Commission also adopted a rule addressing margin in the
cross-border context. See 17 CFR 23.160.
\5\ See 17 CFR 23.151.
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Prior to the CFTC Margin Rule effective date of April 1, 2016, if
initial margin \6\ was to be exchanged by counterparties to uncleared
swaps involving an SD or MSP, the requirements of subpart L applied.
The CFTC Margin Rule amended Regulation 23.701 to clarify that from and
after the effective date of the CFTC Margin Rule, the requirements of
Regulations 23.702 and 23.703 would not apply where segregation is
mandatory under the CFTC Margin Rule.\7\ As a result, Regulations
23.702 and 23.703 generally apply only when initial margin is to be
exchanged between an SD or MSP and either: (1) A nonfinancial end-user,
or (2) a financial end-user without ``material swaps exposure,'' as
defined in the CFTC Margin Rule.
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\6\ The Commission notes that the term ``Initial Margin'' is
used only for purposes of subpart L of the Commission's regulations.
\7\ 81 FR at 704. The amendment did not address the application
of subpart L to swaps subject to mandatory segregation under the
Prudential Regulator Margin Rules. As described infra, this Proposal
would clarify that the swaps subject to the Prudential Regulator
Margin Rules are to be addressed in the same manner as swaps subject
to the CFTC Margin Rule.
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2. Subpart L as Originally Adopted
Regulation 23.700, as originally adopted, defines certain terms
used in subpart L. Regulation 23.701 requires an SD or MSP: (1) To
notify each counterparty to a swap that is not submitted for clearing
that the counterparty has the right to require that any initial margin
it provides be segregated; (2) to identify a creditworthy custodian
that is a non-affiliated legal entity, independent of the SD or MSP and
the counterparty, to act as depository for segregated margin assets;
and (3) to provide information regarding the costs of such segregation.
The regulation specifies that the notification is to be made (with
receipt confirmed in writing) to an officer of the counterparty
responsible for management of collateral (or to specified alternative
person(s)), and that it need only be made once in any calendar year.
Finally, the regulation provides that a counterparty can change its
election to require (or not to require) segregation of initial margin
by written notice to the SD or MSP.
Regulation 23.702 reiterates the requirement that the custodian be
a legal entity independent of the SD or MSP and the counterparty. It
also requires that segregated initial margin be held in a designated
account segregated for, and on behalf of, the counterparty. Finally,
the regulation specifies that the segregation agreement must provide
that: (1) Withdrawals from the segregated account be made pursuant to
agreement of both the counterparty and the SD or MSP, with notification
to the non-withdrawing party; and (2) the custodian can turn over
segregated assets upon presentation of a sworn statement that the
presenting party is entitled to control of the assets pursuant to
agreement among the parties.
Regulation 23.703 restricts investment of segregated assets to
investments permitted under Regulation 1.25 and (subject to that
restriction) permits the SD or MSP and the counterparty to agree in
writing as to investment of margin and allocation of gains and losses.
Regulation 23.704 requires the SD's or MSP's chief compliance
officer (``CCO'') to report quarterly to any counterparty that does not
elect to segregate initial margin, whether or not the SD's or MSP's
back office procedures regarding margin and collateral requirements
were, at any point in the previous calendar quarter, not in compliance
with the agreement of the counterparties.
B. Factors Considered by the Commission
Over the course of more than four years of administering subpart L
of part 23, the Commission has observed that the detailed requirements
of those regulations have proven difficult for SDs and MSPs to
implement and to satisfy in a reasonably efficient manner. These
observations were buttressed by suggestions submitted in response to
the Commission's ``Project KISS'' initiative as described herein. In
addition, the Commission understands that very few swap counterparties
have exercised the right to elect to segregate initial margin
collateral pursuant to subpart L during the four years that the
regulations have been effective.
Early in the implementation period, in response to multiple
inquiries, Commission staff issued CFTC Staff Letter 14-132 (October
31, 2014),\8\ which provided interpretative guidance to SDs and MSPs
regarding application of certain of the segregated margin requirements.
In particular, the letter noted concerns expressed by SDs and MSPs that
despite their earnest efforts to obtain confirmation of receipt of
notification and election regarding segregation, failure by a
counterparty to respond to the SD or MSP could bar any further swap
transactions with the counterparty until a response was received.\9\
However, notwithstanding the issuance of Staff Letter 14-132, issues
regarding compliance with subpart L continue to be raised.\10\
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\8\ See CFTC Staff Letter No. 14-132 (October 31, 2014),
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/14-132.pdf.
\9\ The Proposal aimed to address generally some of the
confusion that prompted the issuance of CFTC Staff Letter 14-132,
supra n.8, in the context of other changes to subpart L that were
proposed.
\10\ For example, issues regarding compliance with these
regulations have been raised with the National Futures Association
as recently as January 2018, indicating ongoing uncertainty. See pp.
6-7 of the transcript of the NFA Swap Dealer Examination Webinar,
January 18, 2018, available at https://www.nfa.futures.org/members/member-resources/files/transcripts/sdexamswebinartranscriptjan2018.pdf.
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On May 9, 2017, the Commission published in the Federal Register a
request for information,\11\ pursuant to the Commission's ``Project
KISS'' initiative, seeking suggestions from the public for simplifying
the Commission's regulations and practices, removing unnecessary
burdens, and reducing costs. A number of suggestions the Commission
received addressed various provisions of subpart L. In general, those
suggestions echoed Commission staff concerns that the requirements in
subpart L may be more burdensome than is necessary to achieve the
purposes of the statute and may be counterproductive to the extent that
they frustrate the decision making process and discourage the use of
individual segregation accounts.\12\ Persons responding to Project KISS
also noted that some requirements cause confusion because they overlap
with segregation requirements in the margin regulations recently
adopted by the CFTC and Prudential Regulators.\13\ Furthermore,
responders stated that the requirements in subpart L are overly
prescriptive, eliminating the possibility for reasonable bilateral
negotiation that
[[Page 12896]]
takes place in the normal course to determine certain terms, including
appropriate collateral arrangements based on the circumstances of the
broader counterparty relationship.\14\
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\11\ See 82 FR 21494 (May 6, 2017) and 82 FR 23765 (May 24,
2017).
\12\ See, e.g., letter from the Financial Services Roundtable
(``FSR Letter''), dated September 30, 2017 at 55 (noting that
``compliance with these regulations has proven to be unduly
burdensome for swap dealers when weighed against the protections
afforded to swap counterparties thereunder''), available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61427&SearchText=.
\13\ Id. See also letter from the Securities Industry and
Financial Markets Association (``SIFMA Letter'') dated September 29,
2017 at 2 (``These requirements create unnecessarily burdensome
obligations, which in many instances are duplicative or create
confusion due to parallel mandatory collateral segregation
requirements found within the CFTC and [prudential regulator] rules
on margin requirements for non-centrally cleared swaps, and similar
requirements in foreign jurisdictions.''), available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61359&SearchText=.
\14\ See SIFMA Letter at 2. See also letter from the Global
Foreign Exchange Division of the Global Financial Markets
Association (``GFMA Letter'') dated September 29, 2017, available
at: https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61414&SearchText=.
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Responders also asserted that counterparties to uncleared swaps
rarely elect to require segregation of margin pursuant to the existing
provisions of subpart L.\15\ Commission staff likewise has observed
evidence of minimal exercise of the election to segregate.\16\ In
addition, Commission staff has discussed this issue with the National
Futures Association (``NFA'') to ascertain NFA's observations from
examining a substantial number of SDs in connection with the
implementation of subpart L. Based on this experience, it appeared that
for nearly every SD examined, fewer than five counterparties elected
segregation pursuant to subpart L since registration. For some SDs, not
a single counterparty elected to segregate pursuant to subpart L.
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\15\ See FSR Letter at 55 (``Our members have advised that
counterparties (1) rarely, if ever, elect to segregate [initial
margin] and (2) have found little use for receiving the notices.'').
\16\ See 83 FR 36484, 36486 (Jul. 30, 2018).
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In light of these considerations, the Commission proposed to amend
the regulations governing segregation of margin for uncleared swaps
(the ``Proposal'').\17\ The Commission expressed its belief that the
proposed amendments would reduce unnecessary burdens on registrants and
market participants by simplifying some overly detailed provisions,
thereby reducing the intricate and prescriptive requirements. The
Commission further opined that the proposed changes would facilitate
more efficient swap execution by eliminating complexity and confusion
that slows down documentation and negotiation of hedging and other swap
transactions. Finally, the Commission asserted that the amendments, by
reducing the prescriptive elements of the rules, potentially could
encourage more segregation (as was intended by the CEA),\18\ by
providing flexibility for the parties to establish segregation
arrangements that better suit their specific needs.
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\17\ See ``Segregation of Assets Held as Collateral in Uncleared
Swap Transactions,'' 83 FR 36484 (Jul. 30, 2018).
\18\ 83 FR at 38486. See also 75 FR 75432, 75433 (Dec. 3, 2010)
(noting the important right for a counterparty to elect segregation
``with a certain degree of favor given to an affirmative
election'').
