2020-16492
Federal Register, Volume 85 Issue 179 (Tuesday, September 15, 2020)
[Federal Register Volume 85, Number 179 (Tuesday, September 15, 2020)]
[Rules and Regulations]
[Pages 57462-57576]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-16492]
[[Page 57461]]
Vol. 85
Tuesday,
No. 179
September 15, 2020
Part IV
Commodity Futures Trading Commission
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17 CFR Parts 1, 23, and 140
Capital Requirements of Swap Dealers and Major Swap Participants; Final
Rule
Federal Register / Vol. 85 , No. 179 / Tuesday, September 15, 2020 /
Rules and Regulations
[[Page 57462]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 23, and 140
RIN 3038-AD54
Capital Requirements of Swap Dealers and Major Swap Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is adopting new regulations imposing minimum capital
requirements and financial reporting requirements on swap dealers
(``SDs'') and major swap participants (``MSPs'') that are not subject
to a prudential regulator. The Commission is also amending existing
capital requirements for futures commission merchants (``FCMs'') to
provide specific capital deductions for market risk and credit risk for
swaps and security-based swaps entered into by an FCM. The Commission
is further adopting amendments to its regulations to permit certain
entities dually-registered with the Securities and Exchange Commission
(``SEC'') to file an SEC Financial and Operational Combined Uniform
Single Report in lieu of CFTC financial reports, to require certain
Commission registrants to file notices of certain defined events, and
to require notices of bulk transfers to be filed with the Commission
electronically and within a defined period of time.
DATES:
Effective date: November 16, 2020.
Compliance date: October 6, 2021
FOR FURTHER INFORMATION CONTACT: Joshua Sterling, Director, 202-418-
6056, [email protected]; Thomas Smith, Deputy Director, 202-418-5495,
[email protected]; Joshua Beale, Associate Director, 202-418-5446,
[email protected]; Jennifer Bauer, Special Counsel, 202-418-5472,
[email protected]; Rafael Martinez, Senior Financial Risk Analyst, 202-
418-5462, [email protected], Division of Swap Dealer and Intermediary
Oversight; Paul Schlichting, Assistant General Counsel, Office of the
General Counsel, 202-418-5884, [email protected]; Lihong McPhail,
Research Economist and Head of Academic Outreach, 202-418-5722,
[email protected], Office of the Chief Economist; Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581; or Mark Bretscher, Special Counsel, 312-596-0598,
[email protected]; Division of Swap Dealer and Intermediary
Oversight, Commodity Futures Trading Commission, 525 West Monroe
Street, Suite 1100, Chicago, IL 60661.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Background and Statutory Authority
B. Proposed Rulemakings and Reopening of the Comment Period
C. Consultation With U.S. Securities and Exchange Commission and
Prudential Regulators
II. Final Regulations and Amendments to Existing Regulations
A. Capital Framework for FCMs, Covered SDs, and Covered MSPs
B. Capital Requirements for Stand-Alone FCMs and FCM-SDs
1. Introduction to General Capital Requirements for Stand-Alone
FCMs and FCM-SDs
2. Minimum Capital Requirement for Stand-Alone FCMs and FCM-SDs
a. Minimum Fixed-Dollar Amount of Net Capital
b. Minimum Capital Requirement Based on 8% Risk Margin Amount
3. Stand-Alone FCM and FCM-SD Calculation of Net Capital and
Adjusted Net Capital
a. Stand-Alone FCM and FCM-SD Standardized Market Risk Capital
Charges
b. FCM and FCM-SD Standardized Counterparty Credit Risk Capital
Charges
c. Model-Based Market Risk and Counterparty Credit Risk Capital
Charges
(i) FCMs That Are SEC-Registered ANC Firms
(ii) Market Risk and Credit Risk Capital Models for FCM-SDs That
Are Not SEC-Registered BDs
C. Capital Requirements for Swap Dealers and Major Swap
Participants
1. Introduction to Covered SD and Covered MSP Capital
Requirements
2. Capital Requirement for Covered SDs Electing the Net Liquid
Assets Capital Approach
a. Computation of Minimum Capital Requirement
b. Computation of Net Capital To Meet Minimum Capital
Requirement
(i) Swap Dealers Not Approved To Use Internal Capital Models
(ii) Swap Dealers Approved To Use Internal Capital Models
3. Capital Requirement for Covered SDs Electing the Bank-Based
Capital Approach
a. Computation of Minimum Capital Requirement
4. Capital Requirement for Covered SDs Electing the Tangible Net
Worth Capital Approach
5. Capital Requirements for Covered MSP
6. Requirements for Market Risk and Credit Risk Models
a. VaR Models
b. Stressed VaR Models
c. Specific Risk Models
d. Incremental Risk Models
e. Comprehensive Risk Models
f. Credit Risk Models
7. Model Approval Process for Covered SDs and FCM-SDs
8. Liquidity Requirements for Covered SDs and FCM-SDs
9. Equity Withdrawal Restrictions for Covered SDs and Covered
MSPs
10. Leverage Ratio Requirements for Covered SDs
D. Swap Dealer and Major Swap Participant Financial
Recordkeeping, Reporting and Notification Requirements
1. Routine Financial Reporting and Recordkeeping Requirements
2. Swap Dealer and Major Swap Participant Notice Requirements
3. Swap Dealers and Major Swap Participants Subject to the
Capital Rules of a Prudential Regulator
4. Public Disclosures
5. Electronic Filing Requirements for Financial Reports and
Regulatory Notices
6. Swap Dealer and Major Swap Participant Reporting of Position
Information
7. Reporting Requirements for Swap Dealers and Major Swap
Participants Approved To Use Internal Capital Models
8. Weekly Position and Margin Reporting
E. Comparability Determinations for Eligible Covered SDs and
Covered MSPs
F. Additional Amendments to Existing Regulations
1. Financial Reporting Requirements for FCMs or IBs That Are
Also Registered SBSDs
2. Amendments to the FCM and IB Notice Provisions in Regulation
1.12
3. FCM and IB Unsecured Receivables From Swap Transactions
4. Amendments to FCM and IB Notice and Disclosure Requirements
for Bulk Transfers
5. Conforming Amendments to Delegated Authority Provisions in
Regulation 140.91
G. Effective Date and Compliance Date
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. Background
2. New Information Collection Requirements and Related Burden
Estimates
i. FOCUS Report
ii. Notice of Failure To Maintain Minimum Financial Requirements
iii. Requests for Extensions of Time To File Financial
Statements
iv. Capital Requirements Elections
v. Application for Use of Models
vi. Equity Withdrawal Requirements
vii. Financial Recordkeeping, Reporting and Notification
Requirements for SDs and MSPs
viii. Capital Comparability Determinations
IV. Cost Benefit Considerations
A. Background
B. Regulatory Capital
C. General Summary of Rulemaking
D. Baseline
E. Overview of Approaches
1. Bank-Based Capital Approach
2. Net Liquid Assets Approach
3. Alternative Net Capital (``ANC'')
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4. Tangible Net Worth
5. Substituted Compliance
F. Entities
1. Bank Subsidiaries
2. SD/BD (Without Models)
3. SD/BD/OTC Derivatives Dealers (Without Models)
4. FCM-SD (Without Models)
5. ANC Firms (SD/BD and/or FCMs That Use Models)
6. Stand-Alone SD (With and Without Models)
7. Non-Financial SD (With and Without Models)
8. MSP
9. Substituted Compliance
G. Liquidity Requirements
H. Equity Withdrawal Restrictions
I. Reporting and Recordkeeping Requirements
J. Section 15(a) Factors
1. Protection of Market Participants and the Public
2. Efficiency, Competitiveness, and Financial Integrity of Swaps
Markets
3. Price Discovery
4. Sound Risk Management Practices
5. Other Public Interest Considerations
K. Attachment A to Cost Benefit Considerations
I. Introduction
A. Background and Statutory Authority
The Commission is adopting capital and financial reporting
requirements for SDs and MSPs, and is amending existing capital rules
for FCMs to provide explicit capital requirements for proprietary
positions in swaps and security-based swaps that are not cleared by a
clearing organization. The adoption of the capital requirements for SDs
and MSPs completes the Congressional mandate directing the Commission
to adopt rules imposing both capital requirements on SDs and MSPs that
are not subject to a prudential regulator, and imposing initial and
variation margin on uncleared swaps entered into by SDs and MSPs that
are not subject to a prudential regulator.\1\
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\1\ The term ``prudential regulator'' is defined for purposes of
the section 4s(e) capital and margin requirements to mean the Board
of Governors of the Federal Reserve System (``Federal Reserve
Board''); the Office of the Comptroller of the Currency (``OCC'');
the Federal Deposit Insurance Corporation (``FDIC''); the Farm
Credit Administration; and the Federal Housing Finance Agency. See
section 1a(39) of CEA (7 U.S.C. 1 et. seq.).
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Title VII of the Dodd-Frank Act established a new regulatory
framework for swap and security-based swap transactions.\2\ The
legislation was enacted, among other reasons, to reduce risk, increase
transparency, and promote market integrity within the financial system,
including by: (i) Providing for the registration and comprehensive
regulation of SDs, security-based swap dealers (``SBSDs''), MSPs and
major security-based swap participants (``MSBSPs''); (ii) imposing
clearing and trade execution requirements on swaps and security-based
swaps, subject to certain exceptions; (iii) creating rigorous
recordkeeping and real-time reporting regimes; and (iv) enhancing the
rulemaking and enforcement authorities of the Commissions with respect
to, among others, all registered entities and intermediaries subject to
the Commission's oversight. The Dodd-Frank Act further established a
jurisdictional boundary by authorizing the Commission to regulate
``swaps,'' and granting the SEC authority to regulate ``security-based
swaps.'' \3\ Sections 721 and 761 of the Dodd-Frank Act also added
definitions of the terms ``swap dealer,'' ``security-based swap
dealer,'' ``major swap participant,'' and ``major security-based swap
participant'' to the CEA and Exchange Act.\4\
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
\3\ The term ``swap'' is defined in section 1a(47) of the CEA (7
U.S.C. 1a(47)) and Commission regulation Sec. 1.3 (17 CFR 1.3). The
term ``security-based swap'' is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)). Commission regulations referred
to in this release are found at 17 CFR chapter I (2019), and are
accessible on the Commission's website at https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
\4\ See CEA sections 1a(33) and (49) (7 U.S.C. 1a(33) and (49))
for the definition of the terms ``major swap participant'' and
``swap dealer,'' respectively; See Exchange Act section 3(a)(67) and
(71) (15 U.S.C. 3(a)(67) and (71)) for the definition of the terms
``major security-based swap participant'' and ``security-based swap
dealer,'' respectively.
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An additional provision of the new swap regulatory framework,
section 731 of the Dodd-Frank Act, amended the CEA \5\ by adding
section 4s, which requires an entity meeting the definition of an SD or
an MSP to register with the Commission.\6\ Section 4s authorizes the
Commission to adopt rules requiring such SDs and MSPs to maintain daily
trading records of their swaps and all related records (including
related cash or forward transactions) and recorded communications.\7\
Section 4s further requires each SD or MSP to conform with the business
conduct standards prescribed by the Commission that relate to: (i)
Fraud, manipulation, and other abusive practices involving swaps; (ii)
diligent supervision of the business of the SD or MSP; (iii) adherence
to applicable position limits; and (iv) such other matters as the
Commission determines appropriate.\8\
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\5\ 7 U.S.C. 1 et seq.
\6\ 7 U.S.C. 6s(a).
\7\ 7 U.S.C. 6s(g).
\8\ 7 U.S.C. 6s(h).
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Section 4s(e) also addresses minimum capital requirements for SDs
and MSPs, and imposes initial and variation margin obligations on swaps
entered into by SDs and MSPs that are not cleared by a registered
derivatives clearing organization.\9\ Section 4s(e) applies a
bifurcated approach with respect to capital and margin by requiring
each SD and MSP subject to regulation by a prudential regulator to meet
the minimum capital and margin requirements adopted by the applicable
prudential regulator, and requiring each SD and MSP not subject to
regulation by a prudential regulator to meet the minimum capital and
margin requirements adopted by the Commission.\10\ Therefore, the
Commission's authority to impose capital and margin requirements
extends to SDs and MSPs that are non-banking entities that are not
subject to a prudential regulator, including non-banking subsidiaries
of bank holding companies regulated by the Federal Reserve Board. SDs
and MSPs subject to the Commission's capital and margin requirements
are referred to in this document as ``covered SDs'' and ``covered
MSPs,'' respectively. SDs and MSPs subject to the margin and capital
requirements of a prudential regulator are referred to in this document
as ``bank SDs'' and ``bank MSPs,'' respectively.
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\9\ 7 U.S.C. 6s(e).
\10\ 7 U.S.C. 6s(e)(1).
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The Commission previously adopted rules imposing margin
requirements for uncleared swap transactions entered into by covered
SDs and covered MSPs as required by section 4s(e).\11\ The prudential
regulators also adopted rules imposing margin requirements for
uncleared swap and security-based swap transactions entered into by
bank SDs or bank MSPs.\12\ The prudential regulators further adopted
capital requirements applicable to bank SDs
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and bank MSPs that incorporate swap and security-based swap
transactions into the capital framework.\13\
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\11\ The Commission adopted final rules on December 18, 2015
imposing initial and variation margin requirements on covered SDs
and covered MSPs for swap transactions that are not cleared by a
registered derivatives clearing organization (``DCO''). See, Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants, 81 FR 636 (Jan. 6, 2016). The margin rules, which
became effective on April 1, 2016, are codified in part 23 of the
Commission's regulations (17 CFR 23.150-23.159, 23.161). In May
2016, the Commission amended the margin rules to add Commission
regulation Sec. 23.160, providing rules on the cross-border
application of the margin rules. See Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants--Cross-
Border Application of the Margin Requirements, 81 FR 34818 (May 31,
2016).
\12\ The prudential regulators published final margin
requirements in November 2015. See Margin and Capital Requirements
for Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015).
\13\ The prudential regulators have adopted capital rules
addressing capital requirements for swap and security-based swap
transactions. In this regard, the Federal Reserve Board and OCC have
adopted revised capital rules to incorporate Basel III capital
adequacy requirements. See, Regulatory Capital Rules: Regulatory
Capital, Implementation of Basel III, Capital Adequacy, Transition
Provisions, Prompt Corrective Action, Standardized Approach for
Risk-weighted Assets, Market Discipline and Disclosure Requirements,
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital
Rule, 78 FR 62018 (Oct. 11, 2013).
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Furthermore, section 764 of the Dodd-Frank Act added section 15F to
the Exchange Act to address capital and margin requirements associated
with security-based swaps. Section 15F(e)(1)(B) directs the SEC to
adopt capital and margin requirements for SBSDs and MSBSPs that do not
have a prudential regulator (``nonbank SBSDs'' and ``nonbank MSBSPs'').
The SEC adopted final capital rules for nonbank SBSDs and nonbank
MSBSPs, as well as final margin rules for security-based swaps entered
into by nonbank SBSDs and nonbank MSBSPs, in June 2019.\14\
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\14\ Capital, Margin, and Segregation Requirements for Security-
Based Swap Dealers and Major Security-Based Swap Participants and
Capital and Segregation Requirements for Broker-Dealers, Exchange
Act Release No. 86175 (Jun. 21, 2019), 84 FR 43872 (Aug. 22, 2019)
(``2019 SEC Final Capital Rule''). The compliance date for these
rules is October 6, 2021.
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In addition to the new capital authority over covered SDs and
covered MSPs, the Commission also has separate statutory authority to
adopt rules imposing minimum capital requirements on FCMs.\15\ The
Commission expects that certain FCMs will engage in a level of swap
dealing activity that will require their registration as SDs with the
Commission. Such FCMs that are dually-registered as SDs (``FCM-SDs'')
will be subject to the Commission's long-standing FCM capital rules. In
addition, other FCMs may engage in a level of swap dealing activity
that is less than what is required to register as an SD; FCMs may
engage in swaps and security-based swaps as part of their business to,
for example, hedge financial and commercial risks (``stand-alone
FCMs''). Although the general capital treatment of unsecured market
gains as non-current assets and the capital charges for inventory and
fixed price commitments have been applied as applicable to the market
and credit risk of swap positions for FCMs, to now explicitly address
both the market and credit risk of these positions for FCM-SDs and
stand-alone FCMs, the Commission is adopting rules to specifically
incorporate uncleared swaps and security-based swaps into the existing
FCM capital framework by defining specific market risk charges and
credit risk charges for such transactions. The Commission's FCM
regulations are consistent with its authority under section 4f(b) of
the CEA, which authorizes the Commission to impose minimum financial
requirements, including capital requirements, on FCMs. This authority
extends to establishing capital requirements with respect to all of an
FCM's activities, including activities involving swaps and security-
based swaps.\16\ Under the Commission's final rules, an FCM-SD and a
stand-alone FCM are subject to the FCM capital requirements set forth
in regulation 1.17.
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\15\ Section 4f(b) of the CEA (7 U.S.C. 6f(b)) authorizes the
Commission to establish minimum financial requirements for FCMs. The
Commission previously adopted minimum capital requirements for FCMs,
which are set forth in Commission regulation Sec. 1.17 (17 CFR
1.17).
\16\ Section 4s(e)(3)(B) (7 U.S.C. 6s(e)(3)(B)) of the CEA
provides that the nothing in section 4s shall limit, or be construed
to limit, the authority of the Commission to set financial
responsibility rules for an FCM.
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The Commission also is adopting financial reporting and
recordkeeping requirements for SDs and MSPs. Section 4s(f)(2) of the
CEA directs the Commission to adopt rules governing financial condition
reporting and recordkeeping for SDs and MSPs, and section 4s(f)(1)(A)
requires each registered SD and MSP to make such reports as are
required by Commission rule or regulation regarding the SD's or MSP's
financial condition.\17\ The Commission also is adopting record
retention and inspection requirements consistent with the provisions of
section 4s(f)(1)(B).\18\
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\17\ See 7 U.S.C. 6s(f)(1) and (2).
\18\ The Commission previously finalized certain record
retention requirements for SDs and MSPs regarding their swap
activities. See, Swap Dealer and Major Swap Participant
Recordkeeping, Reporting, and Duties Rules; Futures Commission
Merchant and Introducing Broker Conflicts of Interest Rules; and
Chief Compliance Officer Rules for Swap Dealers, Major Swap
Participants, and Futures Commission Merchants, 76 FR 20128 (Apr. 3,
2012).
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The final reporting requirements require covered SDs and covered
MSPs to file periodic unaudited financial statements and an annual
audited financial report with the Commission and with the registered
futures association (``RFA'') of which they are a member.\19\ The final
regulations further require covered SDs and covered MSPs to file
certain regulatory notices with the Commission and with the RFA of
which they are a member. The notices are comparable to the existing FCM
notices, and are intended to alert the Commission and RFA to scenarios
that may indicate potential financial or operational issues, including
instances of undercapitalization and failure to maintain current books
and records. Covered SDs and covered MSPs are also required to file
notice if certain triggering events regarding the failure to post or
collect initial or variation margin with swap counterparties occur.
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\19\ Section 3 of the CEA states that a purpose of the CEA is to
establish a system of effective self-regulation under the oversight
of the Commission. Consistent with the self-regulatory concept
established under section 3, section 17 of the CEA provides a
process whereby an association of persons may register with the
Commission as an RFA. Currently, the National Futures Association
(``NFA'') is the only RFA under section 17 of the CEA.
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The Commission also is adopting a program for non-U.S. domiciled
covered SDs or covered MSPs to petition the Commission for a program of
substituted compliance. Non-U.S. domiciled covered SDs or covered MSPs
may seek a determination from the Commission that they operate in a
jurisdiction that has comparable capital adequacy and financial
reporting objectives and goals as set forth by the Commission in the
final regulations. Non-U.S. domiciled covered SDs or MSPs that operate
in a jurisdiction that the Commission has determined meets the capital
adequacy and financial reporting objectives of the CEA and the
Commission's regulations may meet some or all of their capital and
financial reporting requirements by complying with their home country
jurisdiction requirements.
The Commission is also adopting several amendments to existing
regulations as part of the proposed capital and financial recordkeeping
and reporting requirements. The Commission is amending regulation 1.12
to require an FCM or an introducing broker (``IB'') that is subject to
the capital rules of both the Commission and the SEC to file a notice
with the Commission if the FCM or IB fails to meet the SEC's minimum
capital requirement. The Commission is also adopting amendments to
regulation 1.12 to require an FCM or an IB that is also registered with
the SEC as an SBSD or an MSBSP to file a notice if the SBSD's or
MSBSP's net capital falls below the ``early warning level'' established
in the rules of the SEC.\20\ The Commission is also adopting amendments
to the bulk
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transfer provisions of regulation 1.65 by expanding from 5 to 10 days
the advance notice that an FCM or an IB must provide to the Commission
prior to the transfer. The Commission is further revising the bulk
transfer rules to provide that the notice of the bulk transfer must be
filed with the Commission electronically, and delegating the authority
to accept delivery of such notice in a period shorter than 10 days to
the Director of the Division of Swap Dealer and Intermediary Oversight,
provided that the notice must be provided as soon as practicable and in
no event later than the day of the transfer.
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\20\ The SEC requires each SBSD for which there is no prudential
regulator to provide notice within 24 hours if the SBSD's net
capital or tentative net capital (as applicable) falls below 120% of
the SBSD's minimum net capital or tentative net capital requirement.
An MSBSP is required to provide notice within 24 hours if its
tangible net worth falls below $20 million. See 17 CFR 240.18-8(b).
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The Commission also proposed specific quantitative liquidity
requirements for certain SDs. As discussed in section II.C.8. below,
the Commission has determined to defer consideration of the proposed
liquidity requirements at this time. Accordingly, the Commission is not
adopting the proposed liquidity requirements in this final rulemaking.
SDs will continue to be subject to the existing risk management program
requirements, including the liquidity requirements, set forth in
regulation 23.600.
The Commission intends to monitor the impact of the capital and
financial reporting requirements being adopted today using data
received from covered SDs and covered MSPs once they are subject to
these capital and financial reporting requirements. Information that
the Commission will receive and observe includes data regarding the
level of capital that the covered SDs and covered MSPs are required to
maintain, the level of capital actually maintained, the liquidity that
the firms maintain, the leverage the firms employ, and the scale and
types of swaps and other transactions that they are engaged in. The
Commission also will continue to consult with the prudential regulators
and the SEC to assess the capital adequacy of SDs, MSPs, SBSDs, and
MSBSPs. The Commission will monitor the data resulting from the
adoption of today's rules and general market events and consider
modifications to the capital and financial reporting requirements in
light of this information. The Commission also will monitor the
information that it receives to assess the adequacy of the liquidity of
SDs and, if appropriate, will consider proposing additional liquidity
requirements as necessary.
B. Proposed Rulemakings and Reopening of the Comment Period
The Commission initially proposed capital and financial reporting
requirements for covered SDs and covered MSPs in 2011.\21\ The
Commission received comments from a broad spectrum of market
participants, industry representatives, and other interested parties.
The commenters addressed numerous topics including the permissible use
of models for computing market risk and credit risk capital charges and
the need for harmonization of the Commission's capital and financial
reporting requirements for covered SDs with the capital and financial
reporting rules of the prudential regulators for bank SDs and with the
rules of the SEC for nonbank SBSDs. Commenters particularly emphasized
a need for the harmonization of regulatory requirements for covered SDs
that also are registered with the SEC as SBSDs.
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\21\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 76 FR 27802 (May 12, 2011) (the ``2011 Capital
Proposal'').