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In the preamble to the Proposal, the Commission also sought comment
from the public on the appropriateness of the proposed changes, as well
as suggestions for other amendments that could streamline, simplify,
and reduce the costs of subpart L without sacrificing the protections
called for by CEA section 4s(l). The comment period for the Proposal
closed on September 28, 2018, and four comment letters \19\ were
received: one from a swap dealer; \20\ one from a registered futures
association;\21\ one from an association of credit risk professionals
in the energy industry; \22\ and one jointly submitted by a trade
organization for participants in over-the-counter derivatives markets
and a trade organization for broker-dealers, investment banks, and
asset managers.\23\
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\19\ The comment letters may be accessed via the Commission's
website at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=2898.
\20\ Letter from INTL FC Stone Markets, LLC, Sept. 27, 2018
(``IFCS'').
\21\ Letter from National Futures Association, Sept. 28, 2018
(``NFA'').
\22\ Letter from International Energy Credit Association, Sept.
28, 2018 (``IECA'').
\23\ Letter from International Swaps and Derivatives Association
and Securities Industry and Financial Markets Association, Sept. 27,
2018 (``ISDA/SIFMA'').
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II. The Final Rule, Summary of Comments, and Commission Response
The Commission is adopting changes to Regulations 23.700, 23.701,
23.702, 23.703, and 23.704 as proposed. In Regulation 23.700, the
definition of ``Margin'' is eliminated (and where that term was used
elsewhere in subpart L it is replaced with ``Initial Margin''). In
Regulation 23.701, the following changes are made: (1) The required
notification of the right to segregate is to be made at the beginning
of the first uncleared swap transaction that provides for exchange of
initial margin; (2) the exception to the notification requirement in
cases where segregation is required under the CFTC Margin Rule is
expanded to include cases where segregation is required under
Prudential Regulator Margin Rules; (3) the annual notification
requirement is eliminated; (4) the requirement to identify in the
notification one or more creditworthy custodians and to provide
information regarding the cost for segregation for each named custodian
is eliminated; (5) the requirement to provide the notification to a
person with specific job title at the counterparty is eliminated; (6)
the terms of segregation are to be established by written agreement
with the counterparty; and (7) the requirement to obtain from the
counterparty and maintain written confirmation of receipt of the
notification is eliminated. In Regulation 23.702, specific requirements
regarding the withdrawal or turnover of control of initial margin are
replaced with a provision that the segregation agreement provide that
instructions to withdraw initial margin be in writing and that
withdrawal notification be given immediately to the non-withdrawing
party. In Regulation 23.703, the restriction on investment of
segregated margin to investments permitted under Regulation 1.25 is
eliminated. In Regulation 23.704, the requirement that the SD's or
MSP's CCO report quarterly to each counterparty that does not elect
segregation is replaced by a general requirement that the SD or MSP so
report, and that the report must state that the SD's or MSP's back
office procedures were in compliance with the agreement of the
counterparties.
All of the commenters generally supported the Proposal and the
Commission's efforts to simplify and rationalize the existing
requirements. Comments that addressed particular provisions of subpart
L will be discussed below.
A. Regulation 23.700--Definitions
As proposed, the Commission is amending Regulation 23.700 to
eliminate the definition of ``Margin'' and to make conforming changes
to subpart L by replacing the term ``Margin'' with ``Initial Margin''
in Regulations 23.701, 23.702, and 23.703. As originally adopted,
Regulation 23.700 defines ``Margin'' as ``both Initial Margin and
Variation Margin.'' \24\ As amended, subpart L will no longer refer
collectively to initial margin and variation margin, because the right
to require segregation applies only to initial margin, and not to
variation margin. Thus, there is no need for the separate defined term
``Margin.'' \25\
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\24\ See 17 CFR 23.700.
\25\ The Commission is also adopting a grammatical change for
the definition of the term ``segregate'' (the words ``Segregate. To
segregate two or more items is to keep them in separate accounts . .
.'' were replaced with ``Segregate means to keep two or more items
in separate accounts . . .'').
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IECA was the only commenter to address this issue and asked the
Commission to revise the defined terms to relate more closely to over-
the-counter market terms by clarifying whether or not Initial Margin is
analogous to a deposit. IECA pointed out that independent amounts are
often posted not to secure changes in market position but to protect
settlement risk, and that variation margin is an exchange
[[Page 12897]]
of collateral and not a ``payment'' in exchange for something.\26\ In
the adopting release for subpart L, the Commission considered several
comments questioning its selection of defined terms and it adopted the
``initial margin'' definition notwithstanding those comments, noting
that ``variation margin'' is used in the statute and ``initial margin''
is the obvious complementary term.\27\ After review of the comments,
the Commission confirms the rationale it articulated for proposing the
amendments to Regulation 23.700, and therefore, is adopting the
amendments as proposed.
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\26\ IECA at 3-5.
\27\ See 78 FR at 66623. The Commission considered a range of
comments, including that ``Initial Margin'' was too broad or too
narrow, or that ``independent amount'' should be used instead (or at
least tracked or referenced), before concluding that ``Initial
Margin'' was the most practical choice under the circumstances.
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B. Regulation 23.701--Notification of Right to Segregation
As proposed, the Commission is amending paragraph (a) of Regulation
23.701: (1) To require that the notification to a counterparty be made
prior to execution of the first uncleared swap transaction that
provides for the exchange of initial margin, and not prior to each
transaction; (2) to provide that the notification obligation does not
apply where segregation is required under Prudential Regulator Margin
Rules; (3) to eliminate the requirement that the notification identify
one or more creditworthy, independent custodians; and (4) to eliminate
the requirement to provide information regarding the price for
segregation for each identified custodian. Paragraph (b) remains
unchanged. The Commission is replacing paragraph (c) with a simple
statement that if segregation is elected, the terms shall be
established by written agreement and eliminating paragraphs (d) and (e)
(with existing paragraph (f) redesignated as new paragraph (d)). As
discussed below, after review of the comments, the Commission confirms
the rationale articulated for proposing the amendments to Regulation
23.701, and therefore, is adopting the amendments as proposed.
As originally adopted, paragraphs (a) and (b) of Regulation 23.701
direct an SD or MSP to notify each counterparty to an uncleared swap of
the right to require segregation of initial margin. Paragraph (c)
requires the SD or MSP to furnish the required notification to an
officer of the counterparty responsible for management of collateral,
or, if no such person is identified by the counterparty, then to the
chief risk officer, or, if there is no such officer, to the chief
executive officer, or if none of the foregoing, the highest-level
decision-maker for the counterparty. Paragraph (d) requires the SD or
MSP, ``prior to confirming the terms of any such swap,'' to obtain
confirmation of receipt of the notification and the counterparty's
election to require or not require segregation of initial margin (such
confirmation to be retained in accordance with Regulation 1.31).\28\
Paragraph (e) provides that the notification need be made only once in
any calendar year.\29\ Finally, paragraph (f) provides that the
counterparty may change the segregation election at its discretion by
providing a written notice to the SD or MSP.
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\28\ 17 CFR 1.31.
\29\ Some confusion has been caused by the requirement in
paragraph (d) to provide the notice ``prior to confirming the terms
of any such swap,'' and the requirement in paragraph (e) to provide
the notice once in any calendar year. See SIFMA Letter at 3.
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Based on staff's implementation experience and on suggestions
received in connection with Project KISS, the Commission expressed in
the preamble to the Proposal its belief that these requirements are
unnecessarily prescriptive and that they do not reflect the practical
realities of how over-the-counter swap transactions are negotiated and
managed by the parties. Accordingly, the Commission proposed to modify
the notification requirement in paragraph (a) and to remove the
requirements in existing paragraphs (c), (d), and (e). The Commission
did not propose to amend paragraph (f) except to redesignate it as
paragraph (d).\30\
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\30\ See 83 FR at 36486-88.
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The Commission proposed to revise paragraph (a) to require that the
notification to a counterparty be made prior to execution of the first
uncleared swap transaction that provides for the exchange of initial
margin,\31\ not prior to each transaction or annually as currently
prescribed by paragraphs (a) and (e).\32\ CEA section 4s(l)(1)(A)
requires notification of the right to segregate ``at the beginning of a
swap transaction.'' The Commission stated that it was interpreting that
phrase to mean at the beginning of an SD's or MSP's swap transaction
relationship with each counterparty.\33\
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\31\ This revision is consistent with guidance provided in CFTC
Staff Letter 14-132, supra n.8.
\32\ Thus, under the Proposal, paragraph (e) of Regulation
23.701 (providing that the notification need only be made once in
any calendar year) would become unnecessary, and was proposed to be
deleted.
\33\ See 83 FR at 36487.
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This interpretation is an extension of the view the Commission
expressed when it originally proposed and adopted Regulation 23.701.
Specifically, with respect to the statutory requirement that
notification be provided ``at the beginning of a swap transaction,''
the Commission noted that ``[w]hile this language could be read to
require transaction-by-transaction notification, where the parties have
a pre-existing or on-going relationship, such repetitive notification
could be redundant, costly, and needlessly burdensome. On the other
hand, the importance of the segregation decision, as discussed above,
suggests that some periodic reconsideration might be appropriate.''