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Shortly after the Commission issued the 2011 Capital Proposal, the
Basel Committee on Banking Supervision (``BCBS'') and the International
Organization of Securities Commissions, in consultation with the
Committee on Payment and Settlement Systems and the Committee on Global
Financial Systems, formed a working group (the ``WGMR'') to develop
internationally harmonized standards for margin requirements for
uncleared swaps. Representatives of more than 20 regulatory authorities
participated in the WGMR including the Commission, the SEC, Federal
Reserve Board, OCC, FDIC, and the Federal Reserve Bank of New York. The
Commission elected to defer consideration of the SD and MSP capital and
financial reporting rules until the WGMR had completed its work and the
Commission had adopted margin requirements for uncleared swap
transactions. As noted above, the Commission subsequently adopted final
margin requirements for uncleared swaps in December 2015, and the
compliance period for the final rules is being phased-in through
2021.\22\
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\22\ See 81 FR 636 (Jan. 6, 2016) and Commission regulation
Sec. 23.161 (17 CFR 23.161)). The Commission also has proposed to
extend the compliance date for the final phase-in period to
September 1, 2022. See Margin Requirements for Uncleared Swaps for
Swap Dealers and Major Swap Participants, 85 FR 41463 (July 10,
2020).
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In 2016, in consideration of the substantial amount of time that
had passed since the 2011 Capital Proposal, the Commission re-proposed
the capital and financial reporting rules for SDs and MSPs to provide
commenters with an opportunity to provide further comment in
recognition of the significant developments in the swaps marketplace
since the 2011 Capital Proposal.\23\ These marketplace developments
included more than 100 entities provisionally registering with the
Commission as SDs, the Commission adopting final margin rules for
uncleared swaps, the prudential regulators adopting final capital and
margin rules for swap and security-based swap transactions, and the SEC
proposing capital, margin, segregation and financial reporting
requirements for SBSDs and MSBSPs.
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\23\ Capital Requirements of Swap Dealers and Major Swap
Participants, 81 FR 91252 (Dec. 16, 2016) (the ``2016 Capital
Proposal'' or the ``Proposal''). The comment letters for the 2016
Capital Proposal are available at: https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1769 (the public comment file).
Commenters included financial services associations, agricultural
associations, energy associations, insurance associations, banks,
brokerage firms, investment managers, insurance companies, pension
funds, commercial end users, law firms, public interest
organizations, and other members of the public.
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The Commission again received comments from a broad spectrum of
market participants and other interested parties. The commenters raised
several issues with regards to the 2016 Capital Proposal, including the
appropriateness of basing a capital requirement on initial margin
requirements, the appropriateness of a liquidity requirement for
covered SDs, the use of models to compute market risk and credit risk
capital charges, and the need for harmonization of the Commission's
rules with the rules of the prudential regulators and the SEC.
Commenters also requested that the Commission provide an additional
opportunity for public comment on the 2016 Capital Proposal once the
SEC finalized its capital, margin, and financial reporting requirements
for SBSDs and MSBSPs. The commenters noted the particular necessity for
an opportunity to provide further comment on the 2016 Capital Proposal
as the Commission's Proposal would permit a covered SD to compute its
capital as if it were a SBSD subject to the SEC's SBSD capital
requirements. The commenters noted that the SEC had received many
substantial comments on its proposed nonbank SBSD and nonbank MSBSP
capital requirements. The commenters further stated that they would
need to review the SEC's final capital, margin and financial reporting
rules, including the SEC's response to the many comments on its
proposal, in order to provide full comments on the 2016 Capital
Proposal.
The Commission ultimately reopened the comment period for the 2016
Capital Proposal.\24\ The 2019 Capital Reopening
[[Page 57466]]
was published after the SEC had adopted final capital, margin,
segregation, and financial reporting requirements for SBSD and MSBSPs.
Accordingly, the 2019 Capital Reopening provided interested parties
with an additional opportunity to provide comments on the 2016 Capital
Proposal after the SEC finalized its capital and financial reporting
rules.
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\24\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 84 FR 69664 (Dec. 16, 2019) (the ``2019 Capital
Reopening''). The comment letters for the 2019 Capital Reopening are
available at: https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1769 (the public comment file). Commenters
included financial services associations, agricultural associations,
energy associations, insurance associations, banks, brokerage firms,
investment managers, insurance companies, pension funds, commercial
end users, law firms, public interest organizations, and other
members of the public.
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One commenter stated that the Commission could not finalize the
2016 Capital Proposal due to the lack of cost benefit analysis related
to additional questions contained in the 2019 Capital Reopening and was
unable to fully assess the potential modifications to the proposed
rules without re-proposal.\25\ The commenter further argued that the
2019 Capital Reopening contained only questions and requests for
comment with no specific rule text or accompanying explanation,
including evaluation of costs and benefits as the commenter believed
required. As a result of this, the commenter posited any final
rulemaking following the 2019 Capital Reopening failed to provide
adequate notice of identifiable regulatory outcomes to commenters and
therefore, would not satisfy APA considerations for notice and comment
rulemaking.\26\ The Commission disagrees. The 2019 Capital Reopening
provided an additional opportunity for commenters to address aspects of
the 2016 Capital Proposal in light of the SEC's final capital rule for
SBSDs and MSBSPs, which was itself incorporated by reference into the
2016 Capital Proposal.
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\25\ See Letter From Dennis M. Kelleher, President and CEO,
Better Markets Inc. (March 3, 2020) (Better Markets 3/3/2020
Letter).
\26\ Id. at page 7.
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In 2016, the Commission re-proposed the SD Capital rules for a
second time.\27\ In that release, the Commission specifically noted
that it had considered the comments from the 2011 proposal in
developing the 2016 Capital Proposal.\28\ The 2016 Capital Proposal
again proposed complementary financial reporting rules and recognized
the expected use of models. Further, the Commission stated at the time
that it had also considered capital rules adopted by the prudential
regulators and capital rules proposed by the SEC for security-based
swap dealers and major security-based swap participants.\29\ As such,
the Commission specifically said that it had to a great extent drawn
upon the SEC capital rules in developing the proposed capital
requirements.\30\ The 2019 Capital Reopening did not change the 2016
proposed framework, which has largely remained intact since the
original proposal in 2011--such as, what method an entity could use to
calculate its required capital and the various capital minimums
dependent upon the characteristics of the registered entity, while
seeking to maintain comparability to the other capital regimes of the
Prudential Regulators and the SEC, as statutorily required. The 2019
Capital Reopening sought to specifically respond to commenters who had
asked for an additional opportunity to comment on the 2016 Capital
Proposal following the finalization of capital rules for SBSDs by the
SEC. It gave commenters the opportunity to provide their views on
whether certain items should be included or how the process should
account for them.\31\ Each of the areas addressed in the 2019 Capital
Reopening signaled potential modifications that the Commission was
considering in light of comments received, including modifications
adopted by the SEC.\32\ Modifications in the final rule, including a
discussion and specific inclusion of various approaches, are therefore
the logical outgrowth of the 2016 Capital Proposal.
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\27\ 81 FR 91252 (Dec. 16, 2016).
\28\ Id. at 91254.
\29\ Id. In this regard, Section 4s(e)(3)(D) of the CEA provides
that the CFTC, SEC, and prudential regulators shall, to the maximum
extent practicable, establish and maintain comparable minimum
capital requirements for SDs and MSPs.
\30\ Id.
\31\ See 84 FR 69665.
\32\ Id.
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In addition, the 2016 Capital Proposal included a comprehensive
cost benefit consideration section, addressing the Section 15(a)
factors in detail. The cost-benefit analysis discussed an elective
approach utilizing similar tailored minimums depending on the
characteristics of the registered entity--a net liquid asset approach
incorporating the traditional FCM and SEC registered broker or dealer
(``BD'') capital framework, a bank-based approach incorporating again
the risk-weighted assets framework from banking rules, and again a
tangible net worth approach for certain eligible firms. The 2016
Capital Proposal again proposed complementary financial reporting rules
and recognized the expected use of models. The public was asked to
comment on all aspects of the proposal, and several comments were
received in response. A more fulsome discussion is in the Cost-Benefit
Consideration section of this document; however, as noted above, the
potential modifications described in the 2019 Capital Reopening,
including a discussion and specific inclusion of potential rule
language, were logical outgrowths of the 2016 Capital Proposal.
C. Consultation With U.S. Securities and Exchange Commission and
Prudential Regulators
The Dodd-Frank Act amended the CEA and the Exchange Act to require
the Commission, SEC, and prudential regulators to coordinate and
develop comparable capital requirements for SDs and SBSDs, and for MSPs
and MSBSPs. Section 4s(e)(3)(D) of the CEA (7 U.S.C. 6s(e)(3)(D), in
conjunction with section 15F(e)(3)(D) of the Exchange Act (15 U.S.C.
78o-10(e)(3)(D)), provides that, to the maximum extent practicable, the
Commission, SEC and the prudential regulators shall establish and
maintain comparable minimum capital requirements for SDs and SBSDs, and
for MSPs and MSBSPs. Further, section 4s(e)(3)(D) and section
15F(e)(3)(D) provide that staff of the CFTC, SEC, and prudential
regulators shall meet periodically, but no less frequently than
annually, to consult on minimum capital requirements. Consistent with
this Congressional mandate, the respective staffs of the Commission,
SEC, and the prudential regulators have regularly shared drafts of
proposed and final rulemakings with staffs of the other agencies for
review and comment before taking final action with respect to the
proposed or final rulemakings. Consistent with this approach, the
Commission provided the SEC and prudential regulators with drafts of
the final rules for review and comment, and the final rulemaking
reflects comments received from the SEC and prudential regulators.
II. Final Regulations and Amendments to Existing Regulations
A. Capital Framework for FCMs, Covered SDs, and Covered MSPs
FCMs are subject to existing capital requirements set forth in
regulation 1.17. The Commission is amending regulation 1.17 to
establish capital requirements explicitly for swap and security-based
swap transactions entered into by FCMs. The Commission is also amending
regulation 1.17 to require an FCM-SD to comply with the amended FCM
capital requirements. A discussion of the amendments to
[[Page 57467]]
regulation 1.17 for FCMs and FCM-SDs is contained in section II.B. of
this release.
The Commission is also adopting final capital rules for covered SDs
that are not FCM-SDs, and is adopting final capital rules for covered
MSPs. The Commission is adopting a flexible approach that allows
covered SDs to elect one of three alternative capital frameworks for
establishing their minimum capital requirements and for computing their
regulatory capital. The three alternative approaches draw to a great
extent on the existing CFTC capital requirements for FCMs contained in
regulation 1.17, as well as the SEC's capital requirements for BDs and
nonbank SBSDs, and the prudential regulators' capital requirements for
bank SDs. Specifically, the Commission's final capital rules, depending
on the characteristics of a covered SD, permit such SD to elect: (i) A
capital requirement consistent with the SEC's final capital
requirements for SBSDs, as well as the existing CFTC capital rules for
FCMs and the existing SEC capital rules for BDs (the ``Net Liquid
Assets Capital Approach''); (ii) a capital requirement consistent with
the prudential regulators' capital requirements for bank SDs, and that
is based on existing Federal Reserve Board capital requirements for
bank holding companies (the ``Bank-Based Capital Approach''); or (iii)
a capital requirement based on the covered SD's tangible net worth,
provided that the covered SD or its parent entity is predominantly
engaged in non-financial activities as defined in the rule (the
``Tangible Net Worth Capital Approach''). Each of the approaches is
discussed in section II. below.
With respect to covered MSPs, the Commission is adopting a minimum
regulatory capital requirement based upon the tangible net worth of the
MSP. While there currently are no provisionally-registered MSPs or
entities pending registration as MSPs, the Commission is adopting final
capital requirements in the event that entities seek registration in
the future. A capital requirement based upon the tangible net worth of
the MSP is consistent with the approach adopted by the SEC for nonbank
MSBSPs, as discussed in section II.C.5. of this release.
Broadly speaking, in developing the proposed capital requirements,
the Commission strived to advance the statutory goal of helping to
protect the safety and soundness of covered SDs and covered MSPs, while
also taking into account the diverse nature of the entities registered
as SDs, and the existing capital regimes that apply to covered SDs and/
or their financial group. In this regard, as of June 30, 2020, there
were 108 provisionally registered SDs. Fifty-two of the provisionally
registered SDs are bank SDs, subject to a prudential regulator. The
remaining 56 SDs are covered SDs, subject to the Commission's capital
rules. While each of the 56 covered SDs is registered with the
Commission as a result of their swap dealing activities, the SDs
represent a broad range of business activities and a diverse population
of swap counterparties. Several of the covered SDs are primarily
engaged in commodity-focused swap transactions with commercial
counterparties, while other covered SDs are focused primarily with
financial related swaps, including interest rate, foreign currency, and
credit default swaps, and have a broad range of swaps counterparties
that includes both commercial and financial counterparties.
The 56 covered SDs subject to the Commission's capital requirements
are associated with 21 corporate families, with several families having
more than 1 provisionally-registered covered SD. Many of these
corporate families are part of U.S. bank or foreign bank holding
companies that offer global financial services and are subject to
prudential capital regulation, including BCBS-based capital
requirements that may extend to some of the provisionally-registered
covered SDs. The alternative capital approaches adopted by the
Commission are intended to mitigate potential competitive disadvantages
and unnecessary costs that might otherwise arise if the Commission were
to impose a single capital approach in light of the existing different
operating and corporate structures of the covered SDs. The Commission
further believes that the flexibility of the capital approaches will
potentially benefit market participants by providing a tailored capital
regime that encourages SDs that are not part of global financial firms
to continue to provide liquidity in the swaps market, particularly to
smaller financial or commercial end users that do not have
relationships with the large financial SDs.
As mentioned above, FCM-SDs are subject to the FCM capital
requirements set forth in regulation 1.17. Covered SDs that are not
FCM-SDs and covered MSPs that are not FCM-MSPs are subject to the final
capital requirements set forth in regulation 23.101. Regulation 23.101
details the minimum capital requirements for each of the three capital
approaches for covered SDs and the eligibility criteria (as
applicable), and further defines the capital computations for each
approach, including various market risk and credit risk capital
charges. Regulation 23.101 also defines the minimum capital
requirements for covered MSPs and defines the capital computation for
covered MSPs. Each of these capital approaches is discussed below.
B. Capital Requirements for Stand-Alone FCMs and FCM-SDs
1. Introduction to General Capital Requirements for Stand-Alone FCMs
and FCM-SDs
The capital requirements for FCMs are set forth in regulation 1.17
and require each FCM to maintain a minimum level of ``liquid assets''
in excess of the firm's liabilities to provide resources for the FCM to
meet its financial obligations as a market intermediary in the
regulated futures and cleared swaps markets. As a market intermediary,
an FCM provides services to its customers and the marketplace,
including, in the event of a customer default, guaranteeing the
financial performance of each customer to clearing organizations that
clear the customers' futures and cleared swap transactions. To ensure
that an FCM is capable of meeting its financial obligations, regulation
1.17 requires an FCM to hold at all times more than one dollar of
highly liquid assets for each dollar of liabilities (e.g., money owed
to customers, counterparties and creditors), excluding certain
subordinated debt.\33\ The FCM capital requirements also are intended
to ensure that an FCM maintains a sufficient level of liquid assets in
excess of its liabilities in order to effectively and efficiently wind-
down its operations by transferring customer positions and funds to
other FCMs in the event that the FCM voluntarily or involuntarily
ceases operations.
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\33\ Commission regulation Sec. 1.17(h) (17 CFR 1.17(h))
permits an FCM to exclude certain qualifying subordinated debt from
its liabilities in computing its net capital. In order to qualify,
the person lending cash to the FCM must subordinate its claim
against the FCM to all other creditors of the FCM in addition to
agreeing to other conditions, including potential restrictions
associated with scheduled repayments of the debt.
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The FCM capital requirement contains two components. The first
component is a minimum level of ``adjusted net capital'' that an FCM is
required to maintain at any given time. The minimum adjusted net
capital requirement is generally the greater of the following: (i) A
fixed-dollar amount; (ii) an amount computed based upon the clearing
organization margin imposed on customer and noncustomer futures,
foreign futures, and cleared swap
[[Page 57468]]
positions carried by the FCM; (iii) the amount of net capital required
by the SEC for FCMs that are dually-registered as BDs (``FCM/BDs'');
or, (iv) the amount of adjusted net capital required by an RFA of which
the FCM is a member.\34\
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\34\ See Commission regulation Sec. 1.17(a)(1)(i) (17 CFR
1.17(a)(1)(i)).
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The second component of the FCM capital requirement is the amount
of adjusted net capital that an FCM actually maintains based upon the
assets and liabilities of the firm. In determining its adjusted net
capital, an FCM is first required to compute its net worth under
generally accepted accounting principles (``GAAP'') as adopted in the
United States, and then is required to apply certain rule-based
adjustments to reduce its net worth to the extent it contains illiquid
assets such as fixed assets and unsecured receivables. The resulting
calculation reflects the FCM's ``net capital.'' The FCM is then
required to apply certain rule-based capital charges or haircuts to
reflect market risk associated with its liquid assets. The resulting
calculation reflects the FCM's ``adjusted net capital.'' The
calculation of adjusted net capital in this manner is intended, as
noted above, to ensure that the FCM holds at least one dollar of highly
liquid assets to meet each dollar of liabilities, excluding certain
qualifying subordinated liabilities.
The Commission proposed several amendments to regulation 1.17 in
recognition that the current capital requirements do not explicitly
reflect FCMs transacting in uncleared swap or security-based swap
transactions, or engaging in swap dealing activities. The Commission
also proposed to require FCM-SDs to comply with the FCM capital
requirements.\35\ The Commission proposed to require FCM-SDs to comply
with regulation 1.17 due to the Commission's experience regulating FCMs
and its belief that the FCM capital requirements, with its emphasis on
liquidity, are well-designed to ensure that an FCM will be able to
continue to perform its critical functions in the futures and cleared
swaps marketplace. As noted above, FCMs are market intermediaries that
provide customers with access to the futures and cleared swaps markets.
As market intermediaries, FCMs play a central role in the daily
settlement process at derivatives clearing organizations by paying or
collecting their customers' initial and variation margin obligations.
FCMs also guarantee their customers' financial performance to each DCO,
and contribute to DCO guarantee funds. FCMs also provide numerous
services for their customers, including providing confirmations of each
transaction and periodic account statements. Based on its experience
with FCMs, the Commission believes that the FCM capital rule, which is
a liquidity-based capital rule, is appropriate for FCM-SDs.
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\35\ Section 4s(e)(3)(B)(i) of the CEA (7 U.S.C. 6s(e)(3)(B)(i))
states that nothing in section 4s(e) imposing capital and margin
requirement on SDs and MSPs limits, or shall be construed to limit,
the authority of the Commission to set financial responsibility
rules for FCMs pursuant to section 4f(a).
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2. Minimum Capital Requirement for FCMs and FCM-SDs
a. Minimum Fixed-Dollar Amount of Net Capital
Regulation 1.17(a)(1)(i) requires an FCM to maintain a minimum
amount of adjusted net capital that is equal to or greater than the
highest of: (i) $1 million; (ii) for an FCM that engages in off-
exchange foreign currency transactions with retail forex customers,\36\
$20 million, plus 5% percent of the FCM's liabilities to the retail
forex customers that exceed $10 million; (iii) 8% percent of the sum of
the risk margin of futures, options on futures, foreign futures, and
swap positions cleared by a clearing organization and carried by the
FCM in customer and noncustomer accounts; (iv) the amount of adjusted
net capital required by the RFA of which the FCM is a member; and (v)
for an FCM that is also registered with the SEC as a BD, the amount of
net capital required by the rules of the SEC.\37\
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\36\ Commission regulation Sec. 5.1(k) (17 CFR 5.1(k)) defines
the term ``retail forex customer'' as a person, other than an
eligible contract participant as defined in section 1a(18) of the
CEA, acting on its own behalf in any account agreement, contract or
transaction described in section 2(c)(2)(B) or 2(c)(2)(C) of the CEA
(7 U.S.C. 2(c)(2)(B) or 2(c)(2)(C)).
\37\ See Commission regulation Sec. 1.17(a)(1)(i) (17 CFR
1.17(a)(1)(i)).
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The term ``risk margin'' is defined in regulation 1.17(b)(8) as the
level of maintenance margin or performance bond required for the
customer or noncustomer positions by the applicable exchanges or
clearing organizations, and, where margin or performance bond is
required only for accounts at the clearing organization, for purposes
of the FCM's risk-based capital calculations applying the same margin
or performance bond requirements to customer and noncustomer positions
in accounts carried by the FCM, subject to the following: (i) Risk
margin does not include the equity component of short or long option
positions maintained in an account; (ii) the maintenance margin or
performance bond requirement associated with a long option position may
be excluded from risk margin to the extent that the value of such long
option position does not reduce the total risk maintenance or
performance bond requirement of the account that holds the long option
position; (iii) the risk margin for an account carried by an FCM which
is not a member of the exchange or the clearing organization that
requires collection of such margin should be calculated as if the FCM
were such a member; and (iv) if an FCM does not possess sufficient
information to determine what portion of an account's total margin
requirement represents risk margin, all of the margin required by the
exchange or the clearing organization that requires collection of such
margin for that account, shall be treated as risk margin.\38\
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\38\ Commission regulation Sec. 1.17(b)(8) (17 CFR 1.17(b)(8)).
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The Commission proposed amending regulation 1.17(a)(1)(i)(A) to
increase the minimum fixed-dollar amount of adjusted net capital from
$1 million to $20 million for FCM-SDs. The Commission did not propose
to amend the required minimum fixed-dollar amount of adjusted net
capital for stand-alone FCMs that may engage in swap activities at a
level that does not require registration as an SD, as the Commission
believed that the existing minimum fixed-dollar amount of required
adjusted net capital was properly calibrated for such firms.
The Commission believes that the proposed higher minimum dollar
amount of adjusted net capital for FCM-SDs is appropriate given the
enhanced risk that an FCM-SD assumes in engaging in swap dealing
activities, while also continuing to carry futures and cleared swaps
customers.\39\ As noted above, FCMs act primarily as market
intermediaries for futures and cleared swaps customers and typically do
not use their balance sheet to facilitate customer transactions. Absent
a customer default, an FCM does not take on market risk of its
customers' positions in performing this market intermediary function.
FCMs that are FCM-SDs, however, are engaging in swap dealing
activities. As dealers, FCM-SDs use their balance sheet to facilitate
customer transactions as they are counterparties on swap positions in
addition to performing market intermediary functions for their
customers. Dealing activities present additional risks to FCM-SDs. As
dealers, an FCM-SD is potentially exposed to market risks on uncleared
[[Page 57469]]
swap positions, and is exposed to counterparty credit risk from swap
counterparties. FCM-SDs also may be required to post initial margin and
pay variation margin to swap counterparties on a daily basis for their
proprietary uncleared swap positions. The proposed increase in the
fixed-dollar amount of the minimum adjusted net capital was intended to
address the potential increase in risks posed to FCM-SDs from dealing
activities, including the impact that dealing may have on the liquidity
of FCM-SDs. The proposed increase in the minimum capital requirement
also was intended to otherwise help ensure the safety and soundness of
the FCM-SD, as the insolvency of an FCM-SD could have potential adverse
consequences to the efficient operation of the market, particularly as
the insolvency impacts the futures and cleared swaps customers of the
FCM-SD. The Commission further noted that the proposed $20 million
minimum adjusted net capital requirement was consistent with the $20
million minimum dollar amount of adjusted net capital imposed by
Congress and the Commission on retail foreign exchange dealers
(``RFEDs'') or FCMs that enter into off-exchange foreign currency
transactions with retail persons under section 2(c)(2)(C) of the CEA
and regulation 5.7(a).
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\39\ 2016 Capital Proposal, 81 FR 91252.
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The Commission also proposed amending regulation 1.17(a)(1)(ii) to
require an FCM-SD that receives approval from the Commission or from an
RFA of which it is a member to use internal market risk or credit risk
models to compute capital charges in lieu of the standardized capital
charges or deductions to maintain net capital equal to or in excess of
$100 million, and adjusted net capital equal to or in excess of $20
million. The requirement to maintain a minimum $100 million fixed-
dollar amount of net capital was intended to address the issue that
while models are more risk sensitive and generally result in
substantially lower market risk and credit risk capital charges than
standardized charges, models may not capture all risks, including
extreme market losses (i.e., tail risk) or liquidity concerns. The
requirement for an FCM-SD that is approved to use capital models to
maintain a minimum of $100 million of net capital and $20 million of
adjusted net capital is consistent with the SEC's final capital rule
for SBSDs that are not registered BDs (``stand-alone SBSDs'') and that
are approved to use internal models to compute market risk and credit
risk capital charges. These entities are required to maintain fixed-
dollar tentative net capital of $100 million and fixed-dollar net
capital of $20 million.\40\
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\40\ See SEC rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)).
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The Commission did not receive comment on the proposed $20 million
fixed-dollar amount of adjusted net capital required of FCM-SDs. The
Commission received a comment stating that the proposed $100 million
net capital requirement for FCM-SDs that have approval to use internal
models to compute market risk or credit risk capital charges in lieu of
the standardized capital charges would create an unnecessary barrier to
entry.\41\
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\41\ See Letter from Joanna Mallers, FIA Principal Traders Group
(May 24, 2017) (FIA-PTG 5/24/2017 Letter).
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The Commission has considered the proposed amendments of the
minimum fixed-dollar amount of net capital and adjusted net capital
that FCM-SDs would be required to maintain and is adopting the
amendments as proposed.\42\ As noted above, FCMs play a central role as
market intermediaries for futures and cleared swaps transactions,
including guaranteeing each customer's financial performance to
clearing organizations or carrying FCMs. An adequate level of capital
is necessary to ensure that FCMs meet their financial obligations,
which in turn promotes customer protection and helps ensure the cleared
futures and cleared swaps markets operate efficiently. The increase in
adjusted net capital for FCM-SDs to $20 million is also necessary to
address the additional risk that is inherent in an SD's dealing
activities. As a dealer, an FCM-SD uses its balance sheet to facilitate
customer swap transactions, is a counterparty in swap transactions, and
is obligated to post and collect initial margin and settle variation
margin with swap counterparties. Furthermore, the final requirement for
an FCM-SD to maintain a minimum of $20 million of adjusted net capital
is consistent with the Commission's required minimum adjusted net
capital of $20 million for RFEDs, and is consistent with the SEC's
final minimum capital requirements for SBSDs.
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\42\ The 2019 SEC Final Capital Rule requires BDs that use
internal models to compute market risk and credit risk capital
charges in lieu of standardized capital charges to maintain $5
billion of net capital and $1 billion of adjusted net capital. FCM/
SDs that also are registered with the SEC as BDs are required to
comply with the SEC's capital requirements in meeting the
Commission's minimum capital requirement.
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With respect to the comment that a $100 million minimum net capital
requirement for FCM-SD's seeking approval to use capital models may act
as a barrier to entry, the Commission notes that the regulation was
designed to account for the fact that model-based market risk and
credit risk capital charges, while more risk sensitive than
standardized capital charges, tend to be substantially lower than
standardized charges. The $100 million of net capital is intended to
address potential model errors and tail risk and other factors that may
not be fully or accurately captured in the models. The Commission
further notes that currently the only FCM-SDs provisionally registered
are four BD/FCMs that are subject to substantially higher minimum
capital requirements under SEC and CFTC rules as discussed in section
II.B.3.c.(i). below. Accordingly, no provisionally-registered FCM-SD
will be subject to the $100 million minimum net capital requirement
based on the current list of provisionally registered SDs.
b. Minimum Capital Requirement Based on 8% Risk Margin Amount
Another component of the minimum capital requirements in regulation
1.17 provides that each FCM must maintain adjusted net capital equal to
or greater than 8% of the risk margin amount associated with the
futures, foreign futures, and cleared swaps positions carried by the
FCM in customer and noncustomer accounts.\43\ As discussed in section
II.B.2.a. above, the term ``risk margin'' for an account generally
means the level of maintenance margin or performance bond required for
customer and noncustomer positions by the applicable exchanges or
clearing organizations.\44\ Clearing organizations generally set
initial margin requirements for futures, foreign futures, and cleared
swap positons at a level to cover one-day market moves with a 99% level
of confidence.\45\
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\43\ A noncustomer account is an account that an FCM carries for
persons that generally are officers or employees of the FCM (i.e.,
the persons are not customers of the FCM and the account is not the
proprietary account of the FCM). See Commission regulation Sec.
1.17(b)(4) (17 CFR 1.17(b)(4)).
\44\ See Commission regulation Sec. 1.17(b)(8) (17 CFR
1.17(b)(8)).
\45\ See, for example, Commission regulation Sec. 39.13(g) (17
CFR 39.13(g)) which provides that a derivatives clearing
organization must set margin for futures and swaps on agricultural
commodities, energy commodities, and metals using a one-tailed 99%
confidence interval with a minimum one-day liquidation period, and
must set margin for all other swaps using a one-tailed 99%
confidence interval with a minimum five-day liquidation period.
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In computing the 8% risk margin amount, an FCM is required to
compute risk margin on the positions of each customer on a customer-by-
customer basis, and multiply the resulting aggregate risk margin amount
by 8%. The 8% risk margin amount is a risk
[[Page 57470]]
sensitive calculation in that an FCM's minimum capital requirement is
tied to the level of exchange or clearing organization margin
associated with each customer's and noncustomer's account. Accordingly,
an FCM's minimum capital requirement increases or decreases as the
aggregate of its customer and noncustomer risk margin increases or
decreases. The 8% risk margin amount is also a volume-based metric as
it requires an FCM to compute the risk margin amount on each individual
customer and noncustomer account, with no offsets between accounts to
reflect offsetting positions or to reflect margin collected on the
accounts. As a volume-based metric, an FCM's minimum capital
requirement increases or decreases based upon the aggregate amount of
risk margin required of each customer and noncustomer account carried
by the FCM.
The Commission proposed amending the minimum capital requirement in
regulation 1.17(a)(1)(i)(B) by expanding the types of positions that an
FCM-SD must include in the 8% risk margin amount calculation. The
Commission did not propose to expand the types of positions that must
be included in the risk margin amount calculation for stand-alone FCMs.
An FCM that is not an FCM-SD must continue to calculate the 8% risk
margin amount based upon the customer and noncustomer futures, foreign
futures, and cleared swap positions carried by the FCM.\46\
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\46\ A commenter noted an ambiguity in the 2016 Capital Proposal
in that the Commission stated in the preamble that the proposed
increases in the minimum capital requirements would be applicable
only to FCM-SDs and not to stand-alone FCMs, but that the proposed
rule text in Commission regulation Sec. 1.17 did not clearly draw
that distinction. See Letter from Walt Lukken, Futures Industry
Association, March 3, 2020 (FIA 3/3/2020 Letter). The Commission
confirms that the proposed increases in the minimum capital
requirements were only applicable to FCM-SDs, and has modified the
final rule text to clarify this point.
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Regulation 1.17(a)(1)(i)(B) currently requires an FCM, as noted
above, to include the risk margin associated with the futures, foreign
futures, and cleared swap positions carried in customer and noncustomer
accounts in the 8% risk margin amount calculation. The 2016 Capital
Proposal expanded the list of products that an FCM-SD must include in
the 8% risk margin amount calculation to further include the cleared
security-based swap positions carried for customers and noncustomers,
as well as the FCM-SD's proprietary cleared swaps and proprietary
cleared security-based swap positions. The positions in the risk margin
amount calculation was proposed to be further extended to include the
FCM-SD's uncleared swap and uncleared security-based swap positions.
The Proposal required an FCM-SD to include all swaps and security-
based swaps in the risk margin amount calculation, including swaps that
are excluded from the Commission's margin rules for uncleared swaps and
any security-based swaps that the SEC excluded from its margin rules.
Specifically, the proposal provided that an FCM-SD must include in its
computation of the risk margin amount each outstanding uncleared swap,
including swaps exempt from the scope of the Commission's uncleared
swaps margin rules by regulation 23.150 (``TRIPRA Exemption),\47\
legacy swaps, foreign exchange swaps as the term is defined in
regulation 23.151, or netting set of swaps or foreign exchange swaps,
for each counterparty, as if the counterparty were an unaffiliated SD.
The Proposal further required an FCM-SD to include the initial margin
for all uncleared swaps that would otherwise fall below the $50 million
initial margin threshold amount or the $500,000 minimum transfer
amount, as defined in regulation 23.151, for purposes of computing the
uncleared swap margin amount.\48\
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\47\ Title III of the Terrorism Risk Insurance Program
Reauthorization Act of 2015 amended sections 731 and 764 of the
Dodd-Frank Act to provide that the Commission's margin requirements
shall not apply to a swap in which a counterparty: (i) Qualifies for
an exception under section 2(h)(7)(A) of the CEA; (ii) qualifies for
an exemption issued under section 4(c)(1) of the CEA for cooperative
entities as defined in such exemption; and (iii) satisfies the
criteria in section in section 2(h)(7)(D) of the CEA. See Public Law
114-1, 129 Stat. 3.
\48\ 2016 Capital Proposal, 81 FR 91252 at 91258.
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The Commission received comments on various aspects of the proposed
8% risk margin amount calculation for FCM-SDs. Commenters to the 2016
Capital Proposal and the 2019 Capital Reopening objected to including
cleared and uncleared security-based swaps in the 8% risk margin amount
calculation for FCM-SDs.\49\ Commenters stated that the Commission
should not include security-based swaps in the 8% risk margin amount
calculation as security-based swaps are products regulated by the SEC,
and that including SEC-regulated products in the Commission's minimum
capital requirement is inconsistent with long-standing CFTC and SEC
capital requirements for FCMs and BDs.\50\
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\49\ See FIA 3/3/2020 Letter; Letter from Briget Polichene,
Institute of International Bankers, Scott O'Malia, International
Swaps and Derivatives Association, and Kenneth Bentsen, Jr.,
Securities Industry and Financial Markets Association (March 3,
2020) (IIB/ISDA/SIFMA 3/3/2020 Letter).
\50\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
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A commenter noted that a dually-registered FCM/BD is generally
required to maintain adjusted net capital equal to the greater of (i)
8% of the margin required for futures, foreign futures, and cleared
swaps carried by the FCM for customers and noncustomers, or (ii) 2% of
the debit items calculated in respect of the BD's customer securities
positions.\51\ The commenter further stated that the approach of
setting separate, as opposed to aggregate, requirements for Commission
and SEC regulated products allows the agency that Congress selected to
regulate a given product to determine the appropriate balance between
robust capital cushions and robust market liquidity.\52\
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\51\ Id.
\52\ Id.
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The commenter further noted that the 2019 SEC Final Capital Rule
continued this historical approach as the SEC elected to include in its
minimum capital requirement the initial margin associated only with
customer and noncustomer cleared security-based swaps and the SBSD's
uncleared security-based swaps.\53\ The SEC's final rule did not
incorporate initial margin associated with customer cleared swap
positions or uncleared swap positions, or otherwise include positions
that are not subject to the SEC's jurisdiction.
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\53\ Id.
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One commenter stated that FX forwards and swaps should be excluded
from the 8% risk margin amount calculation as Congress gave the United
States Treasury Department the authority over these products.\54\
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\54\ See Letter from Joanna Mallers, FIA Principal Traders Group
(March 3, 2020) (FIA-PTG 3/3/2020 Letter).
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The Commission has considered the proposal and the comments
received, and is adopting a minimum capital requirement based upon a
percentage of the risk margin amount. The Commission is modifying the
final rule, however, to exclude cleared security-based swap and
uncleared security-based swap positions from the risk margin amount
calculation. The Commission acknowledges that in setting minimum
capital requirements for FCMs, including FCMs that are dually-
registered as FCM/BDs, it has historically considered only the futures
related activities of an FCM. In this regard, the Commission's initial
minimum capital requirement was based upon a percentage of futures
customer and noncustomer funds held by an FCM, and was subsequently
[[Page 57471]]
amended to be based upon a percentage of the risk margin associated
with futures and cleared swaps customer and noncustomer positions
carried by an FCM.\55\ The Commission has not historically required an
FCM/BD to maintain a level of minimum capital necessary to meet the
aggregate of the CFTC's minimum requirement and the SEC's minimum
requirement, which is based on the FCM/BD's securities activities.
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\55\ See Minimum Financial and Related Reporting Requirements
for Futures Commission Merchants and Introducing Brokers, 69 FR
49784 (Aug. 12, 2004).
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The Commission believes that the overall adequacy of the minimum
capital requirement at an FCM-SD should be based upon the activities of
the FCM-SD in CFTC-regulated markets. This allows the Commission to
monitor the adequacy of the minimum capital requirements based upon its
expertise and experience with Commission-regulated products and
markets. In addition, an FCM-SD that is also registered as a BD would
continue to be subject to the minimum capital requirements established
by the SEC for BDs in addition to the minimum capital requirements
established by the Commission for FCM-SDs. The Commission's current
capital rule requires an FCM/BD to maintain a minimum level of capital
that is greater than the higher of the CFTC minimum requirement for
FCMs or the SEC minimum requirement for BDs.\56\ Therefore, an FCM-SD
that is registered as a BD will have to maintain minimum capital in an
amount based upon the greater of the CFTC or SEC minimum requirement.
This would help ensure the safety and soundness of the FCM-SD by
providing readily available financial resources to address operational,
legal, compliance, or other risks, and, if necessary, by providing
financial resources to assist with the orderly liquidation of the FCM-
SD in the event of its insolvency.
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\56\ See Commission regulation Sec. 1.17(a)(1)(i)(D) (17 CFR
1.17(a)(1)(i)(D)).
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Commenters also stated that the Commission's proposed inclusion of
the proprietary futures and proprietary cleared swap positions in an
FCM-SD's 8% risk margin amount calculation would duplicate existing
capital charges required under regulation 1.17.\57\ The commenters
noted that regulation 1.17(c)(5)(x) currently requires an FCM to take a
capital charge in an amount equal to 100% or 150% of the margin
required by a clearing organization for proprietary futures and cleared
swap positions \58\ in computing its adjusted net capital.\59\ Another
commenter stated that including margin associated with proprietary
cleared swaps in the 8% risk margin amount was not necessary as
proprietary cleared positions present minimal credit risk to an FCM-SD
as the only credit exposure is to a clearing organization or
broker.\60\ The proprietary futures and cleared swaps capital charge
also would apply to FCM-SDs under the Commission's Proposal, as FCM-SDs
are required to comply with regulation 1.17. One commenter also stated
that the SEC in its final rules requires a BD or SBSD to take a
standardized capital charge for cleared security-based swaps equal to
100% of the margin required by a clearing agency, and does not impose a
150% charge for positions held by non-clearing BDs or SBSDs.\61\ The
commenter stated that if the Commission adopts this capital charge, it
should do so in a manner that is consistent with the SEC's final rule.
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\57\ See FIA 3/3/2020 Letter.
\58\ Commission regulation Sec. 1.17(c)(5)(x) (17 CFR
1.17(c)(5)(x)) currently requires an FCM that is a clearing member
of a clearing organization to take a capital charge equal to 100% of
the margin required by the clearing organization for the cleared
positions. FCMs that are not clearing members are required to take a
capital charge equal to 150% of the maintenance margin required by
the applicable clearing organization for the cleared positions.
\59\ See Letter from Stephen Berger, Citadel Securities (May 15,
2017) (Citadel 5/15/2017 Letter); Letter from Mary Kay Scucci,
Securities Industry and Financial Markets Association (May 15, 2017)
(SIFMA 5/15/2017 Letter); Letter from Walter Lukken, Futures
Industry Association (May 15, 2017) (FIA 5/15/2017 Letter); FIA-PTG
5/24/2017 Letter; FIA 3/3/2020 Letter; FIA-PTG 3/3/2020 Letter.
\60\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\61\ See IIB/ISDA/SIFMA 3/3/2020 Letter. See also, SEC rule
15c3-1(c)(2)(vi)(O) (17 CFR 240.15c3-1(c)(2)(vi)(O)) which provides
that capital charge for a proprietary cleared security-based swaps
is the margin amount of the clearing agency or, if the security-
based swap references an equity security, the broker or dealer may
take a deduction using the method specified in rule 15c3-1a (17 CFR
240.15c3-1a).
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The Commission has reconsidered the Proposal and the comments
received and is modifying final regulation 1.17(a)(1)(i)(B) to not
include proprietary futures, foreign futures, and proprietary cleared
swaps from the risk margin amount calculation. The Commission believes
that the requirement for an FCM-SD to take a capital charge equal to
100% or 150% of the required initial margin or required maintenance
margin, as applicable, on its proprietary cleared positions adequately
accounts for the risk associated with those positions, as it reflects
the potential market risk presented by the positions as determined by a
clearing organization or broker and further recognizes that the initial
margin posted with the clearing organization or broker is no longer
available for use in the FCM-SD's business and, thus, warrants at least
a 100% capital charge. The market risk capital charge imposed on
proprietary futures and cleared swaps for FCM-SDs approved to use
capital models for market risk would be model-based and not the margin
imposed by a clearing organization. Since a market risk charge would
reduce the FCM-SD's capital, the Commission believes that it is
appropriate to exclude the proprietary cleared positions from the 8%
risk margin amount calculation.
The Commission believes that under such circumstances it is not
necessary to impose an additional capital requirement in the form of an
increase in the minimum capital requirement equal to 8% of the margin
associated with the FCM-SD's proprietary cleared futures, foreign
futures, and swaps positions. In this regard, the Commission notes that
an FCM-SD's credit exposure is limited on cleared positions to either a
clearing organization or to an FCM that carries the FCM-SD's account
(or in the case of foreign futures, a foreign broker that carries the
FCM-SD's account). The credit exposure on such cleared positions is
limited as clearing organizations and FCMs/foreign brokers are
regulated entities that are generally subject to financial
requirements, including capital, margining, and financial reporting
requirements. Clearing organizations and FCMs/foreign brokers are also
subject to regulations regarding the holding of customer funds to
ensure that such funds are used solely for the benefit of the customer
and not for the benefit of other customers or of the clearing
organization or FCM/foreign broker.\62\ Furthermore, as noted above, an
FCM-SD will be required to maintain a level of net capital that is
sufficient to cover the market risk charges associated with the
proprietary cleared futures, foreign futures, and cleared swap
positions.
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\62\ See, e.g., Commission regulations Sec. Sec. 1.20, 1.22,
and 39.15 (17 CFR 1.20, 1.22 and 39.15).
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The Commission is also modifying the final regulation to set the
risk margin amount multiplier for uncleared swaps at 2% of the
``uncleared swap margin'' amount required on such positions. The term
``uncleared swap margin'' is defined in regulation 1.17(b)(11) to mean
the amount of initial margin that the FCM-SD would compute on each
uncleared swap position pursuant to the calculation requirements of
regulation 23.154. The FCM-SD must include all uncleared swap positions
in the
[[Page 57472]]
calculation of the uncleared swap margin amount, including uncleared
swaps that are exempt from the scope of the Commission's margin
regulations for uncleared swaps pursuant to regulation 23.150, exempt
foreign exchange swaps or foreign exchange forwards, or netting set of
swaps or foreign exchange swaps, for each counterparty, as if the
counterparty was an unaffiliated swap dealer. Furthermore, in computing
the uncleared swap margin amount, an FCM-SD may not reduce the
uncleared swap margin amount to reflect the initial margin threshold
amount or the minimum transfer amount as such terms are defined in
regulation 23.151.\63\
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\63\ The Commission is modifying the definition of the term
``uncleared swap margin'' in final paragraph (b)(11) of Commission
regulation 1.17 (17 CFR 1.17(b)(11)) to align the wording of the
regulation to be consistent with the definition of the term
``uncleared swap margin'' in regulation 23.100 for SDs that are not
also registered FCMs.
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The Commission is modifying the risk margin amount multiplier in
recognition that the Commission's margin requirements generally impose
a higher margin requirement on uncleared swap positions relative to
cleared swaps and futures positions. Minimum initial margin
requirements for cleared futures and swap transactions are generally
set by clearing organizations. In this regard, the FCM minimum capital
requirement of 8% of the risk margin amount on futures and cleared
swaps is based upon margin calculations using clearing organization
models that require a 99% one-tailed confidence interval over a minimum
liquidation period of one day for futures, agricultural swaps, energy
swaps, and metal swaps, and a minimum liquidation period of five days
for all other swaps, including financial swaps such as interest rate
swaps.\64\ In contrast, initial margin for uncleared swaps is required
to be calculated at a 99% one-tailed confidence interval over minimum
liquidation period of 10 business days (or the maturity of the swap if
shorter).\65\ The greater margin period of risk for uncleared swaps
generally requires a higher level of initial margin, which would
increase the FCM-SD's minimum capital requirement for uncleared swaps
relative to cleared transactions. The modification of the final rule to
set the risk margin amount multiplier at 2% for uncleared swap
positions is appropriate given the generally higher initial margin
requirements imposed on such positions under the Commission's
regulations relative to cleared positions. In addition, as noted above,
FCM-SD's will also be required to take market risk charges for each of
its proprietary positions, including uncleared swaps, in computing its
adjusted net capital.
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\64\ See Commission regulation Sec. 39.13(g) (17 CFR 39.13(g)).
\65\ See Commission regulation Sec. 23.154(b)(2) (17 CFR
23.154(b)(2)).
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As noted by a commenter, the 8% risk margin amount was proposed in
2003, and subsequently adopted in 2004, based upon an analysis and
comparison of the then existing FCM capital regime that was based on a
percentage of the customer funds held by an FCM, with a minimum capital
requirement based upon risk margin associated with the customer
positions carried by the FCM.\66\ Staff also had the benefit of
observing data of the actual performance of the two capital regimes for
an extended period of time as each FCM was required to calculate its
minimum capital requirement based on customer funds and its capital
requirement based on a percentage of its risk margin amount for
approximately two years as part of a pilot program.\67\
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\66\ See Minimum Financial and Related Reporting Requirements
for Futures Commission Merchants and Introducing Brokers, 68 FR
40835 (July 9, 2003) and 69 FR 49784 (Aug. 12, 2004). See also, CFTC
Division of Trading and Markets, Review of Standard Portfolio
Analysis of Risk Margining System Implemented by the Chicago
Mercantile Exchange, Board of Trade Clearing Corporation, and the
Chicago Board of Trade (Apr. 2001) (``T&M 2001 Report''). See IIB/
ISDA/SIFMA 3/3/2020 Letter.
\67\ See T&M 2001 Report.
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The Commission does not have the benefit of similar comprehensive
data regarding the multiplier for the uncleared swaps risk margin
amount at this time. However, the Commission's decision to modify the
final rule by removing cleared and uncleared security-based swaps, as
well as proprietary futures, foreign futures, and cleared swaps
positions from the risk margin amount calculation, and to set the
multiplier at 2% should mitigate many of the commenters' concerns that
the proposed 8% risk margin amount calculation was over inclusive of
the types of positions included in the calculation and was set at a
percentage that was too high.
The modification to remove proprietary futures, foreign futures,
cleared swap, and cleared and uncleared security-based swap positions
from the risk margin amount calculation also mitigates concerns raised
by commenters that the capital rule ``double counts'' positions by
requiring an FCM-SD to include such positions in its minimum capital
requirement while also requiring the FCM-SD to take market risk and
credit risk charges in computing its adjusted net capital. The
modifications to the final rule also more closely aligns the
Commission's minimum capital requirement for FCM-SDs with the approach
adopted by the SEC for setting minimum capital requirements for BDs
that are SBSDs and stand-alone SBSDs.
The Commission will review within five years of the effective date
of this rule, the impact that the 2% risk margin amount has on the
level of minimum capital required of FCM-SDs after the compliance date
of the rules. The Commission will use the financial statements and
other information that it will receive from FCM-SDs under existing FCM
financial reporting requirements to assess whether the minimum capital
requirements for FCM-SDs are adequately calibrated to ensure their
safety and soundness. The information that the Commission will receive
will allow it to determine if it would be appropriate to propose
amending the minimum capital requirement by, among other things,
increasing or decreasing the risk margin amount multiplier.
3. Stand-Alone FCM and FCM-SD Calculation of Net Capital and Adjusted
Net Capital
As previously noted, the second component of the FCM and FCM-SD
capital requirement is the computation of the firm's adjusted net
capital based upon the assets and liabilities of the firm. Regulation
1.17(c)(5) defines the term ``adjusted net capital'' as an FCM's
``current assets'' (i.e., current, liquid assets excluding, however,
most unsecured receivables), less all of the FCM's liabilities (except
certain qualifying subordinated debt). An FCM is further required to
impose certain prescribed capital deductions (``capital charges'' or
``haircuts'') from the current market value of the FCM's proprietary
positions (e.g., futures, securities, debt instruments, money market
instruments, and commodities) in computing its adjusted net capital to
reflect potential market risk associated with the firm's proprietary
positions, as well as to provide a capital cushion against other
potential risks, including liquidity, legal, and operational risk.