\34\ The Commission then noted that the decision to require an annual
notice was an attempt to balance the interests of ensuring that
counterparties know of their segregation rights against inundating them
with redundant information. The Commission, now, based on its
experience, has determined that this is not the right balance, and in
fact, it has not observed any significant use of segregation. As the
Commission noted in 2013, the statute ``does not merely grant
counterparties the legal right to segregation; it specifically requires
that the existence of this right be communicated to them.'' \35\ These
rule amendments adopted herein still ensure that the rights imparted
under CEA section 4s(l) are communicated to SD/MSP counterparties while
limiting the burden of providing and receiving superfluous
notifications.
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\34\ See 78 FR at 66625.
\35\ Id.
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When it originally adopted Regulation 23.701(e), the Commission
considered comments requesting a loosening of the once-per-year notice
requirement and rejected the requests in the belief that requiring
notification once each year would balance the burden of providing
notices and getting responses with the importance of the right to
segregate initial margin.\36\ However, on the basis of implementation
experience since Regulation 23.701 was originally adopted, the
Commission proposed to require notification at the beginning of a swap
trading relationship that provides for exchange of initial margin. The
importance of the notification informing the counterparty of the right
to segregate is paramount at the beginning of the SD/MSP-counterparty
relationship. It is at the time the parties initiate the first
transaction that the decision to segregate initial margin will
[[Page 12898]]
typically be made.\37\ Subsequent notifications, in addition to the
initial notification, risk adding confusion over the duration of the
contractual relationship between the parties.\38\ In this regard, the
Commission stated its understanding that counterparties rarely change
their election, once made. Accordingly, in addition to modifying the
notification requirement in paragraph (a), the Commission proposed to
eliminate paragraph (e)'s annual notification requirement in light of
the proposed obligatory notification at the beginning of the first
uncleared swap transaction that provides for exchange of initial
margin.
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\36\ Id.
\37\ For existing master netting agreements for which the SD has
already sent a segregation notice, the Commission took the view in
the preamble to the Proposal that such notice would be sufficient
for purposes of complying with the amended regulations, if adopted,
and therefore the SD would not be required to send a new notice.
\38\ See FSR Letter at 55, supra n.12 See also, supra n.10.
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The Commission also proposed that paragraph (a) be revised to
eliminate the notification requirement where segregation is mandatory
under Regulation 23.157 and where it is mandated under applicable rules
adopted by a Prudential Regulator under CEA section 4s(e)(3).
Additionally, paragraph (a)(2) (the requirement that the notification
identify one or more creditworthy, independent custodians) was proposed
to be deleted because selection of a custodian can be made when and if
the counterparty elects to require segregation. Because very few
counterparties elect to require segregation, the Commission stated that
it is unnecessarily burdensome to require an SD or MSP to confirm which
custodians are available and continually update the SD's or MSP's
notification form with the name of the custodian(s) available.
Moreover, the Commission further understood that a counterparty's
initial decision to consider requiring (or not requiring) segregation
is driven principally by the counterparty's concern about protecting
its initial margin and the terms of the segregation agreement, and not
by the identity of the custodian.\39\ Similarly, the Commission
proposed to delete paragraph (a)(3) (information regarding the price
for segregation for each custodian) because such pricing may vary for
each segregation arrangement and would normally be subject to
negotiation. To the extent pricing would be a factor in the decision to
segregate, counterparties can and do discuss pricing as a term of the
custodial arrangement when the counterparty indicates an interest in
segregation.\40\
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\39\ See 83 FR at 36487.
\40\ Id. The Commission also notes that the requirements in
paragraphs (a)(2) and (a)(3) are not found in CEA section 4s(l).
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Similarly, the Commission proposed to eliminate the requirement in
paragraph (c) that the SD or MSP provide the notification to a person
at the counterparty with a specific job title. Based on implementation
experience, the Commission expressed the view that the regulation as
initially adopted is unnecessarily prescriptive in dictating who must
receive the notification. For example, in many cases, the person at the
counterparty best situated to evaluate the notification and the
decision to segregate will be a person directly involved in negotiating
the swap, regardless of that person's title. The Commission notes that
in removing the specific designation of officers to receive the
notification it would not be eliminating the expectation that each
registrant will use reasonable judgment in identifying an appropriate
person at the counterparty who can evaluate the right to elect
segregation (and either act on it or bring it to the attention of
someone in a position to act on it). The Commission stated its
continued belief that, to be effective, the notification must be made
to a person at the counterparty who understands its meaning and, to the
extent necessary, can direct it to the appropriate personnel at the
counterparty. The proposed change sought to advance the same underlying
policy objective as the existing requirement (namely that the
notification be given to appropriate personnel at the counterparty),
but would recognize that dictating how counterparties communicate the
information in question creates unnecessary burdens and potentially
hinders the ability of the parties to direct the information to the
person(s) best situated to evaluate it.\41\
---------------------------------------------------------------------------
\41\ Id.
---------------------------------------------------------------------------
As proposed, new paragraph (c) would simplify requirements in
existing Regulation 23.701 by providing that ``[i]f the counterparty
elects to segregate initial margin, the terms of segregation shall be
established by written agreement.'' \42\
---------------------------------------------------------------------------
\42\ Id.
---------------------------------------------------------------------------
As noted above, the Commission proposed to eliminate the additional
requirements in existing paragraph (d), which are more extensive than
the notification requirements set forth in CEA section 4s(l).
Subsequent to adoption of subpart L, experience with implementation of
the requirements of Regulation 23.701 has made the Commission aware of
problems experienced by registrants in complying with these additional
requirements. For example, persons seeking guidance have noted that
paragraph (d)'s current requirement that the SD not execute a swap with
the counterparty until it receives confirmation of the counterparty's
receipt of the notification has the potential to block swap trading in
some circumstances.\43\ Instances of forestalled trading caused by this
requirement could be particularly harmful for nonfinancial end-users
that have ongoing, dynamic hedging programs (to hedge, for example,
commodity price risk or foreign exchange risk).\44\
---------------------------------------------------------------------------
\43\ See 83 FR at 36487. See also CFTC Staff Letter 14-132,
supra n.8.
\44\ See IECA Letter at 8 (commenting that the proposed
interpretation of CEA section 4s(l)(1)(A) is reasonable given the
commercial realities of uncleared swaps transactions and
relationships between SDs and MSPs and their counterparties).
---------------------------------------------------------------------------
The Commission observed that compliance with the existing
segregation notification requirements in the regulation necessitates
lengthy explanations and instructions from SDs and MSPs to their
counterparties and imposes additional administrative processes
requiring counterparties to take steps that are outside of the normal
course of transacting in swaps. Some of these steps cause transaction
delays and deviations from established business procedures for
collateral custodial arrangements and disclosure of counterparty rights
generally, and do not advance the counterparty's right to segregate
initial margin. For nonfinancial end-user counterparties who tend to
use swaps primarily for hedging purposes, these added compliance steps
often cause confusion and uncertainty that can inhibit opportune,
timely hedging. For counterparties that execute swaps frequently and
have determined that they wish to segregate, the additional
requirements merely add unnecessary hurdles to the transaction process.
Accordingly, the Commission stated that it does not believe that the
burdens imposed by these prescriptive requirements provide meaningful
regulatory benefits beyond those provided by the provisions in proposed
amended Regulation 23.701.\45\
---------------------------------------------------------------------------
\45\ See 83 FR at 36487-36488.
---------------------------------------------------------------------------
Several commenters generally supported the amendments to Regulation
23.701. NFA stated that it supports the Commission's efforts to clarify
and simplify these requirements, and that ``[b]ased on our experience,
we believe that eliminating a segregation notice requirement under
these
[[Page 12899]]
circumstances would help reduce unnecessary correspondence and avoid
confusion.'' \46\ IFCS stated that ``the current notification
requirements often cause confusion to [their] customers--requiring the
Firm to respond with lengthy explanations--rather than providing any
meaningful benefit.'' \47\ Two other commenters supported eliminating
the segregation notice requirement where segregation is mandatory under
rules of a Prudential Regulator, asserting that this will help reduce
unnecessary correspondence and avoid confusion.\48\ In response to a
question in the Proposal, IECA stated that the Commission's proposed
interpretation of the notification requirement in CEA section
4s(l)(1)(A) is reasonable given the commercial realities of uncleared
swaps transactions and relationships between SDs and MSPs and their
counterparties.\49\
---------------------------------------------------------------------------
\46\ NFA at 2.
\47\ IFCS at 2.
\48\ NFA at 1-2; accord ISDA/SIFMA at 3.
\49\ IECA at 8.
---------------------------------------------------------------------------
Because drafting and exchange of relationship documentation can
occur well before the first transaction, ISDA/SIFMA sought confirmation
that notification of the right to segregate may be given at any time
prior to the first transaction,\50\ and further confirmation that
trading can continue during any interim period between a counterparty's
election to segregate initial margin and the execution of related
documentation.\51\ The Commission is declining at this time to specify
what constitutes the beginning of the first swap transaction or to
proscribe when trading may commence because it believes that the
counterparties are best able to determine those parameters under their
specific circumstances. IECA asked the Commission to provide that the
notification can be part of the relationship documentation, noting that
the personnel who negotiate, review, and execute relationship
documentation are appropriate personnel to understand and act upon such
a notification.\52\ The Commission notes that although the statute does
not specify the manner in which the required notification must be
provided, a reasonable interpretation would require that it be
sufficiently conspicuous to draw the counterparty's attention.