Regulation 1.17(c)(5) establishes specific standardized capital
charges for market risk for an FCM's proprietary positions in physical
inventory, forward contracts, fixed price commitments, and securities.
Regulation 1.17(c)(5), however, did not explicitly address market risk
capital charges for uncleared swap or security-based swap positions.
While FCMs have not historically engaged in a significant level of
swaps or security-based swap transactions, the Commission has required
FCMs to use the standardized market risk capital charges specified in
regulation
[[Page 57473]]
1.17(c)(5)(ii), or the standardized market risk capital charges
established by SEC rule 15c3-1 (17 CFR 240.15c3-1) (``SEC rule 15c3-
1'') for dually-registered FCM-BDs, to compute market risk capital
charges for uncleared swap and security-based swap positions.\68\
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\68\ For example, existing Commission regulation Sec.
1.17(c)(5)(ii)(C) (17 CFR 1.17(c)(5)(ii)(C)) imposes a market risk
capital charge on inventory positions held by an FCM equal to 20% of
the market value of the inventory, and Sec. 1.17(c)(5)(ii)(G) (17
CFR 1.17(c)(5)(ii)(G)) imposes the same market risk capital charge
of 20% on the value of fixed price commitments and forward
contracts. FCMs holding agricultural swaps or energy swaps have been
required to take a market risk capital charge equal to 20% of the
notional value of the swap under the application of either of these
two provisions.
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The Commission proposed amendments to regulation 1.17(c)(5) to more
explicitly provide for specific standardized market risk capital
charges for an FCM's or FCM-SD's proprietary positions in uncleared
swaps and security-based swaps.\69\ The Proposal further provided that
an FCM or FCM-SD that obtained approval to use internal market risk
capital models could use such models in lieu of the standardized market
risk charges. In order to use capital models, an FCM-BD must have
obtained SEC approval to use capital models. These dually-registered
FCM-BDs are referred to as ``Alternative Net Capital Firms'' (``ANC
Firms''), and are subject to enhanced minimum capital requirements as
discussed below. An FCM which is not a BD, but also is registered as an
SBSD would also be subject to the approval of both the Commission and
the SEC to use models, but with lesser applicable fixed dollar net
capital and adjusted net capital thresholds. The proposed standardized
market risk charges and model-based charges are also discussed below.
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\69\ 2016 Capital Proposal, 81 FR 91252 at 91266-67.
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a. Stand-Alone FCM and FCM-SD Standardized Market Risk Capital Charges
FCMs currently are required to take standardized market risk
charges for proprietary positions in computing their adjusted net
capital under regulation 1.17. The current standardized market risk
charges are aligned with the SEC's market risk capital charges for BDs,
and reflect the two agencies' long-standing efforts of maintaining a
uniform capital rule for FCMs and BDs as most FCMs are dually-
registered as BDs. In this regard, regulation 1.17 requires FCMs that
hold positions in securities and securities-related products, such as
U.S. Government securities, equity securities and options, municipal
securities, commercial paper, and certificates of deposit, to take
market risk capital charges on such positions in the manner and amount
specified by SEC rule 15c3-1 and rule 15c3-1a (17 CFR 240.15c3-1a)
(``SEC rule 15c3-1a''). FCMs that hold positions in commodities,
including foreign currency and physical commodities, are required to
take market risk capital charges set forth in Commission regulation
1.17(c)(5). For example, regulation 1.17(c)(5) requires an FCM to take
a capital charge equal to 0% to 20% of the market value of inventory
depending on whether the FCM's inventory position is adequately offset
(or ``covered'') by proprietary futures positions.\70\ The standardized
Commission and SEC market risk capital charges are generally computed
based upon the market value of the position multiplied by a percentage
factor set forth in the rule or regulation.
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\70\ See Commission regulation Sec. 1.17(j) (17 CFR 1.17(j))
for the definition of the term ``cover.''
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Regulation 1.17 and SEC rules, however, did not provide explicit
market risk capital charges for swaps or security-based swaps. To the
extent an FCM engages in uncleared swap or security-based swap
transactions, the FCM is required to take a market risk capital charge
based upon the standardized capital charges contained in SEC rules
15c3-1, 15c3-1a, or Commission regulation 1.17(c)(5) that are
applicable to proprietary positions in securities, inventory, foreign
currency, fixed price commitments, or forward contracts. For example,
an energy swap is treated as a fixed price commitment under regulation
1.17(c)(5), and an FCM is required to take a market risk capital charge
equal to 20 percent of the notional value of the swap.\71\ The purpose
of the market risk capital charge is to require an FCM, in computing
its adjusted net capital, to reserve a minimum level of capital to
cover potential future losses in the value of the swap.
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\71\ For example, swaps with a reference asset of a physical
commodity are subject to a capital charge equal to 20% of the
notional value of the contract (See Commission regulation Sec.
1.17(c)(5)(ii)(G) (17 CFR 1.17(c)(5)(ii)(G)).
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The 2016 Capital Proposal proposed amending the standardized market
risk capital charges to explicitly reflect uncleared swap and security-
based swap positions. The Commission proposed to amend regulation
1.17(c)(5)(iii) to provide a schedule of standardized market risk
capital charges for positions in uncleared credit default swaps,
interest rate swaps, foreign exchange swaps, commodity swaps, and all
other uncleared swaps.\72\ The Commission also proposed that an FCM or
an FCM-SD must take the applicable standardized capital charge in SEC
rule 15c3-1, as such rule was proposed to be amended, for proprietary
positions in uncleared security-based swaps, including uncleared
security-based credit default swaps and equity swaps.\73\
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\72\ See 2016 Capital Proposal, 81 FR 91252 at 91266-67.
\73\ The SEC proposed amending rules 15c3-1 and 15c3-1b to
establish standardized capital charges for security-based swaps and
swaps that would apply to stand-alone BDs and BDs that are also
registered SBSDs. See Capital, Margin, and Segregation Requirements
for Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers, 77 FR
70214 (Nov. 23, 2012) (``SEC 2012 Proposed Capital Rule'').
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Credit default swaps are generally defined by the reference asset
or entity, the notional amount, the duration of the contract, and
credit events. The Commission proposed standardized market risk capital
charges for credit default swaps using maturity grids. The ``maturity
grid'' was based on a ``maturity grid'' approach that was proposed and
subsequently adopted by the SEC for credit default swaps and security-
credit default swaps.\74\ Market risk capital charges for uncleared
credit default swaps were proposed to be based on two variables under
the 2016 Capital Proposal: (i) The length of time to maturity of the
credit default swap; and (ii) the amount of the current offered basis
point spread on the uncleared credit default swap. The standardized
market risk charge for an unhedged short position in a credit default
swap was the applicable percentage specified in the grid. The deduction
for an unhedged long position was 50% of the applicable deduction
specified in the grid.\75\
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\74\ SEC rule 15c3-1(c)(2)(vi)(P)(1) (17 CFR 240.15c3-
1(c)(2)(vi)(P)(1)).
\75\ See proposed paragraph (c)(5)(iii)(A) of Commission
regulation Sec. 1.17; 2016 Capital Proposal, 81 FR 91252 at 91307.
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The 2016 Capital Proposal also permitted an FCM to net long and
short positions where the uncleared credit default swaps reference the
same entity or obligation, reference the same credit events that would
trigger payment by the seller of the protection, reference the same
basket of obligations that would determine the amount of payment by the
seller of protection upon the occurrence of a credit event, and are in
the same or adjacent maturity and spread categories (as long as the
long and short positions each have maturities within three months of
the other maturity category). In this case, the FCM was required to
take the specified market risk percentage deduction only
[[Page 57474]]
on the notional amount of the excess long or short position.\76\
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\76\ See 2016 Capital Proposal, 81 FR 91252 at 91267.
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For uncleared interest rate swaps, the Commission proposed a
standardized market risk capital charge approach that required
multiplying the notional amount of the swap by a stated percent.\77\
The percentage that applied to the notional amount was determined by
referencing the standardized haircuts in SEC rule 15c3-1(c)(2)(vi)(A)
for U.S. government securities with comparable maturities to the
interest rate swaps maturities, and would range from 0% (for interest
rate swaps with a remaining time to maturity of less than 3 months) to
6% (for interest rate swaps with a remaining time to maturity of 25
years or more). The 2016 Capital Proposal further provided that an FCM
may net certain long and short uncleared interest rate swaps to reduce
the net notional amount of the interest rate swaps subject to the
market risk capital charge. The net amount of the long and short
interest rate swaps was determined based upon the existing SEC netting
schedule for government securities, which is based upon the time to
maturity of the interest rate swaps. For example, long and short
interest rate swaps with maturity dates ranging between 3 years to less
than 5 years are subject to market risk capital charge equal to 3% on
the net long or short interest rate swap position.
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\77\ Id.
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The Proposal further provided that the market risk capital charge
for interest rate swaps must not be less than 0.5% of the amount of the
long position that was netted against a short position, notwithstanding
that the netting provisions contained in SEC rule 15c3-1 does not
impose a market risk capital charge on U.S. government securities with
less than 3 months to maturity.\78\ The 0.5% floor on the total amount
of the long interest rate swaps netted against the short interest rate
swaps was designed to account for potential differences between the
movement of interest rates on U.S. government securities and interest
rates upon which swap payments are based.
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\78\ The SEC proposed minimum standardized market risk charge of
1% of the net notional value of the interest rate swaps for SBSDs
and 0.5% for BDs. See SEC Proposed Capital Rule, 77 FR 70214 at
70345; Proposed rule 18a-1b(b)(2)(C) for SBSDs and proposed rule
15c3-1b(2)(ii)(C).
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The Commission also proposed specific market risk capital charges
for foreign currency swaps, commodity swaps, security-based swaps, and
all other uncleared swaps. The Proposal requires FCM and FCM-SDs to
take a market risk capital charge for foreign currencies swaps that is
consistent with the standardized market risk charges for foreign
currency positions and foreign currency forwards contained in
regulation 1.17(c)(5). Specifically, the Commission proposed market
risk charges equal to 6% of the notional value of a foreign currency
swap that references euros, British pounds, Canadian dollars, Japanese
yen, or Swiss francs. Foreign currency swaps that reference any other
currency are subject to a market risk capital charge equal to 20% of
the notional value of the respective swap.
With respect to swaps referencing a physical commodity, the
Proposal required FCM and FCM-SDs to take a market risk capital charge
equal to 20% of the market value of the relevant commodity underlying a
commodity swap. Consistent with the foreign currency and interest rate
swaps, the proposed commodity swap market risk capital charge was based
upon the existing capital charges for physical commodities set forth in
regulation 1.17(c)(5). The Proposal further required an FCM or FCM-SD
to take the market risk capital charges specified in SEC rules for
security-based swaps, which would include equity swaps, and for any
swap that has a reference asset that is subject to specific SEC market
risk capital charges and is not otherwise subject to a Commission
imposed capital charge.
Commenters objected to the proposed standardized market risk
capital charges as being too punitive and not tailored to the risk
posed by the relevant portfolios of positions.\79\ Specifically,
commenters noted that the proposed standardized market risk charges for
interest rate swaps are substantially higher than the capital charges
based on clearing house maintenance margin requirements for cleared
interest rate futures contracts.\80\ One commenter provided a sample
matched book portfolio of interest rate swaps demonstrating that an FCM
would have substantially higher capital charges under the proposed
standardized approach as compared to the model approach or as compared
to clearing house maintenance margin requirements.\81\ These commenters
indicated that the excessive capital requirements derived from the
proposed standardized market risk capital charges would particularly
impact small to mid-sized SDs that are not approved or otherwise do not
use internal market risk capital models.\82\
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\79\ See SIFMA 5/15/2017 Letter; Letter from Michael Sharp,
Jefferies Group LLC (May 12, 2017) (Jefferies 5/12/2017 Letter).
\80\ SIFMA and Jefferies each estimated that the proposed
standardized market risk charges for uncleared interest rate swaps
would be substantially higher than the clearing house margin
requirements. See Id.
\81\ See Jefferies 5/12/2017 Letter.
\82\ See proposed Commission regulation Sec. 23.101(a)(1), 2016
Capital Proposal, 81 FR 91252 at 91310-11. See SIFMA 5/15/2017
Letter; Letter from Ryan Hayden, ED&F Man Derivative Products, Inc./
INTL FCStone Markets, LLC (March 3, 2020) (ED&F Man/INTL FCStone 3/
3/2020 Letter); IIB/ISDA/SIFMA 3/3/2020 Letter; FIA 3/3/2020 Letter;
Letter from Alexander Lange, ABN AMRO Securities (USA) LLC; Michael
Bando, ING Capital Markets LLC; Adam Hopkins, Mizuho Capital Markets
LLC; David Moser, Nomura Holding America Inc. (January 29, 2018)
(ABN/ING/Mizuho/Nomura 1/29/2018 Letter).
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Commenters also requested that the Commission reconsider the
standardized capital charge on currency swaps.\83\ The commenters noted
that an FCM or FCM-SD would have to take a market risk capital charge
equal to 20% of the notional amount of an uncleared foreign currency
non-deliverable forward contract, while the standardized (or grid-
based) initial margin requirements on such a contact is 6% of the
notional amount.\84\ One commenter recommended that the final rule
align the capital charge with the volatility and liquidity conditions
of the relevant currency pair.\85\ Another commenter stated that the
standardized capital charge is too high for a product that is highly
liquid and recommended that the capital charge be aligned with the
standardized initial margin requirement of 6% under the uncleared
margin rules.\86\
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\83\ Letter from Stephen John Berger, Citadel Securities, March
3, 2020 (Citadel 3/3/2020 Letter); FIA-PTG 3/3/2020 Letter.
\84\ IIB/ISDA/SIFMA 3/3/2020 Letter; Citadel 3/3/2020 Letter.
\85\ Citadel 3/3/2020 Letter.
\86\ FIA-PTG 3/3/2020 Letter.
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Another commenter stated that a covered SD that enters into a swap
with uncleared swap contracts containing a flip-clause should require a
charge for required margin on such contract plus market risk.\87\
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\87\ Letter from William Harrington (3/3/2020) (Harrington 3/3/
2020 Letter).
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The Commission acknowledged in the 2019 Capital Reopening that the
proposed standardized market risk charges would impact FCMs, FCM-SDs,
and covered SDs that do not have approval to use internal market risk
capital models, which are more likely to be smaller to mid-sized firms
that may not be part of a financial group that has the approval of the
SEC, a prudential regulator, or a foreign regulator to use internal
capital models. The Commission further believed that establishing a
more appropriate market risk capital charge for uncleared interest
[[Page 57475]]
rates swaps, in particular, given the relatively high market risk
capital charge would benefit market participants by encouraging smaller
to mid-sized FCMs, FCM-SDs, and covered SDs to remain in the market or
to enter the market. Accordingly, the Commission requested further
comment on the proposed standardized market risk charge for uncleared
interest rate swaps. The Commission also noted that the SEC's final
capital rule for BDs and SBSDs imposed a minimum capital requirement
for uncleared interest rate swaps equal to \1/8\ of one percent
(0.125%) and only applicable to the matched long position that is
netted against a short position in the case of a uncleared interest
rate swap with a maturity of three months or more.\88\
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\88\ See 2019 SEC Final Capital Rule, rule 18a-
1b(b)(2)(ii)(A)(3) (17 CFR 240.18a-1b(b)(2)(ii)(A)(3) for SBSDs and
rule 15c3-1b(b)(2)(ii)(A)(3) (17 CFR 240.15c3-1b(b)(2)(ii)(A)(3))
for BDs.
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The Commission has considered the comments and is adopting the
proposed standardized market risk charges for uncleared swaps and
uncleared security-based swaps as proposed, with several modifications
that are discussed below. The standardized market risk capital charges
being adopted are generally based on existing Commission and SEC
standardized market risk charges for positions in foreign currencies,
commodities, U.S. treasuries, equities and other instruments, which, in
the Commission's long experience, have generally proven to be effective
and appropriately calibrated to address potential market risk in the
positions. The Commission believes at this time that this approach, in
conjunction with other charges discussed herein, appropriately accounts
for the wide variety of possible uncleared swap transactions that FCMs,
FCM-SDs, and covered SDs may engage in, including bespoke swap
transactions involving flip-clauses or other unique features. Overtime,
the Commission may consider adjusting these charges as a result of
experience with their impacts on required capital in these firms and as
market developments may warrant.
In response to several commenters, the Commission recognizes that
standardized market risk charges are not as risk sensitive as market
risk models, and generally result in higher market risk capital charges
than internal models. The Commission notes, however, the lower capital
charges for firm's approved to use market risk model is one of the
reasons that model approved firms are subject to the higher minimum
capital requirements. As noted in section II.B.2.a. above, FCM-SDs that
are approved to use internal market risk models are required to
maintain net capital of at least $100 million and adjusted net capital
of $20 million, while FCM-SDs that are not approved to use internal
market risk models are required to maintain $20 million of adjusted net
capital, but are not subject to the $100 million dollar net capital
requirement. The imposition of $100 million net capital requirement is
to provide protection for potential model errors or the failure of the
models to address all applicable risks. The Commission believes that it
is appropriate to require FCM-SDs that do not use internal models and
therefore have a lower capital requirement to be subject to the higher
standardized market risk capital charges. The approach is also
consistent with the approach adopted by both the Commission and SEC
with respect to ANC Firms that have been approved to use internal
capital models and, which under the 2019 SEC Final Capital Rule, are
subject to a minimum capital requirement of $5 billion of tentative net
capital and $1 billion of net capital.\89\
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\89\ SEC rule 15c3-1(a)(7) (17 CFR 240.15c3-1(a)(7)).
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In addition, the Commission believes that FCM-SDs will seek
approval to use model-based market risk charges. There currently are
four FCM-SDs provisionally-registered with the Commission. Each of the
FCM-SDs is an ANC Firm that is approved to use market risk capital
models and, which under the 2019 SEC Final Capital Rule, is subject to
the SEC's minimum capital requirement of $5 billion of tentative net
capital and $1 billion of net capital. In order to effectively compete
with the existing FCM-SDs and other covered SDs, any new FCM-SD
registrant would need to obtain model approval.
The Commission is also modifying the final regulation by reducing
the minimum capital charge for a portfolio of interest rate swaps to
align with the SEC's final capital requirement for BD's and SBSD's
using standardized capital charges. In reviewing the comments, the
Commission realizes that the standardized market risk charges for
interest rate swaps that it proposed in its 2016 Capital Proposal was
too high relative to the market risk of the positions. The Proposal's
imposition of a minimum market risk capital charge of .5% of the
notional amount of the matched long interest rate swaps has been shown
by commenters to be poorly calibrated to the market risk of the
positions. Therefore, under the final regulation, an FCM-SD or FCM is
required to take a capital charge of at least \1/8\ of one percent
(0.125%) of the matched long interest rate swap positions that is
netted against a short interest rate swap positions with a maturity of
three months or more. The Commission believes that in making this
change, the overall effect on the amount of capital held by an FCM or
an FCM-SD will not have a substantial adverse impact on the safety and
soundness of these entities. The Commission, however, will monitor the
standardized capital charges and refine the percentages as it obtains
experience with the level of interest rate swaps transactions entered
into by stand-alone FCMs and FCM-SDs and magnitude of the market risk
charges on such positions.
The Commission is also making a technical modification to the final
capital rule for credit default swaps. As noted in the 2019 Capital
Reopening, the 2019 SEC Final Capital Rule includes the same
standardized capital charges for credit default swaps for BDs and SBSDs
as proposed by the Commission for FCMs, FCM-SDs, and covered SDs. There
is a slight difference between the Commission's Proposal and the SEC's
final rule, however, in applying the capital charges based upon the
time to maturity. Specifically, the maturity grids differ by one month,
and there are some slight changes to the rule text. The Commissions is
modifying the time to maturity grids and the wording in the final rule
to align with the SEC's final rule to avoid having dually-registered
entities being subject to slightly different regulatory requirements
with respect to market risk charges for credit default swaps. The
Commission believes that this modification will have no material impact
on its capital requirements.
The Commission is also modifying the final rule to provide that an
FCM or FCM-SD may reduce market risk charges for uncleared swap
positions, other than credit default swaps which as proposed provided
for netting, to account for comparable offsetting positions.\90\ The
Commission noted in the 2019 Capital Reopening that the SEC adopted a
netting proviso applicable to both BDs and SBSDs, permitting a
reduction of the resulting market risk capital charge by an amount
equal to any reduction recognized for comparable long or short
positions in the reference asset or interest rate under
[[Page 57476]]
regulation 1.17 or SEC rule 15c3-1.\91\ For example, an FCM or FCM-SD
that is required to take market risk charges on equal and opposite legs
of a portfolio of foreign currency swaps is permitted to net the market
risk charges on the long and short positions to the extent that the
positions are comparable.
---------------------------------------------------------------------------
\90\ See paragraph (c)(5)(iii)(D) of Commission regulation Sec.
1.17, as amended (17 CFR 1.17(c)(5)(iii)(D)).
\91\ SEC rule 15c3-1b(b)(2)(ii)(B) (17 CFR 240.15c3-
1b(b)(2)(ii)(B)) for BDs and rule 18a-1b(b)(2)(ii)(B) (17 CFR
240.18a-1b(b)(2)(ii)(B)) for SBSDs.
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The Commission stated in the 2019 Capital Reopening that it
intended to maintain consistency with the 2019 SEC Final Capital Rule
with respect to the applicability of the standardized market risk
charges for uncleared currency and commodity swaps, and requested
comment on including the same netting proviso to regulation
1.17(c)(5)(iii).\92\ Commenters to the 2019 Capital Reopening generally
supported the netting provision.\93\ One commenter stated that such an
approach would be consistent with common and current risk management
practices and would allow non-financial SDs to be more responsive to
customer needs.\94\
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\92\ See 2019 Capital Reopening, 84 FR 69664 at 69672.
\93\ See Citadel 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020
Letter; Letter from Alexander Holtan, Commercial Energy Working
Group (March 3, 2020) (CEWG 3/3/2020 Letter); Letter from Sebastian
Crapanzano and Soo-Mi Lee, Morgan Stanley (March 3, 2020) (MS 3/3/
2020 Letter).
\94\ See Citadel 3/3/2020 Letter page 5.
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The Commission believes that it is appropriate that an FCM or an
FCM-SD be permitted to net offsetting swap positions in computing the
market risk on the portfolio of swap positions in an identical fashion
as the SEC has adopted for BDs and SBSDs. Otherwise, the capital rule
would require individual capital charges on each swap position without
any consideration of the actual risk of the positions. Such an approach
would discourage FCMs or FCM-SDs from hedging their exposures and from
participating in the swaps market. The ability to net offsetting
positions in computing market risk is also a fundamental approach that
has been adopted by other regulators including the SEC, prudential
regulators, and others. Therefore the Commission is adopting the
netting provision as set forth at regulation 1.17(c)(5)(iii)(D).
FCMs currently are required by regulation 1.17(c)(5)(x) to take
standardized capital charges on proprietary cleared futures and cleared
swap positions. The capital charge is equal to 100% of the margin
requirement imposed by the clearing organization on the positions if
the FCM is a clearing member of such clearing organization. For FCMs
that are not clearing members of the clearing organization that clears
the positions, the capital charge is equal to 150% of the applicable
maintenance margin requirement of the applicable board of trade or
clearing organization, whichever is greater. FCM-SDs also are subject
to these capital charges as such firms must comply with the FCM capital
requirements set forth in regulation 1.17.
Several commenters requested that the Commission eliminate the
requirement for an FCM to take capital charges equal to 150% of the
margin for proprietary futures or cleared swap positions. One commenter
stated that there is no justification for a higher capital charge as
market risk is independent of whether the firm is or is not a clearing
firm.\95\ This commenter also noted that the SEC's final capital rules
for SBSDs impose a capital requirement for proprietary cleared
positions equal to 100% of the required clearing organization margin,
and do not require a non-clearing SBSD to take a higher capital charge
of 150% of required margin.\96\ Another commenter stated that there is
no justification for assessing covered SDs that are non-clearing
members the higher 150% charge and imposing such a requirement is
placing the SDs at an unnecessary competitive disadvantage. The
commenter recommended that all SDs should be able to take a
standardized market risk charge equal to the clearing organizations'
margin requirement.\97\
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\95\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\96\ Id.
\97\ See FIA-PTG 3/3/2020 Letter.
---------------------------------------------------------------------------
The Commission has considered the Proposal and comments and is not
revising regulation 1.17(c)(5)(x). The capital requirement for FCMs to
take a capital charge for cleared proprietary positions has been in
place for many years. The higher capital charge for non-clearing FCMs
takes into consideration that such firms are not subject to heightened
capital and other requirements that are imposed by clearing
organizations on clearing members. FCM clearing members also are
required to post guarantee fund contributions to clearing organizations
to support their financial obligations, and are subject to clearing
organization assessment authority in the event that a shortfall results
from the default of a fellow clearing member. The higher capital charge
for non-clearing FCMs and FCM-SDs is intended to ensure that such firms
retain an appropriate level of capital and liquid resources to meet
their financial obligations, including to their carrying FCMs and
ultimately to clearing organizations, and the Commission believes that
the 150% capital charge is appropriate to help ensure the safety and
soundness of the FCM or FCM-SD.
b. FCM and FCM-SD Standardized Counterparty Credit Risk Capital Charges
FCMs currently are required to take standardized capital charges to
reflect counterparty credit risk associated with uncleared swap and
security-based swap positions. The Commission's capital rule requires
an FCM that holds swap or security-based swap positions to mark the
positions to their respective fair market values in their financial
records.\98\ Swap and security-based swap positions that have mark-to-
market losses result in the FCM recognizing variation margin payables
to swap and security-based swap counterparties. Such losses reduce the
FCM's capital either by the payment of variation margin or the
recognition of a liability. Swap and security-based swap positions that
have mark-to-market gains result in the FCM recognizing variation
margin receivables from the swap and security-based swap
counterparties. The variation margin receivables, however, are subject
to a 100% counterparty credit risk capital charge unless the
receivables are secured by readily marketable collateral.\99\
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\98\ Commission regulation Sec. 1.17(c)(1) (17 CFR 1.17(c)(1)).
\99\ See Commission regulation Sec. 1.17(c)(1) and (2) (17 CFR
1.17(c)(1) and (2)), which defines the term ``net capital'' and
requires an FCM to include unrealized gains and losses in the
computation of net capital, and further provides that an FCM must
generally exclude unsecured receivables (including unsecured
receivables from swap and security-based swap counterparties).
---------------------------------------------------------------------------
The Commission proposed to retain the 100% counterparty credit risk
charges for unsecured receivables from swap and security-based swap
counterparties in the Proposal, and further proposed extending this
treatment to FCM-SDs. The Proposal further imposed the 100%
counterparty credit risk treatment applied to all swap and security-
based swap counterparties of the FCM or FCM-SD, including commercial
end users, that are exempt from the requirement to exchange variation
margin.\100\ The FCM or FCM-SD also would be required to take a 100%
capital charge on unsecured receivables resulting from transactions
that are exempt from the margin requirements, including legacy swap and
security-based swap transactions and foreign exchange forward and swap
[[Page 57477]]
transactions, as well as any receivables from counterparties that are
subject to a $500,000 minimum transfer amount.\101\
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\100\ See Commission regulation Sec. 23.150 (17 CFR 23.150).
\101\ Commission regulation Sec. 23.153 (17 CFR 23.153),
provides that a covered SD is not required to collect or post
variation margin with a particular swaps counterparty until the
combined initial and variation margin required to be exchanged with
the counterparty exceeds $500,000.
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The Commission proposed the 100% capital charge on unsecured
receivables from swap and security-based swap counterparties as it is
was consistent with the Commission's general approach of requiring an
FCM to exclude unsecured receivables from its adjusted net capital. As
noted above, the Commission's capital rule focuses on the liquidity of
the FCM and unsecured receivables do not reflect a liquid asset to the
FCM that it may use in order to meet its own financial obligations.
The Proposal effectively required an FCM or FCM-SD that did not
have approval to use models to compute counterparty credit risk to take
a 100% capital charge for unsecured receivables due from swap and
security-based swap counterparties. This would include counterparties
that are not obligated to exchange variation margin with the FCM or
FCM-SD, including commercial end users, affiliates, and counterparties
engaging foreign exchange swaps as the term is defined in regulation
23.151.
FCM-SDs are also subject to the Commission's margin rules for
uncleared swap transactions and may be directly or indirectly subject
to the SEC's margin rules for uncleared security-based swaps. Under the
Commission's margin rules, an FCM-SD is generally required to post
initial margin for uncleared swap transactions entered into with other
SDs or financial end users with a third-party custodian and may post
initial margin with the custodian for security-based swaps. Stand-alone
FCMs that engage in swaps and security-based swaps also may be
obligated or elect to post initial margin for such transactions with a
third-party custodian in accordance with the Commission's or the SEC's
respective uncleared swap and security-based swap margin rules. Such
deposits would generally be treated under the Commission's capital rule
as an unsecured receivable from the third-party custodian, and subject
to a 100% capital charge.
The Commission proposed to amend regulation 1.17(c)(2)(ii)(G) to
permit an FCM or an FCM-SD to include initial margin funds it deposited
with third-party custodians for uncleared swaps and uncleared security-
based swaps in its capital computation, provided that the margin is
held in accordance with the requirements established by the applicable
Commission or SEC margin rules.\102\ The Commission proposed to permit
FCMs and FCM-SDs to include initial margin posted with third-party
custodians as capital in recognition that the Commission's capital
rules require an FCM-SD or stand-alone FCM to post initial margin for
their uncleared swap transactions with third-party custodians to ensure
that the FCM-SD or FCM meets its financial obligations to swap
counterparties. The Commission also believes that the FCM-SD has
minimal credit risk from the third-party custodian as the Commission's
margin regulations require that the FCM-SD enter into a custodial
agreement with the third-party custodian that prohibits the custodian
from rehypothecating, repledging, reusing, or otherwise transferring
(including though repurchase agreements) the collateral held by the
custodian.\103\ The custodial agreement also must be a legal, valid,
binding, and enforceable agreement under the laws of all relevant
jurisdictions including in the event of a bankruptcy, insolvency, or
similar proceeding.\104\
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\102\ See 2016 Capital Proposal, 81 FR 91252 at 91306-07,
proposed paragraph (c)(2)(ii)(G) of Commission regulation Sec.
1.17.
\103\ See Commission regulation Sec. 23.157 (17 CFR 23.157).
\104\ Id.
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The Commission is adopting the amendment to regulation
1.17(c)(2)(ii)(G) to permit FCMs and FCM-SDs to recognize margin posted
with a third-party custodian for swap and security-based swap
transactions as a current asset in computing their adjusted net
capital. In order to qualify as a current asset, the initial margin
must be deposited by the FCM or FCM-SD with a third-party custodian in
accordance with the requirements specified in the Commission's
uncleared swap margin rules set forth in regulations 23.150 through
23.161, or the SEC's uncleared security-based swap margin rules. The
Commission is modifying the final regulation to clarify that initial
margin posted by an FCM or FCM-SD with third-party custodians for
uncleared swaps or uncleared security-based swaps entered into with
bank SDs subject to the margin rules of a prudential regulator and
entered into with foreign registered SDs that operate in a jurisdiction
that has received a margin Comparability Determination by the
Commission under regulation 23.160 also may be recognized as a current
asset in computing adjusted net capital.
The Commission also proposed to require an FCM-SD to take a capital
charge to reflect undermargined uncleared swap positions with a
counterparty.\105\ A capital charge for undermargined positions
protects the FCM-SD by ensuring that it maintains capital to cover
potential future credit exposure to swap counterparties, which is
consistent with the statutory objective of ensuring the safety and
soundness of the FCM-SD. The proposed undermargined capital charge
further provided that an FCM-SD could reduce the amount of the capital
charge by any amount owed by the FCM-SD to the counterparty resulting
from uncleared swap transactions. The undermargined capital charge for
uncleared swap positions is consistent with existing Commission
undermargined capital charges for customer and noncustomer futures,
foreign futures, and cleared swap accounts carried by an FCM.\106\ The
Commission did not receive comments on the proposed capital charges,
and is adopting the undermargined capital charges with modifications as
discussed below.
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\105\ Proposed paragraph (c)(5)(xv) of Commission regulation
Sec. 1.17 did not specifically impose undermargined capital charges
for security-based swaps. See 2016 Capital Proposal, 81 FR 91252 at
91308. Such charges, however, are applicable to an FCM-SD under
Commission regulation Sec. 1.17(b)(1) (17 CFR 1.17(b)(1)), which
provides that an FCM (including an FCM-SD) that has an asset or
liability defined in the capital rules of the SEC shall treat such
assets or liabilities for capital purposes in accordance with the
rules of the SEC, provided that the Commission did not define a
specific capital treatment in regulation 1.17.
\106\ See Commission regulation Sec. 1.17(c)(5)(viii) and (ix)
for undermargined capital charges for customer and noncustomer
futures, foreign futures, and cleared swap accounts.
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The Commission is modifying final paragraph (c)(5)(xv) of
regulation 1.17 by adopting two separate paragraphs. Final regulation
1.17(c)(5)(xv) requires an FCM-SD to take a capital charge in an amount
necessary for a swap counterparty or security-based swap counterparty
to meet its respective Commission margin requirement for uncleared swap
positions and the SEC margin requirement for uncleared security-based
swap transactions to the SD. The final regulation would apply only to
uncleared swaps and uncleared security-based swaps that are subject to
the Commission's or SECs' margin requirements under applicable
regulations. The final regulation further provides that the FCM-SD may
reduce the amount of the undermargined charge to reflect calls for
margin issued by the FCM-SD to the counterparty that are outstanding
within the respective time frames established in the margin rules of
the Commission and SEC, as applicable, to collect margin from a
counterparty. This provision replaces
[[Page 57478]]
the proposed language in regulation 1.17(c)(5)(xv) that would have
permitted a covered SD to reduce the undermargined capital charge by
any amount owed by the counterparty to the SD. The modified provision
more accurately reflects the process of an SD calling for outstanding
margin and is consistent with the undermargined capital charges for an
FCM carrying customer and noncustomer accounts and the undermargined
capital charge adopted by the SEC for SBSDs.
Final regulation 1.17(c)(5)(xvi) requires an FCM-SD to take a
capital charge for uncleared swaps and uncleared security-based swaps
that are exempt or excluded from the Commission's or SEC's margin
requirements, such as commercial end users and transactions entered
into prior to the compliance date of the margin regulations (i.e.,
legacy swaps). In this regard, swaps entered into prior to the Phase 6
uncleared margin compliance date or with excluded counterparties for
which no margin has been collected are treated no differently than
other uncollateralized exposures under the Commission's rules. Such
treatment for capital purposes of these counterparty exposures is
consistent with the capital rules of both the SEC and prudential
regulators as applied to their respective registrants.\107\ The final
regulation further provides that the FCM-SD may reduce the amount of
the undermargined capital charge by any funds deposited by the
counterparty to margin its swaps or security-based swap positions.
These deposits would include funds deposited by the counterparty and
held by third-party custodians or held by the FCM directly.
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\107\ See, e.g., SEC rule 18a-1(c)(1)(viii) (17 CFR 240.18a-
1(c)(1)(viii)).
---------------------------------------------------------------------------
The Commission also modified the final rule text to clarify that
the undermargined swap capital charges in regulation 1.17(c)(5)(xv) and
(xvi) are applicable only to FCM-SDs and not FCMs, as FCM-SDs are
subject to the Commission's margin requirements for uncleared swap
transactions. Stand-alone FCMs, however, are not directly subject to
the Commission's uncleared swap margin requirements as they are not
SDs. Final regulations 1.17(c)(5)(xv) and (xvi) also have been modified
to align the regulatory text more closely with the comparable SEC rule
text requiring SBSDs to take capital charges for undermargined
uncleared security-based swap and uncleared swaps positions from
counterparties.\108\ As noted above, the final regulation is designed
to help ensure the safety and soundness of the FCM-SD by requiring the
firm to reserve capital in the event a counterparty defaults on its
swaps and security-based positions that are undermargined.
---------------------------------------------------------------------------
\108\ See SEC rule 18a-1(c)(viii) (17 CFR 240.18a-
1(c)(1)(viii)).
---------------------------------------------------------------------------
The Commission also requested comment on whether FCM-SD's or
covered SD's should be permitted to recognize alternative forms of
collateral (e.g., letters of credit and liens) provided by commercial
end-users that are exempt from clearing and from the uncleared margin
requirements in computing the FCM-SD's or SD's counterparty credit risk
charges for uncleared swap transactions.\109\ Several commenters
supported such alternative or non-financial collateral. One commenter
stated that alternative forms of collateral, such as parent guarantees,
letters of credit, or liens on assets are frequently used by SDs as
credit risk mitigants when non-financial end-users do not post cash
collateral on uncleared derivatives.\110\ The commenter stated that
allowing FCM-SDs to recognize alternative forms of collateral in
computing credit risk charges is consistent with Congressional intent
that FCM-SD capital requirements should not be punitive to end-users.
This commenter further stated that permitting FCM-SDs to recognize non-
cash collateral as a credit risk mitigant is consistent with the
prudential regulators' final rule on the standardized approach to
counterparty credit risk (``SA-CCR''), which provides that banks may
take into account non-cash collateral in computing credit risk charges
for OTC derivatives. Another commenter stated that non-cash collateral
allows for the value of the commercial market participant's assets
making it an effective method for satisfying credit requirements
without unnecessarily setting aside capital from a productive use.\111\
One commenter also stated that the Commission could require FCM-SD's to
appropriately haircut non-cash collateral to address the general
illiquid nature of non-cash collateral.\112\
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\109\ See 2019 Capital Reopening, at 69681.
\110\ See CEWG 3/3/2020 Letter; NCGA/NGSA 3/3/2020 Letter; Shell
3/3/2020 Letter.
\111\ See NCGA/NGSA 3/3/2020 Letter.
\112\ See Shell 3/3/2020 Letter.
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The Commission has considered the comments and is not modifying the
credit risk charges to recognize non-cash collateral. Margin provides
an FCM-SD or a covered SD with protection from a potential counterparty
default. In a default situation, non-financial collateral may not be
immediately available, or the collateral may be available but may take
time to liquidate. This may exacerbate potential losses to the FCM-SD
or covered SD or expose such firms to additional risk by, for example,
leaving them exposed to the market risk of cash market positions that
were being hedged by the swap. While the Commission is not modifying
the final rules to reflect non-cash collateral, it will continue to
monitor and assess FCM-SD's and covered SD's acceptance of non-cash
collateral from commercial end-users and consider possible revisions to
its rules after it gains further experience with the capital condition
of such firms.
c. Model-Based Market Risk and Counterparty Credit Risk Capital Charges
(i) FCMs That Are SEC-Registered ANC Firms
Commission regulation 1.17(c)(6) permits an FCM that is dually-
registered with the SEC as a BD to use internal models to compute
market risk and credit risk capital charges in lieu of standardized
capital charges in computing its adjusted net capital under Commission
regulation 1.17 provided that the SEC has approved the FCM/BD's use of
such models for computing net capital under SEC rule 15c3-1. The SEC
has approved certain FCM/BDs to use internal models to compute market
risk capital charges for proprietary positions in securities, debt
instruments, futures, security-based swaps and swaps in lieu of
standardized capital charges contained in SEC rules 15c3-1 or 15c3-1b.
The SEC also has approved the use of internal models to compute credit
risk charges associated with exposures from swap and security-based
swap counterparties in lieu of the standardized 100% unsecured
receivable capital charges. As noted in section II.B.3. above, these
FCM/BDs are referred to as ANC Firms. Five FCMs currently are ANC
Firms, with four of the firms also provisionally-registered SDs.
Regulation 1.17(c)(6) requires an ANC Firm to file a notice with
the Commission in order to use the SEC's approved capital models. The
notice must include the SEC's approval order and other information,
including: (i) A list of the categories of positions that the ANC Firm
holds in its proprietary accounts, and, for each such category, a
description of the methods that the ANC Firm will use to calculate its
deductions for market risk and credit risk, and also, if calculated
separately, deductions for specific risk; (ii) a description of the
value at risk (VaR) models to be used for its market risk and credit
risk
[[Page 57479]]
deductions, and an overview of the integration of the models into the
internal risk management control system of the ANC Firm; (iii) a
description of how the ANC Firm will calculate current exposure and
maximum potential exposure for its deductions for credit risk; (iv) a
description of how the futures commission merchant will determine
internal credit ratings of counterparties and internal credit risk
weights of counterparties, if applicable; and (v) a description of the
estimated effect of the alternative market risk and credit risk
deductions on the amounts reported by the ANC Firm as net capital and
adjusted net capital. Further qualitative and quantitative requirements
for such market risk and credit risk models are discussed in section
II.C.6. of this release.
ANC Firms also are subject to heightened SEC capital requirements
as a condition of using the capital models. The 2019 SEC Final Capital
rule requires an ANC Firm, including an FCM that is dually-registered
as an ANC Firm, to maintain tentative net capital of at least $5
billion and net capital of not less than the greatest of $1 billion or
the sum of (i) 2% of the risk margin amount associated with customer
cleared security-based swaps and uncleared security-based swaps and
(ii) the aggregate indebtedness of the ANC Firm or 2% of the aggregate
debit items computed in accordance with the Formula for Determination
of Reserve Requirements for Brokers and Dealers (Exhibit A to rule
15c3-3).\113\ The 2019 SEC Final Capital rule also requires an ANC Firm
to provide the SEC, and CFTC if dually-registered as an FCM, with a
written notice if its tentative net capital falls below $6
billion.\114\
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\113\ See 2019 SEC Final Capital Rule, 84 FR 43872 at 43874; 17
CFR 240.15c3-1(a)(7). All ANC firms currently use the 2% aggregate
debit item financial ratio (the ``alternative standard'') under rule
15c3-1(a)(1)(ii).
\114\ Id.
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The Commission proposed to retain the above notice and filing
process to permit ANC Firms that register as FCMs or FCM-SDs to use the
SEC-approved internal capital models in lieu of the standardized market
risk and credit risk capital charges in computing their adjusted net
capital under regulation 1.17. Currently, only four of the 56
provisionally-registered covered SDs are FCMs, and each of the FCM-SDs
is an ANC Firm with capital model approval from the SEC. Accordingly,
such FCM-SDs will be required to maintain tentative net capital of no
less than $5 billion and net capital of no less than $1 billion upon
the compliance date of the 2019 SEC Final Capital Rule.\115\ The
Commission is electing to retain regulation 1.17(c)(6) to permit ANC
Firms to engage in swap and security-based swap transactions under the
existing regulatory structure, including the SEC's revised minimum
capital requirements, as it believes that the minimum capital
requirements are adequately designed to help ensure the safety and
soundness of the FCM-SD.
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\115\ The Commission's term ``net capital'' is equivalent to the
SEC's term ``tentative net capital'' and the Commission's term
``adjusted net capital'' is equivalent to the SEC's term ``net
capital.'' The term ``tentative net capital'' is generally defined
as an entity's assets less liabilities (excluding certain qualifying
subordinated debt), and ``net capital'' as tentative net capital
less certain capital deductions such as market risk and credit risk
deductions. See 17 CFR 240.18a-1.
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(ii) Market Risk and Credit Risk Capital Models for FCM-SDs That Are
Not SEC-Registered BDs
The Commission proposed amending regulation 1.17(c)(6) to permit
FCM-SDs that are not SEC registered BDs to apply to the Commission, or
an RFA of which the FCM-SD is a member, for approval to use internal
market risk or credit risk models in lieu of the standardized capital
charges. If an FCM or covered SD is also a registered BD, it may only
use market risk and credit risk capital models if the SEC has approved
such firm to use such models and the firm meets the capital
requirements of an ANC Firm. Therefore, the Commission's proposal to
extend the use of capital models to FCM-SDs is only applicable to FCM-
SDs that are not registered with the SEC as BDs. The purpose of the
amendment proposed in regulation 1.17(c)(6) was to provide FCM-SDs that
were not dually-registered as BDs with the ability to use internal
capital models in lieu of the standardized capital charges and to
establish a mechanism for the FCM-SDs to obtain approval for such
models. FCM-SDs that may also be registered as SBSDs or OTC Derivatives
Dealers but not BDs would also be able to use this provision with
respect to the use of models; however, they would separately need to
obtain the SEC's approval to use models as registered SBSDs and OTC
Derivatives Dealers. While currently the only FCMs that are
provisionally-registered as SDs are the four ANC Firms, the Commission
believed that other stand-alone FCMs may register as SDs and that the
regulations should provide an opportunity for such firms to use capital
models to compute market and credit risk.
Proposed regulation 1.17(c)(6)(v) required an FCM-SD to apply in
writing, and further required that the market risk and credit risk
models contain specified qualitative and quantitative requirements
proposed to be established by the Commission in new regulation 23.102
and Appendix A to regulation 23.102.\116\ The qualitative and
quantitative requirements for the FCM-SD's models are comparable to the
existing SEC model requirements for ANC Firms and non-BD SBSDs, and the
Commission's proposed model requirements for covered SDs. The
qualitative and quantitative requirements for the capital models are
discussed in detail in section II.C.6. of this release.
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\116\ Please note that due to changes in Federal Register
publication requirements, the appendix that had been referred to as
Appendix A to section 23.102 in previous documents is being
published in this final rule as Appendix A to Subpart E of Part 23.
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The Commission also proposed enhanced fixed-dollar minimum capital
requirements as a condition for an FCM-SD to obtain capital model
approval. Specifically, the Commission proposed that FCM-SDs must
maintain net capital of no less than $100 million and adjusted net
capital of no less than $20 million in order to use capital models. The
$100 million net capital requirement was in recognition that model-
based capital charges are generally substantially lower than the
Commission's standardized capital charges, and that models may not
fully capture all risks at all times.\117\ The minimum fixed-dollar
capital requirement is also consistent with the Commission's proposed
minimum fixed-dollar capital requirement for covered SDs, and is
consistent with the SEC's minimum fixed-dollar capital requirement for
OTC derivative dealers and non-BD SBSDs.\118\
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\117\ See section II.B.2.a. above for a discussion of the fixed-
dollar minimum capital requirements for FCM-SDs.
\118\ See sections II.C.2.a. and II.C.3.a. of this release for a
discussion of the Commission's minimum capital requirements for
covered SDs. See SEC rule 15c3-1(a)(5) (17 CFR 240.15c3-1(a)(5)) for
minimum capital requirements for OTC Derivative Dealers that are not
SBSDs and rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)) for SBSDs that
are not BDs, other than OTC Derivatives Dealers.
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The proposed $100 minimum fixed-dollar amount of net capital for
FCM/SDs, however, is not consistent with the SEC's current approach for
ANC Firms or SBSDs/ANC Firms approved to use internal models. As noted
above, ANC Firms are subject to minimum fixed-dollar tentative net
capital requirement of $5 billion, and a minimum fixed-dollar net
capital requirement of $1 billion. The Commission stated in the
Proposal that it believed that FCM/SDs that are not BDs do not raise
the same types of risks as ANC Firms that would
[[Page 57480]]
warrant a $5 billion minimum tentative net capital requirement. The
Commission noted that ANC firms represent the largest BDs and are
engaged in significant brokerage businesses including providing
customer financing for securities transactions, engaging in repurchase
transactions and other activities. FCMs generally have limited
proprietary futures trading and operate primarily as market
intermediaries for customers trading futures and foreign futures
transactions. In this capacity, FCMs receive and hold customer funds in
segregated accounts that are used to satisfy the customers' financial
obligations to clearing organizations. Even in their capacity as SDs,
the margin regulations mitigate the risks to and from the FCM as they
generally are required to exchange variation margin on swaps on a daily
basis with all other SDs and financial end users, and to post and
collect initial margin with counterparties that are SDs and financial
end users.