---------------------------------------------------------------------------
\50\ ISDA/SIFMA at 3-4.
\51\ Id. at 4.
\52\ IECA at 5-6.
---------------------------------------------------------------------------
Three commenters specifically supported elimination of the existing
requirement to notify counterparties annually of the right to require
segregation. IFCS stated that ``customers have indicated that they find
little use for receiving a Segregation Notice on an annual basis,''
pointing to ``the administrative burdens associated with providing the
notice on an annual basis coupled with its lack of utility'' in
supporting elimination of the requirement.\53\ NFA added that if the
Commission retains the annual notification requirement, it should
eliminate it where counterparties have previously elected to require
segregation, noting that very few counterparties have, over time,
changed their initial election.\54\ Because the Commission is
eliminating this requirement, NFA's comment is moot. In response to a
question in the Proposal, IECA urged that the Commission provide that
there is no need for a swap dealer to provide any such notice unless or
until there is initial margin in the swap trades between the two
parties.\55\ In response, the Commission notes that the language of CEA
section 4s(l) does not condition the obligation to notify on the actual
tender of initial margin. Additionally, in response to a question, IECA
stated that the Commission should not provide that the counterparty may
request or opt to continue to receive notification at the beginning of
each swap transaction or an annual or some other periodic basis.
---------------------------------------------------------------------------
\53\ IFCS at 2; accord IECA at 2 and NFA at 2.
\54\ NFA at 2.
\55\ IECA at 8.
---------------------------------------------------------------------------
IFCS expressly supported elimination of the requirement to include
information about the price of custody services in the notification of
the right to require segregation, stating that ``[c]osts associated
with segregation are largely controlled by the third-party custodian
and may vary for each segregation agreement, which, together, make it
difficult to provide meaningful pricing information in the
notification.'' \56\ All commenters supported elimination of the
requirement to provide the required notification to a specified
individual, noting that SDs and counterparties are best able to
determine an appropriate recipient for the notification.\57\ IECA noted
that by eliminating the requirement to obtain and keep a confirmation
of the counterparty's receipt of the notification of right to require
segregation, over-the-counter market participants will save significant
costs and avoid risk and confusion. Specifically, IECA stated that
``[s]wap trades are documented on `confirmations.' The current rule
calls two different things . . . `confirmations' as necessary for swap
trades,'' \58\ and also pointed out that ``[t]he notice and
`confirmation' mechanisms may also conflict with corporate resolutions,
and agreement representations, regarding who is authorized to trade for
the counterparty.'' \59\ IECA also stated that proposed paragraph (d)
of Regulation 23.701 should be replaced with language that permits a
counterparty to knowingly choose to waive in their master agreement the
right to require segregation under CEA section 4s(l)(1)(B), and that
also permits the counterparty to waive the right to be notified that it
can require segregation.\60\ The Commission believes that the
amendments it is adopting provide sufficient flexibility (e.g.,
eliminating the requirement to provide notification prior to each
swap), and observes that including a waiver mechanism would appear to
be inconsistent with Congressional intent as expressed in CEA section
4s(l) (i.e., that counterparties to uncleared swaps be provided with
affirmative notification of the right to elect segregation).
---------------------------------------------------------------------------
\56\ IFCS at 2.
\57\ IFCS at 2; ISDA/SIFMA at 3; NFA at 2; accord IECA at 2.
\58\ IECA at 2.
\59\ Id.
\60\ Id. at 6-7.
---------------------------------------------------------------------------
C. Regulation 23.702--Requirements for Segregated Initial Margin
As proposed, the Commission is amending paragraph (c) of Regulation
23.702 to replace the specific requirements in subparagraphs (1) and
(2) regarding withdrawal or change in control of margin with a
requirement ``that any instruction to withdraw Initial Margin shall be
in writing and that notification of the withdrawal shall be given
immediately to the non-withdrawing party.'' As adopted, Regulation
23.702 sets forth requirements for the custody of initial margin
segregated pursuant to a counterparty's election under Regulation
23.701. Paragraph (c)(2) of Regulation 23.702 provides specific
requirements for the withdrawal and turnover of control of initial
margin. In particular, paragraph (c)(2) requires the custodian to turn
over control of initial margin upon presentation of a written statement
made by an authorized representative under oath or under penalty of
perjury as specified in 28 U.S.C. 1746. Such statement must provide
that the person presenting it is entitled to assume control of the
initial margin pursuant to the parties' agreement. The other party must
be immediately notified of the turnover of control. As discussed below,
after review of the comments, the
[[Page 12900]]
Commission confirms the rationale articulated for proposing the
amendments to Regulation 23.702, and therefore, is adopting the
amendments as proposed.
In the Proposal, the Commission expressed its belief that, while
paragraph (c)(2) may generally be consistent with the manner in which
custodial arrangements work, the prescriptive requirements of the
regulation, including requiring a specific form, the language used, and
the certification needed, do not account for change in control
arrangements in custodial agreements that are sometimes customized to
reflect the unique business facts and circumstances that may exist
between any two parties and the custodian. For example, the unique
nature of the collateral posted or the specific terms of change in
control triggers may warrant different notice procedures than those
specified by paragraph (c)(2). Alternative notice procedures may allow
for more timely and effective change in control under real-world
circumstances and better protect each party's interests. Accordingly,
the Commission said it believed that more flexibility is warranted, and
that it is more appropriate to leave these matters up to negotiation by
the parties.\61\
---------------------------------------------------------------------------
\61\ See 83 FR at 36488.
---------------------------------------------------------------------------
IFCS specifically expressed support for the proposed amendments to
Regulation 23.702.\62\ IFCS stated that it ``believes the current
regulations are overly prescriptive and welcomes the opportunity for
bilateral negotiations between sophisticated market participants who
are, by definition, deemed to be able to protect their own interests.''
\63\ Another commenter suggested a change to existing paragraph
(c)(2).\64\ However, because the Commission is eliminating that
paragraph, the comment is moot.
---------------------------------------------------------------------------
\62\ IFCS at 3.
\63\ Id.
\64\ IECA at 7.
---------------------------------------------------------------------------
In response to a question in the Proposal regarding whether the
Commission should adopt in Regulation 23.702(a) more specific financial
or affiliation qualifications for the custodian that an SD or MSP uses
as a depository for segregated initial margin, IECA stated that it
should not, and added that if the Commission wishes to educate
counterparties on custodian credit characteristics and risks, it could
hold roundtables from time to time and publish the transcripts.\65\ The
Commission is retaining the requirement that a custodian be a legal
entity independent of both the SD or MSP, and the counterparty. It does
not believe that a roundtable is necessary at this time.\66\
---------------------------------------------------------------------------
\65\ IECA at 8-9.
\66\ If, in the future, the Commission becomes aware of problems
resulting from poorly selected custodians it will consider hosting a
roundtable or other appropriate outreach to remedy any such issues.
---------------------------------------------------------------------------
D. Regulation 23.703--Investment of Segregated Initial Margin
As proposed, the Commission is amending Regulation 23.703 to
eliminate the requirement that investment of margin that is segregated
pursuant to an election under Regulation 23.701 may only be done in a
manner consistent with Regulation 1.25. As originally adopted,
Regulation 23.703 requires initial margin segregated pursuant to
subpart L to be invested consistent with Regulation 1.25.\67\ Paragraph
(b) provides that, subject to consistency with Regulation 1.25, the SD
or MSP and the counterparty may enter into any commercial arrangement,
in writing, regarding the investment of margin and allocation of
resulting gains and losses. Regulation 1.25 sets forth standards for
investment of customer funds by a futures commission merchant (``FCM'')
or DCO in the context of exchange-traded futures and cleared swaps.
When originally proposing Regulation 23.703, the Commission expressed
its view that Regulation 1.25 ``has been designed to permit an
appropriate degree of flexibility in making investments with segregated
property, while safeguarding such property for the parties who have
posted it, and decreasing the credit, market, and liquidity risk
exposures of the parties who are relying on that margin.'' \68\ As
discussed below, after review of the comments, the Commission confirms
the rationale articulated for proposing the amendments to Regulation
23.703, and therefore, is adopting the amendments as proposed.
---------------------------------------------------------------------------
\67\ 17 CFR 1.25.
\68\ See 75 FR at 75434.
---------------------------------------------------------------------------
A suggestion in response to the Project KISS initiative noted that
Regulation 1.25 is designed to protect exchange customers for which
margin investment decisions are outside of their control.\69\
Regulation 1.25 includes fairly extensive and specific requirements as
to the mechanisms for holding and investing margin and the qualitative
aspects of the investments held. With respect to initial margin for
uncleared swaps that is not held in accordance with Regulation 23.157
or with the Prudential Regulator Margin Rules, the margin investment
decisions are typically a matter of contract subject to negotiation
between the parties. As such, each counterparty has a voice in how the
initial margin may be invested.\70\
---------------------------------------------------------------------------
\69\ See SIFMA Letter at 4.