The Commission did not receive specific comments on the use of
models by FCM-SDs that are not ANC Firms. The Commission has considered
the issue and is adopting the proposed amendment to regulation
1.17(c)(6) to provide a model approval process for FCM-SDs that are not
BDs substantially as proposed, but with a modification to not adopt the
proposed liquidity requirement and also to comport with the final model
process requirements for covered SDs.\119\ While the four FCM-SDs
provisionally-registered with the Commission are ANC Firms and already
approved to use models, the Commission believes that other, non-BD FCM-
SDs have the potential to enhance market liquidity in certain sections
of the swaps market, particularly with smaller counterparties and less
frequently traded products. The Commission believes that it is
important to provide an opportunity for such firms to potentially enter
the market and service counterparties that may not have significant
choice in selecting SDs. For example, FCM-SDs may be more willing to
make markets in commodity swaps to agricultural firms and smaller
commercial end users such as farmers and ranchers that might not
otherwise be able to use such markets to manage risks in their
businesses or might have to pay higher fees to engage in swaps if the
number of SDs was limited. The Commission further believes that given
the nature of the business operations of FCM-SDs, the proposed minimum
capital requirement of $100 million of adjusted net capital is
consistent with the objective of section 4s(e) of the CEA of helping to
ensure the safety and soundness of the FCM-SD.
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\119\ Commission regulation Sec. 1.17(c)(6) (17 CFR 1.17(c)(6))
provides that an FCM-SD may apply for model approval with the
Commission or with an RFA of which it is a member. See section
II.C.7. below for a discussion of model approvals, including the
Commission's standards and process for reviewing and approving
capital models, and the process that the Commission will use in
determining whether NFA's approval of an FCM-SD's capital models may
serve as an alternative means of complying with the Commission's
model approval requirement.
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C. Capital Requirements for Swap Dealers and Major Swap Participants
1. Introduction to Covered SD and Covered MSP Capital Requirements
The Commission is adopting final capital requirements for covered
SDs and covered MSPs in order to help ensure the safety and soundness
of the SDs and MSPs by requiring such firms to maintain a minimum level
of financial resources that is based upon the level of margin
associated with the uncleared swaps entered into by the firms. The
appropriate setting of minimum capital requirements will help ensure
that covered SDs and covered MSPs are able to meet their respective
financial obligations to swap and security-based swap counterparties,
and to creditors generally. The ability of the covered SDs and covered
MSPs to meet their financial obligations will provide for a more
efficient and effective swaps marketplace for participants by reducing
the potential for covered SDs or covered MSPs to default on their
obligations to swap and security-based swap counterparties.
There are currently 56 covered SDs subject to the Commission's
capital requirements. As noted in section II.A. above, these 56 covered
SDs represent a diverse group of corporate entities, ranging from
subsidiaries of major global financial and banking institutions to
entities that are primarily engaged in physical commodities such as
agriculture and energy. The Commission also understands that these 56
covered SDs have a significant level of diversity in swap
counterparties, ranging from financial end users to commercial
enterprises.
The Commission is providing flexibility to address the diversity of
the business models of the covered SDs by permitting each SD that is
not also a registered FCM to elect one of two possible capital
alternatives.\120\ The first alternative is the Net Liquid Assets
Capital Approach, which is based on the liquidity-based capital rule
for FCMs in regulation 1.17, as well as the liquidity-based capital
requirements imposed on BDs and SBSDs by the SEC. The second
alternative is the Bank-Based Capital Approach, which is based on the
capital requirements established by the Federal Reserve Board for bank
holding companies and is generally consistent with the prudential
regulators' capital rules applicable to bank SDs. The flexibility
provided by the Commission's covered SD capital rules is consistent
with the Congressional mandate in the Dodd-Frank Act directing the
Commission, SEC, and prudential regulators to adopt, to the maximum
extent practicable, comparable minimum capital requirements for SDs and
SBSDs.\121\
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\120\ SDs that are FCM-SDs are required to comply with the FCM
capital requirements contained in Commission regulation Sec. 1.17
(17 CFR 1.17), as amended by this final rulemaking. See section
II.B. above for a further discussion.
\121\ See section 4s(e)(3)(D) of the CEA (7 U.S.C. 6s(e)(3)(D))
and section 15F(e)(3)(D)(ii) of the Exchange Act (15 U.S.C. 78o-
10(e)(3)(D)(ii)).
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The Commission's final rule further allows certain eligible covered
SDs to elect to compute their regulatory capital under the Tangible Net
Worth Capital Approach. The Tangible Net Worth Capital Approach
requires a covered SD to maintain a tangible net worth, computed in
accordance with GAAP, equal to or greater than the highest of: (i) $20
million, plus the market risk and credit risk exposures associated with
its swap and related hedge positions that are part of the covered SD's
dealing activities; (ii) 8% uncleared swap margin associated with the
covered SD's swaps positions; and (iii) the amount of capital required
by an RFA of which the covered SD is a member.
To use the Tangible Net Worth Capital Approach, a covered SD must
be predominantly engaged in non-financial activities, or be part of a
corporate parent entity that is predominantly engaged in non-financial
activities. The Commission is adopting the Tangible Net Worth Capital
Approach as it would be available only for covered SDs that, either
directly or at their corporate parent level, are primarily involved in
non-financial, commercial activities. As the Commission has previously
noted, financial firms generally present a higher level of systemic
risk to the financial system than commercial firms as the profitability
and viability of financial firms are more tightly linked to the health
of the financial system than commercial firms.\122\
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\122\ See 2016 Capital Proposal, 81 FR 91252 at 91255.
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The Commission's final capital requirements for covered MSPs
require such firms to maintain a positive
[[Page 57481]]
tangible net worth. The final MSP capital requirements are discussed in
section II.C.5. below.
2. Capital Requirement for Covered SDs Electing the Net Liquid Assets
Capital Approach
a. Computation of Minimum Capital Requirement
The Commission's capital requirements for covered SDs electing the
Net Liquid Assets Capital Approach generally incorporate by reference
the SEC's capital requirements contained in rule 18a-1 for SBSDs that
are not also registered as BDs.\123\ The capital requirements are set
forth in regulation 23.101, and are comprised of two components. The
first component of the capital rule requires a covered SD to compute
the minimum amount of capital that the SD is required to hold at any
given point in time. The second component of the capital rules requires
a covered SD to compute, based upon its balance sheet and certain
adjustments including market risk and credit risk capital charges to
its swaps, security-based swaps, and other proprietary positions, the
actual amount of capital that the covered SD maintains. The covered
SD's actual capital must be equal to or greater than its minimum
capital requirement at all times in order for the covered SD to be in
compliance with the rules.
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\123\ Rule 18a-1 (17 CFR 240.18a-1) (``rule 18a-1'') also
applies to SBSDs that are OTC derivatives dealers, as that term is
defined in SEC Rule 3b-12 (17 CFR 240.3b-12).
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The 2016 Capital Proposal required a covered SD electing the Net
Liquid Assets Capital Approach to maintain a minimum level of net
capital \124\ equal to or greater than the highest of the following
criteria:
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\124\ As noted above, covered SDs electing the Net Liquid Assets
Capital Approach are subject to the SEC's capital requirements for
SBSDs set forth in SEC rule 18a-1, which has been incorporated into
the Commission's rules by reference. The Commission and SEC use
different terms to express capital requirements. The Commission's
term ``net capital'' is equivalent to the SEC's term ``tentative net
capital'' and the Commission's term ``adjusted net capital'' is
equivalent to the SEC's term ``net capital.'' The term ``tentative
net capital'' is generally defined as an entity's assets less
liabilities (excluding certain qualifying subordinated debt), and
``net capital'' as tentative net capital less certain capital
deductions such as market risk and credit risk deductions. See 17
CFR 240.18a-1. This document will use the SEC defined terms for
purposes of the discussion of the Net Liquid Assets Capital
Approach.
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(1) $20 million; or
(2) Net capital equal to or greater than 8% of the sum of:
(a) The amount of ``uncleared swap margin'' (as that term was
proposed to be defined in regulation 23.100) \125\ for each uncleared
swap position open on the books of the covered SD, computed on a
counterparty-by-counterparty basis pursuant to Commission regulation
23.154 (17 CFR 23.154);
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\125\ The term ``uncleared swap margin'' is defined in
Commission regulation Sec. 23.100 to mean the amount of initial
margin that a swap dealer would be required to collect from each
swap counterparty pursuant to the margin rules for uncleared swap
transactions (Commission regulation Sec. 23.154 (17 CFR 23.154)).
The term ``uncleared swap margin'' includes all uncleared swaps that
an SD is required to collect margin for under the margin
regulations, and also includes all uncleared swaps that are exempt
or excluded from the margin requirements including swaps with
commercial end users, swaps entered into prior to the respective
compliance dates of the Commission's margin requirements set forth
in Commission regulation Sec. 23.161 (17 CFR 23.161) (i.e., legacy
swaps), and excluded swaps with an affiliated entity.
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(b) The amount of initial margin required for each uncleared
security-based swap position open on the books of the covered SD,
computed on a counterparty-by-counterparty basis pursuant to SEC Rule
18a-3(c)(1)(i)(B) (17 CFR 240.18a-3(c)(1)(i)(B)), without regard for
any amounts that may be excluded or exempted under the SEC's rules;
(c) The amount of ``risk margin requirement'' (as that term is
defined in Commission regulation 1.17(b)(8) (17 CFR 1.17(b)(8))) for
the covered SD's cleared futures, foreign futures, and swaps positions
open on the books of the covered SD; and
(d) The amount of initial margin required by a clearing
organization for proprietary cleared security-based swaps positions
open on the books of the covered SD; or
(3) The capital required by the RFA of which the covered SD is a
member.\126\ The 2016 Capital Proposal also required a covered SD that
received approval from the Commission, or from an RFA of which the
covered SD was a member, to use internal models to compute market risk
and credit risk capital charges for its swaps, security-based swaps,
and other proprietary positions when computing its capital, as
described in section II.C.2.a. of this release, to maintain a minimum
level of tentative net capital equal to $100 million.
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\126\ See 2016 Capital Proposal, 81 FR 91252 at 91260-61.
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Fixed-Dollar Capital Requirement for Net Liquid Assets Capital Approach
The first criterion under the Net Liquid Assets Capital Approach
required a covered SD to maintain a minimum of $20 million of net
capital and, if the covered SD was approved to use market risk or
credit risk models, $100 million of tentative net capital and $20
million of net capital.\127\ The Commission requested comment in the
2016 Capital Proposal on the appropriateness of the fixed-dollar
capital requirements of $100 million of tentative net capital and $20
million of net capital.\128\ The Commission received one comment
regarding the proposed requirement that covered SDs must maintain a
minimum of $20 million of net capital, and a minimum of $100 million of
tentative net capital and $20 million of net capital if approved to use
market risk or credit risk models.\129\ The commenter stated that the
requirement that SDs using internal models must have $100 million in
tentative net capital would create an unnecessary barrier to
entry.\130\ The Commission recognizes the commenter's concern but
believes that covered SDs must maintain a minimum of $100 million of
tentative net capital if approved to use models in order to provide an
appropriate buffer of capital to protect against model errors and to
protect against the models not recognizing all types of risk, such as
operational risk, compliance risk, legal risk, and liquidity risk.
Models will result in substantially lower market risk charges than the
standardized market risk charges, which will allow a covered SD to
engage in more of the transactions than they otherwise would be able to
enter into at the same level of capital. In order to protect against
model errors, the Commission believes that it is necessary to have an
enhanced minimum capital requirement.
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\127\ See 2016 Capital Proposal, 81 FR 91252 at 91261.
\128\ See 2016 Capital Proposal, 81 FR 91252 at 91262.
\129\ See FIA-PTG 5/24/2017 Letter.
\130\ Id. at 3-4.
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The Commission has considered the Proposal further and is adopting
the requirements as proposed. The Commission believes, given the role
that covered SDs play in the financial markets by engaging in swap
dealing activities, it is appropriate to require all covered SDs to
maintain a minimum level of net capital, stated as an absolute fixed-
dollar amount, that does not fluctuate with the level of the firms'
dealing activities to help ensure the safety and soundness of the
covered SDs. The $20 million minimum net capital requirement also is
consistent with the minimum regulatory capital requirements adopted for
covered SDs that elect the Bank-Based Capital Approach or the Tangible
Net Worth Capital Approach, as discussed in sections II.C.3. and
II.C.4., respectively, of this release. Furthermore, the $20
[[Page 57482]]
million minimum net capital requirement for covered SDs that elect the
Net Liquid Assets Capital Approach is consistent with the minimum
capital requirements adopted by the SEC for SBSDs.\131\ In addition,
the requirement for a covered SD to maintain a minimum of $100 million
of tentative net capital if approved to use models is consistent with
the SEC minimum capital requirement for stand-alone SBSDs approved to
use capital models.\132\
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\131\ See SEC rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(1)).
\132\ See SEC rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)).
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Risk Margin Amount Calculation Under Net Liquid Assets Capital Approach
The second criterion under the proposed Net Liquid Assets Capital
Approach required a covered SD to maintain a minimum level of net
capital equal to or greater than 8% of the sum of: (i) The amount of
``uncleared swap margin'' (as that term was proposed to be defined in
regulation 23.100) for each uncleared swap position open on the books
of the covered SD, computed on a counterparty-by-counterparty basis
pursuant to Commission regulation 23.154; (ii) the amount of initial
margin required for each uncleared security-based swap position open on
the books of the covered SD, computed on a counterparty-by-counterparty
basis pursuant to SEC rule 18a-3(c)(1)(i)(B) without regard to any
initial margin exemptions or exclusions that the rules of the SEC may
provide to such security-based swap positons; (iii) the amount of
``risk margin'' (as defined in Commission regulation 1.17(b)(8))
required by a clearing organization for the covered SD's futures,
swaps, and foreign futures positions that are open on the books of the
covered SD; and (iv) the amount of initial margin required by a
clearing organization for security-based swaps that are open on the
books of the covered SD.\133\ The proposed 8% risk margin amount
required a covered SD to include all swaps and security-based swaps in
its computation of the margin for uncleared swaps and security-based
swaps subject to the 8% risk margin amount calculation, including any
swaps positions that are not included in the margin requirements under
Commission regulations 23.150 through 23.161, and any security-based
swaps positions that are exempt or excluded from the SEC's margin
requirements in rule 18a-3(c)(1)(i)(B).
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\133\ See paragraph (a)(1)(ii)(A)(1) of proposed Commission
regulation Sec. 23.101. See 2016 Capital Proposal, 81 FR 91252 at
91310.
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The proposed 8% risk margin amount was based on the Commission's
minimum capital requirements for FCMs, which includes a requirement
that each FCM must maintain a level of adjusted net capital that is
equal to or greater than 8% of the risk margin amount associated with
the futures, foreign futures, and cleared swap positions carried in
customer and noncustomer accounts.\134\ This requirement was intended
to ensure that a covered SD electing the Net Liquid Assets Capital
Approach maintains a minimum level of capital that is proportionate to
all risks associated with the SD's operations and activities. The
Commission believed that the proposed 8% risk margin amount was an
appropriate approach as the minimum capital requirement was correlated
with the ``risk'' of the SD's futures, foreign futures, swaps, and
security-based swaps positions as measured by the margin required on
the positions. Specifically, a covered SD's minimum capital requirement
would increase or decrease in proportion to the number, size,
complexity, and market risk inherent in the SD's derivatives
business.\135\
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\134\ See section II.B. above for a discussion of the minimum
capital requirements for FCMs.
\135\ See 2016 Capital Proposal, 81 FR 91252 at 91258.
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The proposed 8% risk margin amount also was consistent with the
proposed minimum capital requirements for covered SDs that elect the
Bank-Based Capital Approach, as discussed in section II.C.3. below, and
was consistent with the capital requirements of the Tangible Net Worth
Capital Approach, discussed in section II.C.4. below. The proposed 8%
risk margin amount also was comparable with the SEC's capital
requirements for SBSDs, with the exception that the SEC's proposal
required a SBSD to include a significantly more limited set of
positions in the 8% risk margin amount calculation. Specifically, a
SBSD's risk margin amount would include only customer cleared security-
based swaps and uncleared security-based swaps.\136\
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\136\ See SEC 2012 Proposed Capital Rule, 77 FR 70214 at 70223.
The SEC modified the capital requirement in the final rule to
require a SBSD to maintain net capital in excess of 2% of the risk
margin amount, with the possibility of the SEC increasing the
percentage amount to 4% or less after the third anniversary of the
rule's compliance date, and then to 8% or less after the fifth
anniversary of the rule's compliance date. The rule further provides
that the SEC will only raise the 2% risk margin amount multiplier
after publishing a notice of the potential change. See rule 18a-
1(a)(1) (17 CFR 240.18a-1(a)(1)).
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The Commission received numerous comments regarding the proposed 8%
risk margin amount in response to the 2016 Capital Proposal. One
commenter strongly supported the 8% risk margin amount threshold on a
comprehensive basis.\137\ The commenter noted a concern that basing
capital requirements on internal models could be manipulated, and that
a floor based on 8% of initial margin of a covered SDs positions was
appropriate as a counterbalance to ensure that internal modelling does
not reduce loss absorbency.\138\
---------------------------------------------------------------------------
\137\ See Letter from Marcus Stanley, Americans for Financial
Reform (May 15, 2017) (AFR 5/15/2017 Letter).
\138\ Id.
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Commenters, however, raised concerns with the proposed 8% risk
margin amount.\139\ Commenters stated that the proposed 8% risk margin
amount has a limited relationship to the actual risk of the covered
SD's swaps, SBS, futures, and foreign futures positions.\140\
Commenters noted that the 8% risk margin amount is computed on a
counterparty-by-counterparty basis and not on the aggregate of all of
the covered SD's positions across all counterparties, which may
overstate the covered SD's risk by not taking into account offsetting
positions across multiple counterparties, including hedging
positions.\141\ A commenter also noted that the 8% risk margin amount
did not reflect the actual risk of a covered SD's proprietary cleared
swap, cleared security-based swaps, futures, and foreign futures
positions, as the risk margin amount is required to be computed on a
clearing organization-by-clearing organization basis and, therefore,
does not recognize hedging and risk-reducing portfolio margin across
multiple clearing organizations.\142\
---------------------------------------------------------------------------
\139\ See, e.g., SIFMA 5/15/2017 Letter; FIA 5/15/2017 Letter;
Citadel 5/15/2017 Letter); Letter from William Dunaway, INTL FCStone
Markets, LLC (May 15, 2017) (IFM 5/15/2017 Letter); Letter from
Sebastien Crapanzano and Soo-Mi Lee, Morgan Stanley (May 15, 2017)
(MS 5/15/2017 Letter); Letter from Christine Stevenson, BP Energy
Company (May 15, 2017) (BPE 5/15/2017 Letter); Letter from Steven
Kennedy, International Swaps and Derivatives Association (May 15,
2017) (ISDA 5/15/2017 Letter); Letter from the Japanese Bankers
Association (March 14, 2017) (JBA 3/14/2017 Letter); and, FIA-PTG 5/
24/2017 Letter.
\140\ Id.
\141\ See, e.g., ISDA 5/15/2017 Letter; JBA 3/14/2017 Letter;
SIFMA 5/15/2017 Letter.
\142\ See FIA-PTG 5/24/2017 Letter.
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Commenters further noted that the Net Liquid Assets Capital
Approach double counts the risks of various positions held by a covered
SD.\143\ The commenters stated that the 8% risk
[[Page 57483]]
margin amount requires a covered SD to hold net capital equal to or in
excess of the 8% risk margin amount, while also requiring the covered
SD to reduce the amount of capital it actually holds by the amount of
market risk and credit risk charges associated with the covered SD's
positions.\144\ The commenters noted that including these positions in
the 8% risk margin amount effectively results in both an increase in
the amount of capital that a covered SD is required to hold to meet its
minimum requirement and a decrease to the amount of capital the covered
SD actually maintains due to the market risk and credit risk charges.
---------------------------------------------------------------------------
\143\ See SIFMA 5/15/2017 Letter; ISDA 5/15/2017 Letter; FIA 5/
15/2017 Letter; FIA-PTG 5/24/2017 Letter; JBA 3/14/2017 Letter;
Letter from Sunhil Cutinho, CME Group, Inc. (May 15, 2017) (CME 5/
15/2017 Letter); and Citadel 5/15/2017 Letter.
\144\ Id. See also IIB/ISDA/SIFMA 3/3/2020 Letter.
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Several commenters also generally stated that the 8% risk margin
amount was both too high of a percentage and over-inclusive of the
various types of business activities engaged in by covered SDs.\145\
One commenter suggested that the Commission consider limiting the 8%
risk margin amount solely to uncleared swaps subject to the
Commission's uncleared margin rules,\146\ and another commenter
requested the Commission to reconsider the application of the 8% risk
margin threshold to cleared swaps.\147\
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\145\ Id.
\146\ See IFM 5/15/2017 Letter.
\147\ See ISDA 5/15/2017 Letter.
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Several commenters also stated that if the Commission were to
retain the 8% risk margin amount as a component of the minimum capital
requirement for covered SDs, that the Commission adjust the 8% to a
lower multiplier, such as 2%, for a period of time to allow the
Commission to gather empirical data in order to determine an
appropriate level.\148\
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\148\ See SIFMA 5/15/2017 Letter; MS 5/15/2017 Letter.
---------------------------------------------------------------------------
The Commission acknowledged in the 2019 Capital Reopening the
receipt of a significant number of comments concerning the proposed 8%
risk margin amount and the potential impact that it may have on driving
a covered SD's minimum capital requirement, and, consequently, the
funding and business activities of the covered SD. The 2019 Capital
Reopening invited interested parties to comment on all aspects of the
proposed 8% risk margin amount. The Commission also requested comment
and supporting data on the quantification of the potential minimum
capital requirements required of covered SDs electing the Net Liquid
Assets Capital Approach as a result of the proposed 8% risk margin
amount threshold. The Commission further requested comment and
supporting data on how the amount of potential minimum capital based
upon the 8% risk margin requirement compared with the amount of capital
currently maintained by entities that are provisionally registered as
covered SDs, and how such amounts compared with the amounts of capital
required of SBSDs under the 2019 SEC Final Capital Rule.\149\
---------------------------------------------------------------------------
\149\ See 2019 Capital Reopening, 84 FR 69664 at 69668-69 (Dec.
19, 2019).
---------------------------------------------------------------------------
The 2019 Capital Reopening also requested comment and supporting
data on whether the proposed 8% risk margin amount should be modified
for covered SDs electing the Net Liquid Assets Capital Approach to a
lower percentage requirement, such as 4%, or to another percentage, and
requested that commenters state why the suggested percentage was an
appropriate percentage properly calibrated to the inherent risk of a
covered SD and the activities that it engages in.\150\ The Commission
further requested commenters to quantify the difference in the amount
of capital that would be required of a covered SD pursuant to the
proposed 8% risk margin amount and 4%, or any other suggested lower
percentage, of risk margin amount, and to the extent possible to model
the impact of different percentages of risk margin on the minimum
capital requirements for an actual or hypothetical portfolio of
positions.\151\
---------------------------------------------------------------------------
\150\ Id.
\151\ Id.
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The 2019 Capital Reopening also requested comment on whether the
proposed 8% risk margin amount should be harmonized with the approach
adopted by the SEC for SBSDs in the 2019 SEC Final Capital Rule.\152\
Specifically, the Commission requested comment on whether the proposed
regulation should be revised to lower the risk margin amount percentage
from 8% to 2%, and whether the regulation should be further modified to
authorize the Commission by order to increase the risk margin amount
percentage in stages from 2% to 4% or less, and from 4% to 8% or less
based upon the Commission's future experience with covered SD capital
levels after the implementation of the final regulations.\153\
---------------------------------------------------------------------------
\152\ Id.
\153\ Id.