\70\ See 83 FR at 36488.
---------------------------------------------------------------------------
In addition, the terms of most exchange-traded and cleared products
are standardized and the customer's primary relationship with the FCM
or DCO centers upon the trading and clearing of those standardized
products. Conversely, over-the-counter swaps, by their nature, tend to
be more customized and are often part of a broader financial
relationship. For example: Interest rate swaps with end-users are often
designed to match maturities of loans or bonds, with the rate of the
swap tied to the rate on the loan or bond; commodity swaps often hedge
the counterparty's physical commodity production or consumption risks
that arise from a particular commercial enterprise; and foreign
exchange swaps often hedge an entity's exposure to cross-border
commercial transactions. In each case, the SD or MSP sometimes plays
additional financial roles, such as brokering physical commodity
purchases or sales, providing a loan or other credit or liquidity
support, or acting as a correspondent bank. Accordingly, each
counterparty, particularly nonfinancial end-user counterparties, may
find better transactional efficiencies and may be better served and
protected in related credit transactions if the types of collateral and
the investment procedures and mechanisms used are determined through
bilateral negotiation by the parties.\71\
---------------------------------------------------------------------------
\71\ See 83 FR at 36488.
---------------------------------------------------------------------------
In the preamble to the Proposal, the Commission stated that, given
the greater breadth and variability, both in the terms and purposes of
uncleared swaps and in the nature of the relationship between the
counterparty and the SD or MSP, a regulation that provides greater
flexibility for the parties to negotiate appropriate initial margin
investment terms will, in most cases, better serve the parties'
interests. For the same reasons, allowing greater flexibility may also
encourage more counterparties to elect to segregate pursuant to subpart
L.\72\
---------------------------------------------------------------------------
\72\ Id.
---------------------------------------------------------------------------
The Commission also recognized that in some circumstances,
nonfinancial end-user counterparties might have less negotiating
leverage with a sophisticated SD or MSP.\73\ However, the regulations
as originally adopted give little or no flexibility for
[[Page 12901]]
counterparties and SDs or MSPs to negotiate mutually beneficial terms
and to consider other factors such as the broader financial
relationship between the parties. For nonfinancial end-user
counterparties, the segregation of initial margin is at their
discretion. If these counterparties have a voice in how segregated
initial margin is invested, the returns of which they will often
receive, they may be more likely to elect to require segregation.\74\
---------------------------------------------------------------------------
\73\ Id.
\74\ Id.
---------------------------------------------------------------------------
ISDA/SIFMA stated that ``[b]y taking steps to remove unnecessary
requirements regarding annual notices, disclosures and Rule 1.25
limitations which prevent counterparties from negotiating preferred
terms regarding the investment of segregated collateral, among other
proposed amendments, the Commission is furthering its goal to
streamline overly burdensome rules in a manner more consistent with
market practice, while still achieving its regulatory oversight
objectives.'' \75\ IFCS supported the Proposal's ``allowance for more
flexibility in the requirements for segregated margin and investment of
segregated margin,'' describing the existing requirements as overly
prescriptive and welcoming the opportunity for bilateral negotiations
between sophisticated market participants.\76\ In response to the
Commission's question regarding how the requirement that margin that is
segregated pursuant to an election under Regulation 23.701 may only be
invested consistent with Regulation 1.25 has impacted counterparties'
decisions to make an election under Regulation 23.701, IECA stated that
because ``the right to require segregation is so rarely exercised, any
response to this question would at best be anecdotal.'' \77\
---------------------------------------------------------------------------
\75\ ISDA/SIFMA at 3.
\76\ IFCS at 3.
\77\ IECA at 9 [footnote omitted].
---------------------------------------------------------------------------
E. Regulation 23.704--Requirements for Non-Segregated Margin
As proposed, the Commission is amending Regulation 23.704 by
placing on the SD or MSP as an entity the obligation to report on a
quarterly basis to counterparties that do not elect to require
segregation of initial margin (instead of obligating the firm's CCO
specifically). A further amendment to paragraph (b) of Regulation
23.704 eliminates the phrase ``with respect to each counterparty.''
Existing Regulation 23.704(a) requires the CCO of each SD or MSP to
report quarterly to each counterparty that does not elect segregation
of initial margin on whether or not the SD's or MSP's back office
procedures relating to margin and collateral requirements failed at any
time during the previous calendar quarter to comply with the agreement
of the counterparties.\78\ As discussed below, after review of the
comments, the Commission confirms the rationale articulated for
proposing the amendments to Regulation 23.704, and therefore, is
adopting the amendments as proposed.
---------------------------------------------------------------------------
\78\ Consistent with CFTC Staff Letter 14-132, supra n.8, the
Commission confirms that the reporting requirement under Regulation
23.704 does not apply if no initial margin will be required as part
of the swap transaction.
---------------------------------------------------------------------------
In the preamble to the Proposal, the Commission expressed its
belief that it is unnecessary to specify that the CCO be the individual
that makes such reports, so long as the information is provided to
counterparties. For many firms, middle or back office staff, not the
CCO, implements collateral management pursuant to the terms of each
collateral management agreement. Those individuals are therefore better
situated to assess compliance with agreements and to provide the
quarterly report.\79\ Accordingly, there are likely personnel at each
SD or MSP other than the CCO who are better situated to more accurately
and efficiently provide the report.\80\ The Commission therefore
proposed to require that the SD or MSP make the reports without
specifying any particular person to perform that function. The
Commission further proposed to clarify the language regarding timing of
the required reports to eliminate uncertainty as to the regulation's
meaning. With respect to paragraph (b) of the regulation, the
Commission proposed to specify that the reports required under
paragraph (a) need be delivered only to counterparties who choose not
to require segregation (by removing the phrase ``with respect to each
counterparty'') consistent with the statutory authority underlying this
requirement.\81\
---------------------------------------------------------------------------
\79\ Any potential conflicts of interest on the part of such
individuals are mitigated by the oversight function of the CCO with
respect to the firm's overall regulatory compliance.
\80\ The Commission notes that the CCO continues to be
responsible, under Regulation 3.3, to report in the CCO annual
report any material non-compliance issues involving back office
procedure relating to margin and collateral requirements.
\81\ See 83 FR at 36489.
---------------------------------------------------------------------------
IFCS generally supported the changes to Regulation 23.704 while
urging the Commission to continue to evaluate the regulation.\82\ NFA
and IFCS stated their support for eliminating the requirement that an
SD's or MSP's CCO be the individual to issue the quarterly report
regarding back office compliance. NFA noted that eliminating the
requirement will provide greater flexibility,\83\ and IFCS stated that
eliminating the requirement does not lessen the burden but only shifts
it to another corporate department.\84\
---------------------------------------------------------------------------
\82\ IFCS at 3.
\83\ NFA at 2.
\84\ IFCS at 3-4.
---------------------------------------------------------------------------
IFCS and ISDA/SIFMA stated that the quarterly report does not
provide the customer protection benefits the Commission intended to
achieve, and urged that instead of requiring quarterly reporting, the
Commission should require an SD or MSP to report only when issues of
non-compliance are present.\85\ NFA asked the Commission to clarify the
language of proposed Regulation 23.704(a) to indicate whether a
quarterly report is required in those instances when an SD or MSP is
and is not in compliance with an agreement with a counterparty.\86\ The
Commission notes that the statute specifically requires an SD or MSP to
report quarterly to any counterparty that does not elect segregation of
initial margin for uncleared swaps ``that the back office procedures of
the [SD or MSP] relating to margin and collateral requirements are in
compliance with the agreement of the counterparties.'' \87\
Accordingly, an SD or MSP is required to ensure that its back office
procedures are in compliance with the agreement with the counterparty
and to report that fact on a quarterly basis, whether or not such
procedures are properly carried out on an ongoing basis.
---------------------------------------------------------------------------
\85\ IFCS at 3-4; ISDA/SIFMA at 4.
\86\ NFA at 3.
\87\ 7 U.S.C. 6s(l)(4).
---------------------------------------------------------------------------
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires Federal agencies
to consider whether the regulations they propose will have a
significant economic impact on a substantial number of small entities
and, if so, provide a regulatory flexibility analysis respecting the
impact.\88\ Whenever an agency publishes a general notice of proposed
rulemaking for any regulation, pursuant to the notice-and-comment
provisions of the Administrative Procedure Act,\89\ a regulatory
flexibility analysis or certification typically is required.\90\ The
Commission previously has established certain definitions of ``small
entities'' to be used in evaluating the impact of its regulations on
small
[[Page 12902]]
entities in accordance with the RFA.\91\ The Commission has previously
established that SDs, and MSPs, and eligible contract participants \92\
are not small entities for purposes of the RFA.\93\
---------------------------------------------------------------------------
\88\ 5 U.S.C. 601 et seq.
\89\ 5 U.S.C. 553. The Administrative Procedure Act is found at
5 U.S.C. 500 et seq.
\90\ See 5 U.S.C. 601(2), 603, 604, and 605.
\91\ See Registration of Swap Dealers and Major Swap
Participants, 77 FR 2613 (Jan. 19, 2012).
\92\ Eligible contract participants, as defined in CEA section
1a(18), 7 U.S.C. 1a(18).
\93\ See Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR
30596, 30701 (May 23, 2012).
---------------------------------------------------------------------------
Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the Proposal will not have a
significant economic impact on a substantial number of small entities.
B. Paperwork Reduction Act
1. Background
The Paperwork Reduction Act of 1995 (``PRA'') \94\ imposes certain
requirements on Federal agencies (including the Commission) in
connection with their conducting or sponsoring a collection of
information as defined by the PRA. The rule amendments adopted today
would result in such a collection, as discussed below. A person is not
required to respond to a collection of information unless it displays a
currently valid control number issued by the Office of Management and
Budget (``OMB''). The rule amendments include a collection of
information for which the Commission has previously received a control
number from OMB. The title for this collection of information is
``Disclosure and Retention of Certain Information Relating to Swaps
Customer Collateral, OMB control number 3038-0075.'' \95\ Collection
3038-0075 is currently in force with its control number having been
provided by OMB.
---------------------------------------------------------------------------
\94\ 44 U.S.C. 3501 et seq.
\95\ See OMB Control No. 3038-0075, https://www.reginfo.gov/public/do/PRAOMBHistory?ombControlNumber=3038-0075#.
---------------------------------------------------------------------------
The Commission is revising collection 3038-0075 to incorporate
changes to reduce the number of notices an SD or MSP must provide to
its counterparties with respect to the rights of such counterparties to
segregate initial margin for uncleared swaps. The Commission does not
believe the rule amendments as adopted impose any other new collections
of information that require approval of OMB under the PRA.
2. Modification of Collection 3038-0075
The rule amendments adopted today modify collection 3038-0075 by
eliminating the requirement that the notification of the right to
segregate be provided on an annual basis to a specified officer of the
counterparty such that the notice would only need to be provided once
to each counterparty at the beginning of the first non-cleared swap
transaction that provides for the exchange of initial margin. The
Commission originally estimated that each SD and MSP would, on average,
provide the segregation notice to approximately 1,300 counterparties
each year and that the burden for preparing and furnishing the notice
would be 2 hours, for an annual burden of 2,600 hours.\96\ The
Commission now estimates that each SD and MSP will, on average, have
approximately 300 new counterparties each year for a total burden of
600 hours per registrant. The Commission received no comments regarding
its discussion of the PRA burden analysis in the preamble to the
Proposal. Accordingly, the Commission is revising its overall burden
estimate associated with Regulation 23.701 for this collection by
reducing the per registrant annual burden by 2,000 hours. The
Commission further estimates that there are 103 SD/MSPs and that the
aggregate total burden hours associated with Regulation 23.701 is
61,800. The Commission continues to estimate that Regulation 23.704
would require a total of approximately 2,600 disclosures and 798 hours
per year per entity. However, the Commission is adjusting its estimate
of the total annual responses and burden hours to reflect an increase
by one of the number of respondents. The Commission now estimates that
approximately 267,800 total annual responses (which is based on 103 SD/
MSPs and the 2,600 disclosures per year per entity) would require total
annual burden hours of 82,194.\97\
---------------------------------------------------------------------------
\96\ See 78 FR at 66631.
\97\ The change in the estimated total annual burden hours for
Regulation 23.704 from the original estimate reflects both a change
in the total number of registrants and a slight correction to the
calculation to correct for arithmetical errors.
---------------------------------------------------------------------------
C. Cost-Benefit Considerations
1. Background
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\98\ CEA section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. With respect to the rule amendments discussed above,
the Commission has considered the costs and benefits resulting from its
discretionary determinations with respect to the CEA section 15(a)
factors, and sought comments from interested persons regarding the
nature and extent of such costs and benefits.
---------------------------------------------------------------------------
\98\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
The Commission notes that this consideration of costs and benefits
is based on the understanding that the swap market functions
internationally, with many transactions involving U.S. firms occurring
across different international jurisdictions, with some SDs, MSPs, and
their counterparties organized outside the U.S., and other entities
operating both within and outside the U.S., and commonly following
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
discussion below of the costs and benefits of the regulations being
adopted refers to their effects on all subject swaps activity, whether
by virtue of the activity's physical location in the United States or
by virtue of the activity's connection with or effect on U.S. commerce
under CEA section 2(i).
2. Regulations 23.700, 23.701, 23.702, and 23.703--Notification of
Right to Initial Margin Segregation
The baseline for these cost and benefit considerations is the
status quo, which is existing market conditions and practice in
response to the requirements of current Regulations 23.700, 23.701,
23.702, and 23.703.\99\ Subpart L: (1) Requires SDs or MSPs to notify
counterparties of the right to segregate initial margin; (2)
establishes certain procedures regarding the notification; and (3)
establishes certain requirements for the initial margin segregation
arrangements.
---------------------------------------------------------------------------
\99\ See 78 FR at 66632-36 (discussing the cost-benefit
considerations with regard to the segregation regulation). The
Commission believes that the changes to Regulation 23.704 do not
change the costs or benefits originally determined when that
regulation was adopted.
---------------------------------------------------------------------------
The rule amendments adopted herein are intended to provide a more
flexible approach that reduces some regulatory burdens that provide
little or no corresponding benefit. The definition of ``Margin'' is
eliminated because it will no longer be needed. The rule amendments
would also revise when the segregation notice is required.
Additionally, the amendments eliminate the requirements that the SD or
MSP: (1)
[[Page 12903]]
Provide the segregation notice to an officer of the counterparty with
specific qualifications, and (2) obtain the counterparty's confirmation
of receipt of the segregation notice. Finally, the rule amendments as
adopted allow the parties to establish the notice of change of control
provisions and the commercial arrangements for investment of segregated
collateral by contract instead of imposing specific requirements.
(i) Cost and Benefit Considerations
The general purpose of the adopted rule amendments is to reduce
burdens and improve the benefits intended by subpart L. The Commission
believes that the amendments would not impose any new requirements on
registrants and instead would reduce or make the regulations more
flexible, allowing market participants to use standard market practices
regarding the implementation of the initial margin segregation
requirements. The simplification of the notification requirements will
likely reduce the time needed to complete the notification process. The
simplification of the notification requirements may also facilitate
more resource-efficient development and maintenance of customer
relationships by reducing the search costs for some of the removed
items. The rule amendments will also reduce costs by eliminating the
requirements for those swaps that must comply with the Prudential
Regulator Margin Rules mandatory margin requirements. In addition, the
amendments as adopted will provide benefits to the parties to swaps by
allowing the parties to establish by contract the terms for collateral
management and for change in control and investment of segregated
initial margin in a manner that better suits their business needs. To
the extent the parties will be able to negotiate more efficient
segregation investment arrangements that generate higher returns that
are passed on to the counterparty, as is most often the case for
uncleared swaps, the parties will benefit. The Commission believes that
the simplification of the requirements and greater flexibility will
therefore encourage more counterparties to elect to segregate initial
margin.
As noted above, in some circumstances, nonfinancial end-user
counterparties might have less negotiating leverage when negotiating
the terms of segregation agreements with experienced SDs or MSPs.
Reducing the prescriptive requirements in the current rule could
therefore reduce protections for the counterparties. However, it is not
clear how incentives or disincentives may impact the negotiating
choices of SDs and MSPs as well as the counterparties and therefore the
extent to which the requirements provide protections. For example,
regarding the choice of investments, the SD or MSP may seek to restrict
investments to the most liquid investments that could be easily
liquidated if the counterparty defaults. Those liquid investments,
which would likely be similar to the investments permitted under
Regulation 1.25, may in turn generate lower returns passed on to the
SD's or MSP's counterparties. Conversely, the current regulations give
little or no flexibility for counterparties and SDs or MSPs to
negotiate mutually beneficial terms and consider other factors such as
the broader financial relationship between the parties. Furthermore,
for nonfinancial end-user counterparties, the segregation of initial
margin is discretionary. If the counterparties have no voice in how
segregated initial margin is invested, there may be less incentive for
the counterparty to elect to require segregation. In addition, because
the counterparty will no longer receive an annual notice of its right
to segregation, this may result in a counterparty not exercising its
right, as a result of new or other employees taking over this
responsibility; however, as noted above, once a counterparty selects an
option, it rarely changes. Lastly, there is less information given to
the counterparty (i.e., custodial prices, including a non-affiliated
custodian); however, as noted above, this information is typically not
comparable and therefore, may be misleading, as each custodial
agreement is privately negotiated.
The Commission believes that the rule amendments to subpart L might
lead to reduced costs for registrants, because they will no longer have
to comply with some of the more prescriptive requirements imposed by
the regulations. The Commission is, however, unable to quantify the
potential cost savings because the cost savings depend on numerous
factors that are particular to each SD or MSP and each counterparty
relationship. For example, the factors affecting the costs involved
could include: The size and complexity of an SD's dealing activities,
the actual number of swaps that would be affected by this rulemaking,
the complexity of the swap transactions, the level of sophistication of
each counterparty, the degree to which automated notice technologies
may be used to satisfy these requirements, and the nature of the
custodial and investment documents in particular segregation
arrangements.