---------------------------------------------------------------------------
The Commission received several comments in response to the 2019
Capital Reopening addressing the 8% risk margin amount. One commenter
stated that the Commission should eliminate the 8% risk margin amount
requirement for covered SDs from the Net Liquid Assets Capital
Approach.\154\ This commenter stated that while the Commission based
the 8% risk margin amount on an existing requirement of an FCM to
maintain adjusted net capital in excess of 8% of the risk margin amount
for futures, foreign futures, and cleared swap positions carried by the
FCM in customer and noncustomer (i.e., affiliates) accounts, there are
fundamental differences between the business activities of FCMs and
covered SDs that makes the application of the 8% risk margin amount
requirement to covered SDs illogical.\155\ This commenter further
stated that the 8% risk margin amount is not necessary to ensure that
covered SDs maintain appropriate capital levels, noting that market
risk and credit risk charges will apply to all of the covered SD's
derivatives positions under the proposed Net Liquid Assets Capital
Approach, and noting that other applicable regulatory authorities do
not impose a requirement similar to the 8% risk margin amount, which
indicates that it is not necessary for a robust capital framework.\156\
---------------------------------------------------------------------------
\154\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\155\ Id.
\156\ Id. The commenter noted that the capital rules of the
prudential regulators rely on setting a minimum capital requirement
based on the risk-weighted assets of prudentially-regulated
institutions, including bank SDs, without any 8% risk margin amount
add-on. The commenter stated that the Commission did not articulate
a rationale for departing from the approaches of other regulators,
and that the CEA requires the Commission, SEC, and prudential
regulators to maintain comparable minimum capital requirements to
the maximum extent practicable.
---------------------------------------------------------------------------
The commenter also stated that the 8% risk margin requirement would
discourage covered SDs from hedging market risk.\157\ This commenter
noted that a covered SD enters into swaps and other derivatives
transactions as a counterparty, which exposes the derivative positions
to market risk. The commenter further noted that the covered SD may
hedge this market risk by entering into offsetting positions with other
counterparties. The commenter stated that instead of recognizing the
risk-mitigating effects of entering into hedged positions, the Proposal
penalizes the covered SD by requiring the initial margin of both the
original and hedge positions to be subject to the 8% risk margin
amount, which increases costs to the covered SD and discourages risk
management.\158\
---------------------------------------------------------------------------
\157\ Id.
\158\ Id.
---------------------------------------------------------------------------
Commenters also stated that the 8% risk margin amount fails to
recognize the risk-reducing effects resulting from
[[Page 57484]]
the collection of initial margin.\159\ One commenter noted that the
proposed 8% risk margin amount would impose the same minimum capital
requirement on a covered SD regardless of whether the SD collected
initial margin from the counterparty.\160\ Another commenter stated
that the 8% risk margin amount would be improved through the
recognition of initial margin that is collected by the covered SD and
held by an independent custodian as required by the Commission's margin
rules.\161\ The commenter stated that the collection of initial margin
reduces the potential credit risk exposure that a covered SD has from a
counterparty, which should be reflected in the minimum capital
requirements.\162\
---------------------------------------------------------------------------
\159\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
\160\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\161\ See MS 3/3/2020 Letter.
\162\ Id.
---------------------------------------------------------------------------
One commenter stated that the 8% risk margin amount would impose
significant and expensive operational burdens on covered SDs.\163\ The
commenter noted that proposed 8% risk margin amount requires a covered
SD to include positions in the calculation that are not subject to the
Commission's uncleared swap margin rules. The commenter stated that the
requirement to include positions, such as certain foreign currency
forwards and foreign currency swaps, legacy swaps and other swaps and
security-based swaps that are excluded from the Commission's or SEC's
uncleared margin rules in the 8% risk margin amount calculation will
potentially require a covered SD to obtain approval from NFA to use a
model to compute initial margin for these positions in order to avoid
having to include the initial margin requirements based upon the
standardized table in the Commission's margin rules. The commenter
further noted that notwithstanding the burden and potential costs
associated with obtaining model approval for these positions that are
otherwise exempt from uncleared margin requirements, there is a burden
and cost associated with computing margin for swaps and security-based
swaps that are not subject to the Commission's or SEC's margin
requirements. The commenter also noted that the traditional 8% risk
margin amount under the FCM capital rules does not present the same
challenges and costs as the traditional FCM rule applies only to
cleared customer and noncustomer transactions where clearing
organizations provide the relevant initial margin requirements.\164\
---------------------------------------------------------------------------
\163\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\164\ Id.
---------------------------------------------------------------------------
This commenter also stated that the proposed 8% risk margin amount
could make it difficult for covered SDs and other market participants
to enter into swaps that facilitate the transition from interbank
offered rates (``IBORs'') to other risk-free rates.\165\ The commenter
stated that the Commission has previously recognized that market
participants may seek to transition swap or other portfolios that
reference IBORs to an alternative reference rate by means of a basis
swap that swaps the entire IBOR basis of a portfolio with an
alternative reference rate basis.\166\ The commenter note that the
basis swaps and other similar transactions serve to reduce risk, both
to covered SDs and to their counterparties. The transactions, however,
may also increase the aggregate gross notional amount of a covered SD's
swaps as well as the initial margin that a covered SD is required to
collect, and that absent a revision in the final rule, the transactions
may also increase the minimum capital requirement under the 8% risk
margin amount.\167\
---------------------------------------------------------------------------
\165\ Id.
\166\ See Letter No. 19-28 (Dec. 17, 2019); Letter No. 19-27
(Dec. 17, 2019); Letter 19-26 (Dec. 17, 2019).
\167\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------
The commenter also stated that the 8% risk margin amount would
exacerbate the impacts resulting from the current limited availability
of portfolio margining.\168\ The commenter noted that under current
Commission and SEC margin rules, a dually-registered SD/SBSD is
required to compute initial margin separately for uncleared swaps and
security-based swaps with a single counterparty, which prevents the SD/
SBSD from recognizing the risk-reducing impacts of offsetting swaps and
security-based swap positions. The commenter stated the Commission was
distorting the minimum capital requirement by establishing an 8% risk
margin amount that scaled up with the initial margin requirements and
not the actual risk of the positions viewed from a portfolio
basis.\169\
---------------------------------------------------------------------------
\168\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\169\ Id.
---------------------------------------------------------------------------
Several commenters stated that certain elements of the 8% risk
margin amount calculation should be revised if the Commission were to
adopt it as part of a covered SD's minimum capital requirements.
Commenters stated that the Commission should revise the 8% risk margin
amount contained in the Net Liquid Assets Capital Approach to eliminate
the ``double-counting'' of a covered SD's positions.\170\ These
commenters noted that under the proposed Net Liquid Assets Capital
Approach, a covered SD is required to maintain capital equal to 8% of
the risk margin amount computed on the covered SD's futures, foreign
futures, cleared and uncleared swaps, and cleared and uncleared
security-based swaps positions. The covered SD is also required to
subtract the amount of the market risk and credit risk associated with
its proprietary positions in futures, foreign futures, cleared and
uncleared swaps, and cleared and uncleared security-based swaps in
determining the amount of capital that the covered SD has in order to
meet the minimum capital requirement. The commenters stated that the
proposed Net Liquid Assets Capital Approach double counts a covered
SD's proprietary positions as the approach both reduces the covered
SD's net capital (through the proposed market and credit risk charges)
and increases the covered SD's minimum capital requirement (through the
proposed 8% risk margin amount). The commenters stated that the Net
Liquid Assets Capital Approach's double-counting overstates the risk
that swaps present to the covered SD, and places the covered SD at a
competitive disadvantage relative to covered SDs that elect the Bank-
Based Capital Approach, which does not double-count a covered SD's
proprietary positions.\171\
---------------------------------------------------------------------------
\170\ See FIA-PTG 3/3/2020 Letter.
\171\ Supra fn 143. See also IIB/ISDA/SIFMA 3/3/2020 Letter. As
discussed further in section II.C.3.a. below, under the Bank-Based
Capital Approach, a covered SD is required to maintain a minimum
amount of regulatory capital that is equal to or in excess of the
greater of 8% of (i) the risk margin amount or (ii) the SD's risk-
weighted assets. A covered SD that elects the Bank-Based Capital
Approach is not required to deduct the market risk or credit risk
associated with its proprietary positions in computing its
regulatory capital necessary to meet the above to minimum standards.
---------------------------------------------------------------------------
Commenters stated that the Commission should address the ``double-
counting'' issue by revising the final Net Liquid Assets Capital
Approach to impose the 8% risk margin amount as a capital requirement
prior to the imposition of proprietary market and credit risk
charges.\172\ Under this approach, a covered SD electing the Net Liquid
Assets Capital Approach would be required to maintain minimum tentative
net capital equal to or greater than 8% of the risk margin amount.
---------------------------------------------------------------------------
\172\ Id.
---------------------------------------------------------------------------
Commenters also stated that the Commission should reduce the
multiplier if it adopts the 8% risk margin amount.\173\ Commenters
noted
[[Page 57485]]
that the 8% risk margin amount was based upon the Commission's capital
requirements for FCMs, which imposes an obligation on FCMs to maintain
adjusted net capital of at least 8% of the margin required on customer
and noncustomer futures, foreign futures, and cleared swaps
positions.\174\ One commenter stated that there is no evidence to
support a conclusion that an 8% calibration is appropriate in the
context of non-cleared swaps markets, with fundamentally different
regulatory standards and risk management principles than FCM's
customers and noncustomer clearing activities.\175\
---------------------------------------------------------------------------
\173\ Id.
\174\ See Commission regulation Sec. 1.17(a)(1)(i) (17 CFR
1.17(a)(1)(i)).
\175\ See MS 3/3/2020 Letter. The commenter further noted, for
instance, that SDs act as counterparties to market participants, and
not as financial guarantors of their customers.
---------------------------------------------------------------------------
Another commenter stated that the FCM capital requirement based on
8% of customer and noncustomer margin was never intended to apply
broadly to the uncleared swaps market.\176\ This commenter stated that
data collected almost two decades ago in the context of futures
positions does not provide a logical foundation for the adoption of the
8% risk margin requirement, as it does not reflect appropriately the
risks faced by covered SDs on their positions, particularly their
uncleared positions, which are subject to higher margin requirements
based on a 10-day liquidation horizon as opposed to a 1-day horizon
common for futures.
---------------------------------------------------------------------------
\176\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------
The commenter also stated that if the Commission did not modify the
8% risk margin amount requirement to reflect the ``double-counting''
discussed above, then reducing the 8% risk margin amount multiplier
would be necessary to prevent competitive disparities. The commenter
also stated that based on data it had compiled, an 8% multiplier for
the risk margin amount would be high for covered SDs that elect the Net
Liquid Assets Capital Approach.\177\
---------------------------------------------------------------------------
\177\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------
Such a requirement would dramatically increase the amount of
capital required to support the derivatives activities well beyond any
current capital requirements applicable to such SDs.\178\ Further, this
same higher required capital would occur on covered SDs regardless of
the elected approach under the Commission's proposed framework or
relative to capital requirements for bank SDs on portfolios of similar
positions.\179\
---------------------------------------------------------------------------
\178\ Id.
\179\ Id.
---------------------------------------------------------------------------
Commenters also explicitly stated that if the Commission adopts a
minimum capital requirement based upon the initial margin of a covered
SD's proprietary positions, the multiplier should be reduced from 8% to
2%.\180\ The commenters further stated that a 2% risk margin amount
would be consistent with the 2019 SEC Final Capital Rule. One of the
commenters also stated that consistency with the SEC's 2% calibration
is particularly important for dually-registered SD/SBSDs, otherwise the
Commission would be setting the risk margin multiplier for security-
based swaps, which effectively undermines the SEC's capital approach to
SBSDs that are also covered SDs.\181\
---------------------------------------------------------------------------
\180\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter;
FIA-PTG 3/3/2020 Letter.
\181\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------
Commenters also stated that the Commission should exclude
proprietary futures, cleared swaps and cleared security-based swaps
from the calculation if the Commission adopts the 8% risk margin
amount.\182\ One commenter stated that including proprietary futures,
cleared swaps and cleared security-based swaps in the 8% risk margin
amount fails to recognize the limited risks and leverage associated
with proprietary cleared positions. Unlike customer cleared positions
or proprietary uncleared swaps and security-based swaps, proprietary
positions present minimal credit risk as the covered SD's only exposure
is to clearing organizations. The commenter further noted that
centrally cleared transactions present limited leverage since the
initial margin associated with such transactions is not reused, but
maintained at the clearing organization or custodian. The commenter
further stated that the proposed 8% risk margin amount would treat
proprietary cleared positions no differently from uncleared swaps,
thereby eliminating the incentive to clear transactions and subjecting
product types that present markedly different risks to the same capital
treatment.\183\ Another commenter stated that including a covered SD's
cleared futures, swap and security-based swap positions in the 8% risk
margin amount fails to recognize the risk mitigating nature of
centralized clearing.\184\
---------------------------------------------------------------------------
\182\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter;
FIA-PTG 3/3/2020 Letter.
\183\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
\184\ See FIA-PTG 3/3/2020 Letter.
---------------------------------------------------------------------------
The Commission has considered the comments on the 8% risk margin
amount and continues to believe that a minimum capital requirement
based on initial margin is an appropriate component of a covered SD's
minimum capital requirement under the Net Liquid Assets Capital
Approach. The Commission acknowledges commenters' views that the risk
margin amount could more precisely measure portfolio-related risks if
it were to recognize the risk mitigating effects of margin collateral
received from counterparties or if it was computed on a total portfolio
basis as opposed to being computed on a counterparty-by-counterparty
basis. However, the intent of the risk margin amount requirement was to
establish a method of developing a minimum amount of capital for a
covered SD to meet all of its obligations as a SD to market
participants, and to cover potential operational risk, legal risk, and
liquidity risk, and not just the risks of its trading portfolio.
The Commission believes that the risk margin amount is a minimum
capital requirement that provides a floor based on a measure of the
risk of the positions, the volume of positions, the number of
counterparties and the complexity of operations of the covered SD.
Initial margin reflects the degree of risk associated with the
positions, with lower risk positions having lower initial margin
requirements and higher risk positions having higher initial margin
requirements. Therefore, the amount of the minimum capital required of
a covered SD under the risk margin amount calculation is directly
related to the volume, size, complexity and risk of the covered SD's
positions, however, the minimum capital requirement is intended to
cover a multitude of potential risks faced by the SD. This concept is
generally consistent with the FCM capital rule, which bases the minimum
capital requirement on margin associated with customer and noncustomer
futures, foreign futures and cleared swaps transactions, but is
intended to address the general risks of operating an FCM such as
operational, legal, liquidity and other risks in addition to risks
arising from carrying customer accounts. Therefore, the Commission
believes that it is appropriate to set a minimum capital requirement
for covered SDs that is a floor that reflects the risk margin
associated with the SD's uncleared swap positions.
The Commission, however, is modifying the final rule in response to
its reconsideration of the issues and the comments received. The
Commission is modifying the proposed risk margin amount by removing
cleared and uncleared security-based swap positions from the
calculation. As noted in section II.B.2.b. above, the Commission
believes that a registrants' minimum capital requirements should be
based upon the transactions that are within
[[Page 57486]]
the Commission's jurisdiction and not the jurisdiction of another
regulatory agency. This allows the Commission to set minimum capital
requirements for registrants, including covered SDs, based upon markets
and products that the Commission regulates and for which it has
expertise.
Modifying the proposed risk margin amount by removing security-
based swaps also maintains a consistency with the long-standing
historical approach that the Commission and SEC have followed with
respect to dually-registered FCM/BDs. Under the existing FCM/BD capital
rules, the Commission sets minimum capital requirements for FCMs based
upon the firm's futures and cleared swaps activities, and the SEC sets
the minimum capital requirements based upon the firm's securities
activities.\185\ As noted by commenters above, the proposed inclusion
of security-based swap positions in the Commission's minimum capital
requirement for dually-registered SD/SBSDs not only goes against this
historical approach, it also effectively overrides the SEC's decision
regarding the appropriate level of capital that should be imposed on
SBSDs with respect to SEC-regulated security-based swap products,
particularly if the Commission's and SEC's multiplier are different. In
addition, the Commission notes that security-based swaps have only been
excluded from the risk margin amount, which establishes the minimum
capital requirement. To the extent that a covered SD engages in
security-based swaps or other proprietary transactions, including
equities, foreign currencies, physical commodities, futures, and swaps,
the covered SD is required to reflect these transactions in its capital
in the form of market risk and, as appropriate, credit risk charges,
and the SD is required to hold capital in an amount sufficient to cover
such charges. The exclusion of the security-based swaps from the risk
margin amount addresses commenters concern that the proposed Net Liquid
Assets Capital Approach ``double counts'' the covered SD's security-
based swap positions in the capital computation by including such
positions in the both the computation of net capital and in the
calculation of the minimum capital requirement. The Commission also
notes that to the extent a covered SD is also a registered SBSD, it
will be subject to a minimum capital requirement established by the
SEC, which requires the SBSD to maintain minimum net capital equal to
the greater of $20 million or 2% of the risk margin amount associated
with the SBSD's uncleared security-based swaps and customer cleared
security-based swaps. Therefore, to the extent a covered SD that is
dually-registered as a SBSD engages in a substantial amount of
security-based swaps such that its SEC minimum capital requirement is
greater than the CFTC minimum capital requirement, the SD would have to
maintain compliance with the higher SEC minimum capital requirement in
order to comply with the SEC rules.
---------------------------------------------------------------------------
\185\ See Commission regulation Sec. 1.17(a)(1)(i) (17 CFR
1.17(a)(1)(i)) and SEC rule 15c3-1.
---------------------------------------------------------------------------
The Commission is also modifying the proposed risk margin amount
calculation to exclude proprietary futures, foreign futures, and
cleared swap transactions. The Commission believes that it is
appropriate to revise the proposed risk margin amount to exclude
proprietary cleared positions from the minimum capital requirement as
the covered SD's credit exposure is limited on such positions to either
a clearing organization or to an FCM that carries the SD's account (or
in the case of foreign futures, a foreign broker that carries the SD's
account). The credit exposure on such cleared positions is limited
relative to swap counterparties as clearing organizations and FCM/
foreign brokers are regulated entities that are generally subject to
financial requirements, including capital, margining, and financial
reporting requirements. Clearing organizations and FCM/foreign brokers
are also subject to regulations regarding the holding of customer funds
to ensure that such funds are used solely for the benefit of the
customer and not for the benefit of other customers or of the clearing
organization or FCM/foreign broker.\186\ The clearing of the positions
also ensures that the potential default by the SD is reduced as it is
obligated to post initial margin with an FCM/foreign broker or clearing
organization, and to settle open positions on a daily basis. Therefore,
any default on the part of the SD is promptly identified by the FCM/
foreign broker or clearing organization and steps are taken to mitigate
the potential losses resulting from the default. These types of
restrictions on the holding of customer funds by FCMs, foreign brokers,
and clearing organizations and the clearing organizations' daily
margining processes mitigate the risk associated with the covered SD's
cleared futures, foreign futures, and cleared swaps transactions.
Furthermore, while the cleared proprietary positions are being excluded
from the minimum capital requirement based upon the risk margin amount,
the positions are reflected in the covered SD's capital in the form of
market risk and credit risk charges and the covered SD is required to
hold capital sufficient to cover those charges.
---------------------------------------------------------------------------
\186\ See, e.g., Commission regulations Sec. Sec. 1.20, 1.22
and 39.15 (17 CFR 1.20, 1.22 and 39.15).
---------------------------------------------------------------------------
The Commission is also modifying the proposed 8% risk margin amount
for covered SDs electing the Net Liquid Assets Capital Approach by
setting the multiplier at 2%. The Commission has reviewed the proposed
capital requirements and has considered the comments received and
believes that it is appropriate to modify the risk margin amount
multiplier in the Net Liquid Assets Capital Approach, and to retain the
8% risk margin amount multiplier in the Bank-Based Capital Approach and
the Tangible Net Worth Capital Approach. Therefore, under the final
regulation, a covered SD that elects the Net Liquid Assets Capital
Approach must maintain a minimum level of net capital that is equal to
or greater than 2% of the initial margin of its uncleared swaps,
computed on a counterparty-by-counterparty basis.
The Commission believes that modifying the risk margin amount
multiplier under the Net Liquid Assets Capital Approach is appropriate
due to (i) differences in the assets that comprise regulatory capital
under the Net Liquid Assets Capital Approach relative the Bank-Based
Capital Approach and the Tangible Net Worth Capital Approach, and (ii)
differences in how the minimum capital requirement is applied under the
Net Liquid Assets Capital Approach relative the Bank-Based Capital
Approach and the Tangible Net Worth Capital Approach. As previously
discussed, the Net Liquid Assets Capital Approach is a liquidity-based
capital approach that requires a covered SD to hold at least one dollar
of highly liquid assets for each dollar of the firm's liabilities
(excluding qualifying subordinated debt). With respect to the assets
that comprise net capital under the Net Liquid Assets Capital Approach,
a SD is required to calculate its net worth in accordance with U.S.
GAAP, and subtract all illiquid assets, such as fixed assets and
intangible assets, and deduct all of the firm's liabilities (except
certain qualifying subordinated debt) to determine its tentative net
capital. The SD then deducts market risk charges on all of its
proprietary positions, including uncleared swap and security-based swap
positions, and credit risk charges on its exposures to counterparties
on its derivative positions, to determine its net capital.
In contrast to the liquidity-based approach of the Net Liquid
Assets
[[Page 57487]]
Capital Approach, the Bank-Based Capital Approach and the Tangible Net
Worth Capital Approach are more properly viewed as solvency-based
capital requirements that require a covered SD to maintain positive
balance sheet equity. Under the Bank-Based Capital Approach and
Tangible Net Worth Capital Approach, a covered SD is not required to
deduct fixed assets or other illiquid assets from its balance sheet
equity.\187\ A covered SD is also not required to deduct market risk
and credit risk charges from its balance sheet equity. Therefore, the
capital that is available and that may be used to meet the minimum
capital requirement is substantially more conservative under the Net
Liquid Assets Capital Approach than it is under the Bank-Based Capital
Approach and the Tangible Net Worth Capital Approach.
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\187\ SDs electing the Tangible Net Worth Capital Approach are
required to deduct intangible assets.
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In addition to what assets qualify as capital, the risk margin
amount requirement is applied in a more conservative manner to covered
SDs under the Net Liquid Assets Capital Approach than it is under the
Bank-Based Capital Approach and the Tangible Net Worth Capital
Approach. Under the proposed Net Liquid Assets Capital Approach, a
covered SD was required to maintain a level of net capital (as defined
above) that equaled or exceeded 8% of the risk margin amount. Covered
SDs electing the proposed Bank-Based Capital Approach or Tangible Net
Worth Capital Approach were required to maintain balance sheet equity
(without deductions for fixed assets and market risk and credit risk
charges) that equaled or exceeded 8% of the risk margin amount.
Therefore, covered SDs electing the Bank-Based Capital Approach or
Tangible Net Worth Capital Approach may have substantially more assets
that qualify as capital to meet the proposed 8% risk margin amount
requirement.
The Commission recognizes that the differences in the capital
approaches discussed above may provide a competitive advantage to
covered SDs electing the Bank-Based Capital Approach and Tangible Net
Worth Capital Approach due to the ability of such SDs to include fixed
assets and not have to deduct market and credit risk charges. To
address this potential competitive disadvantage, the Commission is
modifying the regulation by setting the risk margin amount multiplier
at 2% under the Net Liquid Assets Capital Approach. Given the
differences in the operation of the respective capital approaches as
discussed above, the Commission believes that setting the risk margin
amount multiplier at 2% for covered SDs electing the Net Liquid Assets
Capital approach imposes a minimum capital requirement that is more
equivalent to the 8% risk margin amount requirement for Bank-Based
Capital Approach and Tangible Net Worth Capital Approach SDs. Setting
the risk margin amount at 2% also mitigates commenters' concern that
the Net Liquid Assets Capital Approach results in ``double counting''
of positions in the capital computation.