(ii) Section 15(a) Considerations
a. Protection of Market Participants and the Public
Subpart L is intended to provide counterparties to SDs and MSPs
with notice of the right to elect to segregate initial margin. The
Commission recognizes that the amendments adopted to make the
regulations less prescriptive might potentially negatively impact the
goal of protecting market participants by removing specific
requirements for the segregation agreements. However, the Commission is
of the view that the intended purpose and benefits of subpart L remain
in place because the rule amendments as adopted continue to implement
the statutory requirements. Each counterparty will still receive
notification of its right to segregate its initial margin. In addition,
the parties and the selected custodian will now have the flexibility to
establish requirements for margin segregation through negotiated
contracts that meet their respective needs, thereby providing market
participants with the flexibility and opportunity to protect themselves
better by contract. Finally, the greater flexibility provided by these
amendments may increase the voluntary use of initial margin segregation
by counterparties, a process that was intended to provide better
protection for the counterparty in the event of default by the SD or
MSP.
The Commission acknowledges that by eliminating the requirement to
reinvest initial margin in Regulation 1.25 liquid securities, it may be
lowering protections to SDs or MSPs and their counterparties, which may
affect other market participants and the public. The Commission
believes that this change provides market participants with the ability
to privately negotiate the terms of reinvestment. The private terms of
reinvestment allow each party to assess its risk tolerance and enter
into a written agreement that reflects this tolerance and possibly earn
higher anticipated returns on excess margin than potential returns from
Regulation 1.25 liquid securities investments.
b. Efficiency, Competitiveness, and Financial Integrity of Markets
Subpart L promotes the financial integrity of markets by providing
for the protection of counterparty collateral and by mitigating
systemic risk that may result from the loss of access to the collateral
in the event of a counterparty
[[Page 12904]]
default. As discussed above, given that registrants will still be
expected to enter into segregation arrangements with counterparties
that elect to segregate, and, with adoption of the rule amendments to
subpart L, registrants will now be able to develop segregation
arrangements tailored to their businesses and swap transactions, the
Commission is of the view that the amendments likely will have a
positive impact on market integrity.
The Commission believes that the rule amendments will not have a
significant impact on the competitiveness or efficiency of markets
because this rulemaking affects only how collateral is protected and
segregated, and not how market participants elect to trade. In
addition, the Commission believes that not requiring SDs or MSPs to
provide custodial pricing information to their counterparties may have
an impact on the efficiency, competitiveness, and financial integrity
of the markets, as discussed above, although the effect of this
information might not have a consequential impact on the decisions of
swap counterparties.
c. Price Discovery
The Commission believes the rule amendments as adopted will not
have a significant effect on price discovery.
d. Sound Risk Management
Subpart L provides for the management and protection of
counterparty collateral and therefore mitigates the risk of loss of
access to the collateral, which loss can have an adverse impact on
registrants, counterparties and the U.S. financial markets. As
discussed, the rule amendments adopted herein remove certain
prescriptive requirements, but do not alter the overall principles of
the existing requirements of subpart L. Therefore, the Commission is of
the view that sound risk management practices will not be adversely
impacted by these rule amendments. However, as noted above, the
Commission acknowledges that by eliminating the requirement to reinvest
initial margin in Regulation 1.25 liquid securities, the rule may be
lowering protections to SDs or MSPs and their counterparties, which
affects other market participants and the public. On the other hand,
the Commission believes that the rule provides market participants with
the ability to privately negotiate the terms of reinvestment, thereby
allowing each party to assess its risk tolerance and enter into an
agreement that reflects this tolerance and to earn higher anticipated
returns on excess margin than Regulation 1.25 liquid securities tend to
earn.
e. Other Public Interest Considerations
The Commission has not identified any other public interest
considerations for the rule amendments as adopted.
(iii) Request for Comment
The Commission invited comment on its preliminary consideration of
the costs and benefits associated with the proposed changes to subpart
L, especially with respect to the five factors the Commission is
required to consider under CEA section 15(a). In addressing these areas
and any other aspect of the Commission's preliminary cost-benefit
considerations, the Commission encouraged commenters to submit any data
or other information they may have quantifying and/or qualifying the
costs and benefits of the proposal. The Commission also specifically
requested comment on the following questions:
To what extent do the proposed amendments reduce or
increase burdens and costs for SDs or MSPs or their counterparties?
Commenters have supported the Commission's assessment that
finalizing the rule amendments will eliminate burdens on SDs and MSPs.
Specifically, IECA stated that the current rules have been
unnecessarily burdensome and asserted that by eliminating, for example,
Regulation 23.701(d), market participants will save significant costs
and avoid risk and confusion.\100\ IFCS stated its belief that many of
the requirements under the current regulations create unnecessary
operational and administrative burdens on swap dealers that outweigh
the intended protections afforded to swap counterparties.\101\ ISDA/
SIFMA stated that the Proposal will meaningfully reduce unnecessary
costs and burdens associated with the rule, without diminishing the
Commission's ability to meet its regulatory duties. ISDA/SIFMA added
that, based on their members' experience, the current initial margin
segregation requirements are overly prescriptive and remove the
opportunity for bilateral negotiations between sophisticated market
participants.\102\
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\100\ IECA at 2.
\101\ IFCS at 2.
\102\ ISDA/SIFMA at 3.
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To what extent do the proposed amendments impact
collateral management risk considerations?
The Commission is persuaded further by commenters that it is
appropriate to make its rules less prescriptive and allow more
bilateral negotiations between swap counterparties. NFA stated that it
agrees with the Commission's goal of reducing unnecessary burdens on
market participants, facilitating more efficient swap execution and
potentially encouraging more segregation of collateral.\103\ ISDA/SIFMA
stated that, based on their members' experience, the current initial
margin segregation requirements are overly prescriptive and remove the
opportunity for bilateral negotiations between sophisticated market
participants who should be allowed to determine what collateral
arrangements are most appropriate for their circumstances.\104\
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\103\ NFA at 1.
\104\ ISDA/SIFMA at 3.
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Are counterparties to SDs or MSPs at a substantial
disadvantage when negotiating the terms for segregation arrangements
that would no longer be required if the proposed amendments are
adopted? Would that disadvantage cause them to receive unfair terms on
those segregation arrangements? Are there mitigating factors?
The Commission is sympathetic to comments that swap counterparties
do not require any additional protections from the CFTC given their
requisite levels of sophistication. IFCS stated its support for
increased flexibility on the requirements for segregated margin in
Regulation 23.702. IFCS believes the current regulations are overly
prescriptive and welcomes the opportunity for bilateral negotiations
between sophisticated market participants who are, by definition,
deemed to be able to protect their own interests.\105\
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\105\ IFCS at 3.
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Would the elimination of the requirement to list at least
one non-affiliated custodian and the cost of the custodial services
have an effect on the selection of an independent custodian and the
cost of the services to the non-SD/MSP counterparty? If yes, please
explain.
The only commenter to address this issue, IFCS, agrees with the
Commission's decision to remove this condition. IFCS said that they
supported eliminating the requirement, adding that costs associated
with segregation are largely controlled by the third-party custodian
and may vary for each segregation agreement, which, together, make it
difficult to provide meaningful pricing information in the
notification.\106\
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\106\ IFCS at 2.
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[[Page 12905]]
D. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to ``take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of this Act, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of the Act.'' \107\
---------------------------------------------------------------------------
\107\ See 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requested comment on whether the proposed rule implicates any other
specific public interest to be protected by the antitrust laws. No
comments were received in response to this request.
The Commission has considered whether the adopted rule amendments
are anticompetitive and has identified no anticompetitive effects. The
Commission requested comment on whether the proposed rule is
anticompetitive and, if it is, what the anticompetitive effects are. No
comments were received in response to this request.
Because the Commission has determined that the proposed rule is not
anticompetitive and has no anticompetitive effects, the Commission has
not identified any less anticompetitive means of achieving the purposes
of the Act. The Commission requested comment on whether there are less
anticompetitive means of achieving the relevant purposes of the Act
that would otherwise be served by adopting the proposed rule. No
comments were received in response to this request.
List of Subjects in 17 CFR Part 23
Custodians, Major swap participants, Margin, Segregation, Swap
dealers, Swaps, Uncleared swaps.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 23 as follows:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
1. The authority citation for part 23 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
Section 23.160 also issued under 7 U.S.C. 2(i); Sec.721(b), Pub.
L. 111-203, 124 Stat.1641 (2010).
0
2. Revise subpart L to read as follows:
Subpart L--Segregation of Assets Held as Collateral in Uncleared Swap
Transactions
Sec.
23.700 Definitions.
23.701 Notification of right to segregation.
23.702 Requirements for segregated initial margin.
23.703 Investment of segregated initial margin.
23.704 Requirements for non-segregated margin.
Subpart L--Segregation of Assets Held as Collateral in Uncleared
Swap Transactions
Sec. 23.700 Definitions.
As used in this subpart:
Initial Margin means money, securities, or property posted by a
party to a swap as performance bond to cover potential future exposures
arising from changes in the market value of the position.
Segregate means to keep two or more items in separate accounts, and
to avoid combining them in the same transfer between two accounts.
Variation Margin means a payment made by or collateral posted by a
party to a swap to cover the current exposure arising from changes in
the market value of the position since the trade was executed or the
previous time the position was marked to market.
Sec. 23.701 Notification of right to segregation.
(a) At the beginning of the first swap transaction that provides
for the exchange of Initial Margin, a swap dealer or major swap
participant must notify the counterparty that the counterparty has the
right to require that any Initial Margin the counterparty provides in
connection with such transaction be segregated in accordance with
Sec. Sec. 23.702 and 23.703, except in those circumstances where
segregation is mandatory pursuant to Sec. 23.157 or rules adopted by
the prudential regulators pursuant to section 4s(e)(2)(A) of the Act.
(b) The right referred to in paragraph (a) of this section does not
extend to Variation Margin.
(c) If the counterparty elects to segregate Initial Margin, the
terms of segregation shall be established by written agreement.
(d) A counterparty's election, if applicable, to require
segregation of Initial Margin or not to require such segregation, may
be changed at the discretion of the counterparty upon written notice
delivered to the swap dealer or major swap participant, which changed
election shall be applicable to all swaps entered into between the
parties after such delivery.
Sec. 23.702 Requirements for segregated initial margin.
(a) The custodian of Initial Margin, segregated pursuant to an
election under Sec. 23.701, must be a legal entity independent of both
the swap dealer or major swap participant and the counterparty.
(b) Initial Margin that is segregated pursuant to an election under
Sec. 23.701 must be held in an account segregated for, and on behalf
of, the counterparty, and designated as such. Such an account may, if
the swap dealer or major swap participant and the counterparty agree,
also hold Variation Margin.
(c) Any agreement for the segregation of Initial Margin pursuant to
this section shall be in writing, shall include the custodian as a
party, and shall provide that any instruction to withdraw Initial
Margin shall be in writing and that notification of the withdrawal
shall be given immediately to the non-withdrawing party.
Sec. 23.703 Investment of segregated initial margin.
The swap dealer or major swap participant and the counterparty may
enter into any commercial arrangement, in writing, regarding the
investment of Initial Margin segregated pursuant to Sec. 23.701 and
the related allocation of gains and losses resulting from such
investment.
Sec. 23.704 Requirements for non-segregated margin.
(a) Each swap dealer or major swap participant shall report to each
counterparty that does not choose to require segregation of Initial
Margin pursuant to Sec. 23.701(a), on a quarterly basis, no later than
the fifteenth business day after the end of the quarter, that the back
office procedures of the swap dealer or major swap participant relating
to margin and collateral requirements are in compliance with the
agreement of the counterparties.
(b) The obligation specified in paragraph (a) of this section shall
apply no earlier than the 90th calendar day after the date on which the
first swap is transacted between the counterparty and the swap dealer
or major swap participant.
Issued in Washington, DC, on March 28, 2019, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
[[Page 12906]]
Appendices to Segregation of Assets Held as Collateral in Uncleared
Swap Transactions--Commission Voting Summary, Chairman's Statement, and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Giancarlo and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Chairman J. Christopher Giancarlo
This final rule is another Project KISS proposal simplifying and
reducing burdens by revisiting our rules based on staff
implementation experience and public comment. Today's amendments
will remove overly burdensome and prescriptive conditions for
providing notice to counterparties of their right to segregate
initial margin for uncleared swaps and the commercial arrangement
between the parties regarding the investment of segregated initial
margin.
Staff experience shows that counterparties rarely elect to
segregate initial margin, even though the option to do so was
provided for in the Commodity Exchange Act and in the CFTC's
Regulations 23.700 through 23.704. Enabling the election of
segregation is a bipartisan goal, starting with a unanimous
Commission rulemaking by a previous commission. By reducing the
burdens and prescriptiveness of these rules, and providing
additional flexibility for the parties to engage in written
segregation arrangements to fit their needs, as the final rule does
here, more counterparties may opt to use this provision and avail
themselves of any benefits of doing so.
Appendix 3--Concurring Statement of Commissioner Rostin Behnam
I respectfully concur with the Commodity Futures Trading
Commission's (the ``Commission'' or ``CFTC'') approval of amendments
to subpart L of the Commission's Regulations (``Segregation of
Assets Held as Collateral in Uncleared Swap Transactions''
consisting of Regulations 23.700 through 23.704), which implement
section 4s(l) of the Commodity Exchange Act (``CEA'' or the
``Act''). The amendments to subpart L respond to ongoing concerns
and confusion created by the finalization of the CFTC and Prudential
Regulator Margin Rules and CFTC interpretive guidance. I voted for
the proposal of the subpart L amendments. However, I expressed
reservations about the Commission's proposal to extend its prior
interpretation of CEA section 4s(l) concerning the timing and
frequency of required notifications of swap counterparties regarding
their right to segregate initial margin for uncleared swaps.\1\ I
continue to believe that the Commission's rationale in support of
interpreting CEA section 4s(l) to require a single, one-time
notification to a counterparty of their right to require segregation
of any initial margin may be based on an incomplete record; it is
nevertheless based on the record before us. The Commission sought
comment from the public on the appropriateness of the proposed
amendments and received just four comment letters. However, none of
the letters addressed whether and how requiring the notice to be
provided annually has actually impacted or effected decision making
by counterparties.
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\1\ Segregation of Assets Held as Collateral in Uncleared Swap
Transactions, 83 FR 36484, 36493 through 36494 (proposed July 30,
2018).
---------------------------------------------------------------------------
I am disappointed that the Commission is declining to specify
what constitutes the beginning of the first swap transaction or to
proscribe when trading may commence following the initial
notification.\2\ In an effort to remain flexible, the Commission is
creating uncertainty that may ultimately lead to additional
rulemaking. Where the record suggests that need for the current
amendment to the notification requirement in CFTC Regulation
23.701(a)(i) may be a consequence of a stakeholder-led compliance
effort, I believe the Commission ought not to risk making the same
mistake twice.
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\2\ Segregation of Assets Held as Collateral in Uncleared Swap
Transactions, section II.B. (to be codified at 17 CFR part 23).
---------------------------------------------------------------------------
Appendix 4--Statement of Commissioner Dan M. Berkovitz
The final rule amends CFTC regulations giving certain swap
counterparties the right to require initial margin segregation. I
support the amendments.
In this instance, real world experience in implementing new
regulations demonstrates that modifying certain of the regulatory
requirements may help better achieve the intended customer
protection goals. An added benefit of fine-tuning the regulations is
a reduction in costs for registrants without a reduction in customer
protections.
CFTC regulations 23.701 through 23.704 (``Margin Segregation
Rules'') set forth certain requirements concerning the right of
counterparties of swap dealers to elect segregation of initial
margin posted to secure uncleared swaps. These regulations support
an important safety measure for mostly non-financial swap
counterparties by providing them the right to have collateral posted
as initial margin for swaps to be held in segregated accounts at
third-party custodians. Segregation protects the counterparty by
keeping the counterparty's collateral, and the collateral posted by
the swap dealer to cover obligations to the counterparty, separate
from the swap dealer's other assets and liabilities in the event of
a bankruptcy. The regulations currently in effect provide detailed
requirements regarding the delivery of notices by swap dealers to
their counterparties of the right to segregate as well as specific,
limited investment choices for the collateral.
The Margin Segregation Rules were adopted in 2013. Since that
time, two things have happened to warrant changes to the
regulations. First, in 2016, the Commission adopted its uncleared
swaps margin regulations. The margin rules effectively superseded
regulations 23.702 and 23.703 regarding investment of margin funds
for a large majority of affected swap counterparties. Second, as
detailed in the final release, experience from implementing the
Margin Segregation Rules demonstrated that certain aspects of these
rules have provided little or no benefit. Almost no counterparties
are electing to segregate initial margin in the manner provided by
the Margin Segregation Rules with fewer than five counterparties
making the election at each of the swap dealers examined for this
issue. In addition, some of the specific requirements of the rule
added unnecessary costs and the rule's purpose could be achieved
through more efficient means.
The amendments in the final rule will reduce the burdens of the
rule's notice requirements while assuring that each counterparty is
properly notified of the important right to segregate initial margin
at the most effective time in the swap documentation process. The
final rule also provides the parties with greater flexibility to
negotiate mutually beneficial terms for the segregation arrangements
based on the specific needs of the counterparties. This flexibility
may encourage more counterparties to elect segregation. In addition,
the final rule will increase regulatory efficiency by reducing
unnecessary notices and procedural requirements that must be
documented and examined by the National Futures Association in their
oversight of swap dealers.
The reduced costs and greater flexibility that will result from
the final rule should benefit both swap dealers and end users in
uncleared swap transactions. The comment letters that the Commission
received on the notice of proposed rulemaking all provided reasoned
support for the proposal. I therefore support today's final rule.
[FR Doc. 2019-06424 Filed 4-2-19; 8:45 am]
BILLING CODE 6351-01-P