The Commission proposed an 8% risk margin amount multiplier based
upon its experience with FCM capital requirements, which requires each
FCM to maintain a minimum capital requirement based upon 8% of the risk
margin on the futures, foreign futures, and cleared swap positions
carried in customer and noncustomer accounts. As noted by a commenter,
the 8% risk margin amount was proposed in 2003 and adopted in 2004
based upon an analysis and comparison of the capital regime in effect
at the time, which was based on a percentage of the customer funds held
by an FCM, with a minimum capital requirement based upon risk margin
associated with the customer positions carried by the FCM.\188\ Staff
also had the benefit of observing data of the actual performance of the
two capital regimes for an extended period of time as each FCM was
required to calculate its minimum capital requirement based on customer
funds and its capital requirement based on a percentage of its risk
margin amount for approximately three years as part of a pilot
program.\189\
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\188\ See Minimum Financial and Related Reporting Requirements
for Futures Commission Merchants and Introducing Brokers, 68 FR
40835 (July 9, 2003) (``2003 Proposed Risk-based Capital
Rulemaking''). The final rule is available at 69 FR 49784 (Aug. 12,
2004). See also, IIB/ISDA/SIFMA 3/3/2020 Letter.
\189\ See 2003 Proposed Risk-based Capital Rulemaking, 68 FR
40835 at 40839.
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The Commission does not have sufficient data to perform a
quantitative analysis of the optimal level to set the multiplier for
the risk margin amount at this time. However, the Commission's decision
to modify the final rule by removing cleared and uncleared security-
based swaps, as well as proprietary futures, foreign futures, and
cleared swaps positions from the risk margin amount calculation and to
set the multiplier at 2% should mitigate many of the commenters'
concerns that the proposed 8% risk margin amount calculation was over
inclusive of the types of positions included in the calculation and was
set at a percentage that was too high. In addition, as the commenters
noted, the FCM capital requirement of 8% of the risk margin on futures,
foreign futures and cleared swaps is based upon margin calculations
using clearing organization models that require the clearing
organization to use a 99% one-tailed confidence interval over a minimum
liquidation period of one day for futures, agricultural swaps, energy
swaps, and metal swaps of one day, and a minimum liquidation period of
five days for all other swaps.\190\ In contrast, initial margin for
uncleared swaps is required to be calculated at a 99% one-tailed
confidence interval over minimum liquidation period of 10 business days
(or the maturity of the swap if shorter).\191\ The greater minimum
holding period for uncleared swaps generally requires a higher level of
initial margin, which would increase the covered SD's minimum capital
requirement relative to cleared transactions.
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\190\ See Commission regulation Sec. 39.13(g) (17 CFR
39.13(g)).
\191\ See Commission regulation Sec. 23.154(b)(2) (17 CFR
23.154(b)(2)).
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Also, the Commission's final approach is consistent with the
Congressional mandate to adopt capital requirements that are to the
maximum extent practicable, comparable with the SEC and prudential
regulators' capital requirements. The SEC's final rules require a SBSD
to maintain net capital (not tentative net capital) that is equal to or
greater than 2% of the risk margin amount calculated on its customer
cleared security-based swaps and uncleared security-based swaps.
Therefore, the Commission's final regulation is comparable with the
SEC's final rule for SBSDs.\192\
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\192\ Under the Commission's final rule, a covered SD will be
required to maintain a minimum level of adjusted net capital equal
to or greater than 2% of the risk margin associated with the SD's
proprietary uncleared swap transactions. Under the SEC's final rule,
a stand-alone SBSD will be required to maintain a minimum level of
net capital equal to or greater than 2% of the sum of the SBSD's
customer cleared security-based swaps and uncleared security-based
swaps. Covered SDs that clear customer swaps would be required to
register as an FCM and will be subject to the FCM-SD capital
requirements discussed in section II.B. above, which includes a
minimum capital requirement of 8% of the risk margin amount
associated with the FCM-SD's cleared customer futures, foreign
futures, and cleared swap positions.
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The Commission believes it will be necessary to monitor and
evaluate whether the numerical percentage is effective in achieving the
statutory requirement for capital. Therefore, unlike the SEC, the
Commission is not committing to a predetermined upward ratcheting
percentage, but will
[[Page 57488]]
continually monitor and evaluate, which provides the Commission more
flexibility in making fact-based assessments about the efficacy of the
final rule in the future.
The Commission will monitor the impact that the 2% risk margin
amount has on the level of minimum capital required of covered SDs
electing the Net Liquid Assets Capital Approach after the compliance
date of the rules. The Commission intends to use the financial
statements and other information that it will receive from covered SDs
under the financial reporting requirements discussed in section II.D.
below to continually monitor the minimum capital requirements under the
final rule, ensuring the Commission's capital requirements are
adequately calibrated to protect the safety and soundness of the
covered SDs. The information that the Commission will receive will
allow it to determine if it would be appropriate to propose amending
the minimum capital requirements by, among other things, increasing or
decreasing the risk margin amount multiplier.
The Commission also has considered the comments that the minimum
capital requirement should be revised to require a covered SD to
maintain tentative net capital in excess of the risk margin amount as
opposed to the proposed net capital requirement. The Commission is not
modifying the final rule to reflect these comments. While the
Commission acknowledges that a covered SD electing the Net Liquid
Assets Capital Approach is required to both include its uncleared swaps
in the 2% risk margin amount calculation in order to establish its
minimum capital requirement and to take capital charges for market risk
and credit risk on the uncleared swaps in computing the amount of
capital the covered SD holds, the Commission does not believe that it
would be appropriate to revise the final rule at this time to only
apply to tentative net capital. If the Commission were to revise the
final regulation consistent with the comments, then a covered SD would
be subject only to the minimum fixed-dollar net capital requirement of
$20 million (and those approved to use capital models, a tentative net
capital requirement of $100 million). Including the uncleared swaps in
establishing a minimum capital requirement is intended to provide a
floor of net capital that each SD following the Net Liquid Assets
Capital Approach is required to maintain to cover all risks to the
firm, including market, credit, operation, liquidity, and legal risk.
With respect to commenters' concerns that the proposed risk margin
amount would exacerbate the impact of a covered SD's inability to
portfolio margin uncleared swaps and uncleared security-based swaps
with a counterparty in a single account, the Commission recognizes the
capital and margin efficiencies that portfolio margining provides to
covered SDs and counterparties. The Commission also recognizes that the
inability of a covered SD that is dually-registered with the SEC as a
SBSD to portfolio margin uncleared swaps and uncleared security-based
swaps impacts the SD's ability to compete with bank SDs that may margin
uncleared swaps and security-based swaps in a single account, subject
to the rules of the applicable prudential regulator. Under the Dodd-
Frank Act framework, the Commission has the authority to establish
margin requirements for swaps and the SEC has the authority to
establish margin requirements for security-based swaps. Therefore, the
respective Commissions need to take coordinated action in order for a
dually-registered covered SD and SBSD to margin uncleared swaps and
security-based swaps with a counterparty in a single account. The
Commission will consult with the SEC regarding portfolio margining and,
as part of such consultation, address capital issues.
With respect to comments that the risk margin amount may make it
difficult for covered SDs and other market participants to enter into
swaps that facilitate the transition from interbank offered rates to
other risk-free rates, the Commission invites market participants that
may be impacted by the capital rule to seek guidance from Commission
staff. As noted above, Commission staff has provided no-action relief,
including margin relief, to facilitate a covered SD's transition of
open swaps with an interbank offered rate to other rates.
Minimum Capital Requirement of a Registered Futures Association Under
Net Liquid Assets Capital Approach
The third criterion of the proposed Net Liquid Assets Capital
Approach required a covered SD to maintain net capital that was equal
to or greater than the amount of net capital required by an RFA of
which the covered SD was a member. As noted in the 2016 Capital
Proposal, the proposed minimum capital requirement based on membership
requirements of an RFA is consistent with section 17(p)(2) of the CEA
and current regulation 1.17 for FCMs and IBs.\193\
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\193\ See Commission regulations Sec. Sec. 1.17(a)(1)(i)(C) and
170.16 (17 CFR 1.17(a)(1)(i)(C) and 170.16).
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Section 17(p)(2) of the CEA provides, in relevant part, that an RFA
must adopt rules establishing minimum capital and other financial
requirements applicable to the RFA's members for which such
requirements are imposed by the Commission.\194\ Section 17(p)(2)
further requires an RFA to implement a program to audit and enforce its
members' compliance with such capital and other financial requirements.
As noted above, the NFA currently is the only RFA, and each SD is
required to be a member of NFA.\195\
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\194\ See section 17(p)(2) of the CEA (7 U.S.C. 21(p)(2)), which
requires RFAs to adopt rules establishing minimum capital and other
financial requirements applicable to its members for which such
requirements are imposed by the Commission, provided that such
requirements may not be less stringent than the requirements imposed
by the CEA or by Commission regulations.
\195\ Commission regulation Sec. 170.16 (17 CFR 170.16)
provides, in relevant part, that each person registered as an SD
must become and remain a member of at least one futures association
that is registered with the Commission under section 17 of the CEA
and provides for the membership of SDs. NFA is currently the only
RFA and accepts SD members.
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The 2016 Capital Proposal noted that NFA is required by section 17
of the CEA to adopt SD capital rules once the Commission imposes
capital requirements on SDs, and that NFA's capital rules must be at
least as stringent as the Commission's capital requirements on covered
SDs.\196\ The Commission's proposed Net Liquid Assets Capital Approach
incorporated the NFA minimum capital requirement into the Commission's
capital rule, which would make a violation of the NFA's rule also a
violation of the Commission's rule in a manner that is consistent with
the current FCM capital rules.\197\
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\196\ See 2016 Capital Proposal, 81 FR 91252 at 91259 and
footnote 87 at 91269.
\197\ Commission regulation Sec. 1.17(a)(1)(i)(C) (17 CFR
1.17(a)(1)(i)(C)) currently incorporates NFA's minimum capital
requirement for an FCM into the Commission's minimum capital
requirement by providing that each person registered as an FCM must
maintain adjusted net capital required by an RFA of which the FCM is
a member.
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The Commission received several comments regarding the proposed
requirement that a covered SD must meet the capital rules adopted by
the NFA. Several commenters stated that any future NFA capital rules
for covered SDs should be subject to public comment.\198\ One commenter
also stated that creating, revising and implementing
[[Page 57489]]
systems, controls, processes, reporting and related internal mechanisms
requires ample notice of uninterrupted requirements that could be
jeopardized by an inconsistent NFA capital requirement.\199\ To address
this issue, the commenter requested that the Commission require NFA to
establish a public comment period to solicit feedback on any covered SD
capital requirements prior to mandating compliance with such
requirements.\200\
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\198\ ED&F Man/INTL FCStone 3/3/2020 Letter; Letter from Scott
Earnest, Shell Trading Risk Management LLC (March 2, 2020) (Shell 3/
3/2020 Letter).
\199\ ED&F Man/INTL FCStone 3/3/2020 Letter.
\200\ Id.
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Another commenter stated that the Commission's efforts to obtain
public input pursuant to the 2016 Capital Proposal and the 2019 Capital
Reopening may be nullified if the NFA adopts capital rules that are
different from the Commission's final rules.\201\ The commenter
requested that the Commission require NFA to adopt capital rules that
closely mirror the Commission's final capital rules, or, at the least,
require NFA to conduct a rigorous notice and comment process prior to
finalizing its capital rules.\202\
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\201\ See Shell 3/3/2020 Letter.
\202\ Id.
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The Commission appreciates the commenters concerns regarding the
need for conformity between its final capital rules governing covered
SDs and those that may be adopted by NFA as an RFA in the future. The
Commission believes, however, that the concerns are largely mitigated
by the existing statutory and Commission regulatory requirements as
well as the internal governance structure of NFA, which was established
to comply with these requirements. Section 17(j) of the CEA, for
example, requires NFA to file with the Commission any change in or
addition to its rules. Any such change or addition is effective within
10 days of submission unless NFA requests, or the Commission notifies
NFA of its intent to subject the filing to, a review and approval
process.\203\ To the extent NFA plans to adopt significant new rules,
it typically has worked very closely with Commission staff to ensure,
among other things, consistency with existing Commission regulations.
The current capital and financial requirements applicable to FCMs and
IBs, are essentially the same under both Commission regulations and NFA
rules.\204\
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\203\ See section 17(j) of the CEA (7 U.S.C. 21(j)).
\204\ Cf. Commission regulation Sec. 1.17 (17 CFR 1.17) with
NFA Financial Requirements.
---------------------------------------------------------------------------
Further, the statutory and Commission regulatory requirements and
NFA's governance structure ensure that SDs are represented and given a
voice in the potential adoption of NFA rules, including capital and
financial reporting rules, that may impact them. Specifically, section
17(b)(5) of the CEA and regulation 170.3 require generally that the
rules of an RFA assure fair representation of its members in the
adoption of any rule, in the selection of its officers, directors, and
in other aspects of its administration.\205\ In this regard, NFA's
Articles of Incorporation require that its Board of Directors include 5
elected representatives of registered (or provisionally-registered)
SDs, registered (or provisionally registered) major swap participants
and registered RFEDs. Of these representatives, at least 2 must be SDs
that are Large Financial Institutions \206\ (as of June 30 of the prior
calendar year) and at least 2 others must be representatives of SDs,
MSPs or RFEDs that are not Large Financial Institutions.\207\
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\205\ 7 U.S.C. 21(b)(5) and Commission regulation Sec. 170.3
(17 CFR 1.17). See also, section 17(b)(11) of the CEA (7 U.S.C.
21(b)(11)) which requires that an RFA provide for meaningful
representation on the governing board of such association of a
diversity of membership interests and provides that no less than 20
percent of the regular voting members of the board be comprised of
qualified nonmembers of or persons not regulated by such
association.
\206\ The term ``Large Financial Institution'' is defined in
Article XVIII(n) of NFA's Articles of Incorporation as ``a Swap
Dealer included in a well defined, publicly available and
independent list of financial institutions that the Board of
Directors identifies by resolution from time to time.''
\207\ Article XVII, Section 2A(d) of NFA Articles of
Incorporation. Article VIII, Section 3(c)(iv) requires that NFA's
Executive Committee composition include 13 Directors, 2 of whom
represent SDs, MSPs or RFEDs.
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In light of NFA's governance structure, the Commission's review
process with respect to new NFA rules and the typically close
interaction between Commission and NFA staff with regard to NFA's
adoption of new rules, the Commission believes that an additional
mandatory public comment period for NFA capital rules would be
unnecessary. Accordingly, the Commission is adopting the third
criterion that a covered SD electing the Net Liquid Assets Capital
Approach must maintain capital in an amount equal to or in excess of an
amount of capital, if any, imposed by an RFA of which the covered SD is
a member.
b. Computation of Net Capital To Meet Minimum Capital Requirement
The second component of the proposed Net Liquid Assets Capital
Approach required a covered SD to compute the amount of ``tentative net
capital'' and ``net capital'' that the SD maintains in order to satisfy
its minimum capital requirement. Proposed regulation 23.101(a)(1)(ii)
required each covered SD electing the Net Liquid Assets Capital
Approach to compute its tentative net capital and net capital in
accordance with the SEC's computation of tentative net capital and net
capital for nonbank SBSDs under Rule 18a-1 as if the covered SD was a
nonbank SBSD, subject to several adjustments.\208\
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\208\ See 2016 Capital Proposal, 81 FR 91252 at 91260-61.
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The Net Liquid Assets Capital Approach and the SEC capital approach
for SBSDs are based on the existing FCM and BD capital rules and place
an emphasis on liquidity of the entity. The FCM and BD capital rules
are liquidity-based capital requirements that generally require a firm
to maintain at all times at least $1 dollar of highly liquid assets to
cover each dollar of its unsubordinated liabilities, which is generally
money owed to customers, counterparties and creditors.
A covered SD electing the Net Liquid Assets Capital Approach will
compute net capital by first determining its net worth under U.S. GAAP,
which generally reflects the firm's total assets less its total
liabilities. The covered SD would then adjust its net worth by
deducting certain assets such as unsecured receivables and
undermargined counterparty accounts. The covered SD would also be able
to add back to its net worth certain qualifying subordinated
liabilities. The result of these adjustments would be the covered SD's
``tentative net capital.''
The covered SD will then compute its ``net capital'' by deducting
from ``tentative net capital'' prescribed capital charges from the
mark-to-market value of its proprietary swap, security-based swap,
equities, and commodity positions. The prescribed capital charges for
the covered SD's proprietary positions are the existing standardized
capital charges set forth in Commission regulation 1.17 for FCMs and
SEC rule 15c3-1 for BDs. The Proposal also provided that a covered SD
could seek approval from the Commission or an RFA to use internal
models to compute market risk and credit risk capital charges in lieu
of the standardized capital charges. The application and approval
process for market risk and credit risk capital models is discussed in
section II.C.7. below.
(i) Swap Dealers Not Approved To Use Internal Capital Models
The 2016 Capital Proposal required a covered SD electing the Net
Liquid Assets Capital Approach to apply, in computing its net capital,
standardized market risk and credit risk capital
[[Page 57490]]
charges set forth in SEC Rule 18a-1, and the appendices thereto, for
positions in swaps, security-based swaps, and other proprietary
positions, if the covered SD had not obtained Commission or RFA
approval to use internal models. The standardized market risk charges
under SEC rule 18a-1 are rules-based capital charges that require a
covered SD to compute market risk capital charges for swaps, security-
based swaps, and other positions by multiplying the notional amount or
fair market value of the positions by a specified percentage set forth
in SEC rule 18a-1.\209\ The resulting market risk charges would be
deducted from the covered SD's tentative net capital to arrive at the
firm's net capital.
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\209\ See, e.g., SEC rule 18a-1.
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Standardized credit risk charges under SEC Rule 18a-1 generally
provide that unsecured receivables are subject to a 100 percent credit
risk capital charge (i.e., the covered SD would have to deduct 100
percent of any unsecured receivable balance, including receivables from
swap and security-based swap counterparties for unpaid variation margin
or mark-to-market gains, from tentative net capital in computing net
capital).\210\ Accordingly, under the proposed standardized credit risk
charges, covered SDs were required to deduct any unsecured receivables
arising from not collecting variation margin from any counterparty,
including counterparties that are exempt or excepted from having to pay
and collect variation margin with the covered SD. Therefore, covered
SDs would have to take a capital charge for any exposures arising from
unpaid variation margin to any counterparties, including commercial end
users and counterparties excluded from or exempt from the requirement
to exchange variation margin with the covered SD.
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\210\ See 2019 SEC Final Capital Rule, 84 FR 43872 at 44053.
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The Commission proposed several adjustments that a covered SD
electing the Net Liquid Assets Capital Approach could make to the
standardized credit risk capital charges set forth in SEC rule 18a-1.
In this regard, the Commission proposed that a covered SD, in computing
its regulatory capital, may recognize unsecured receivables from third-
party custodians as a current asset in computing its regulatory
capital, where the receivable represents the amount of initial margin
that the covered SD posted with the third-party custodian for uncleared
swaps or uncleared security-based swaps pursuant to the margin rules of
the Commission or SEC, as applicable.\211\ Absent this modification of
the application of Rule 18a-1, a covered SD would have to take a 100%
capital charge for the receivables from the third party
custodians.\212\ The Commission proposed this modification to rule 18a-
1 to take into account that covered SDs are required to post initial
margin for all swaps with SD counterparties and with all financial end
users with material swaps exposure under the uncleared swap margin
rules, while the SEC's final rules do not require a SBSD to post
initial margin for security-based swaps with other SBSDs or with
financial end users.\213\
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\211\ See paragraph (a)(1)(ii)(A)(4) of proposed Commission
regulation Sec. 23.101; 2016 Capital Proposal, 81 FR 91252 at
91310.
\212\ The 2019 SEC Final Capital Rule provides interpretive
guidance stating that a BD or a stand-alone SBSD does not have to
take a capital charge for initial margin for swaps and security-
based swaps that is posted with a third-party custodian if: (i) The
initial margin requirement is funded pursuant to a fully-executed
written loan agreement with an affiliate of the stand-alone BD or
SBSD; (ii) the loan agreement provides that the lender waives re-
payment of the loan until the initial margin is returned to the
stand-alone BD or SBSD; and (iii) the liability of the stand-alone
BD or SBSD to the lender can be fully satisfied by delivering the
collateral serving as the initial margin to the lender. See 2019 SEC
Final Capital Rule, 84 FR 43872 at 43887.
\213\ Commission regulation Sec. 23.152 (17 CFR 23.152).
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The Commission received a comment on the proposed adjustment to
permit covered SDs to recognize receivables from third-party custodians
as a current asset in computing their net capital under SEC rule 18a-
1.\214\ The commenter stated that it supported the proposed adjustment,
but noted that the rule was too restrictive by recognizing initial
margin held by third-party custodian pursuant to the Commission's rules
and the rules of the SEC. The commenter noted that covered SDs may
enter into uncleared swap or security-based swap transactions with SDs
that are subject to the margin rules of a prudential regulator, or a SD
that operates in a foreign jurisdiction that has received a margin
comparability determination from the Commission. The commenter stated
that in order to avoid creating unwarranted disparities depending on
the parties with which a covered SD trades, the Commission should
expand the adjustment to allow an SD to recognize IM posted in
accordance with the margin rules of a prudential regulator or foreign
jurisdiction for which the Commission has made a comparability
determination.\215\
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\214\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\215\ Id.
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The Commission has considered the comment and is modifying the
final regulation to allow a covered SD electing the Net Liquid Assets
Capital Approach to recognize initial margin for uncleared swaps and
security-based swaps deposited with third-party custodians as a current
asset in computing its net capital. The covered SD must deposit the
initial margin with a third-party custodian in accordance with the
applicable rules of the Commission, SEC, prudential regulators, or a
foreign jurisdiction that has obtained a margin comparability
determination from the Commission. The modification of the final
regulation is consistent with the original intent of the proposed
regulation, which was to permit covered SDs to recognize initial margin
posted with third-party custodians pursuant to the new margin framework
which requires a SD to both post and collect initial margin with a swap
dealer counterparty or with a financial end user with material swaps
exposure.\216\ The modification more fully and accurately reflects the
types of counterparties that a covered SD may transact with, and the
regulations that may govern such uncleared swap and security-based swap
transactions.
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\216\ The term ``material swaps exposure'' is defined by
Commission regulation 23.150 (17 CFR 23.150) to mean that the entity
and its margin affiliates have an average daily aggregate notional
amount of uncleared swaps, uncleared security-based swaps, foreign
exchange forwards, and foreign exchange swaps with all
counterparties for June, July and August of the previous calendar
year that exceeds $8 billion.
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The Commission also proposed to permit a covered SD that elects the
Net Liquid Assets Capital Approach to exclude a capital charge
contained in proposed SEC rule 18a-1(c)(viii). Applying SEC proposed
rule 18a-1(c)(viii) would require a covered SD to take a capital charge
to the extent that standardized market risk charges computed on a
portfolio of customer security-based swaps exceeded the clearinghouse
margin associated with such cleared security-based swaps
positions.\217\ The SEC did not include this capital charge in its
final rules, and the Commission is deleting the exception from this
capital charge in final regulation 23.101(a)(1)(ii) as it is no longer
necessary.
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\217\ See SEC 2012 Proposed Capital Rule, 77 FR 70214 at 70335.
The SEC also requested comment on proposed rule text that extended
the capital charge to cleared swaps in addition to cleared SBS. See
Capital, Margin, and Segregation Requirements for Security-Based
Swap Dealers and Major Security-Based Swap Participants and Capital
Requirements for Broker-Dealers, 83 FR 53007 (Oct. 19, 2018).
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[[Page 57491]]
(ii) Swap Dealers Approved To Use Internal Capital Models
The 2016 Capital Proposal permitted a covered SD electing the Net
Liquid Assets Capital Approach to seek Commission or RFA approval to
use internal models to compute market risk and credit risk capital
charges on its swaps, security-based swaps and other proprietary
positions in lieu of the standardized deductions contained in the SEC
Rule 18a-1.\218\ In order to be considered for approval, the SD's
models must meet the qualitative and quantitative requirements set
forth in proposed regulation 23.102 and Appendix A to regulation
23.102.
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\218\ The Commission proposed that a covered SD's market risk
models must calculate the total market risk for its proprietary
positions under SEC rule 18a-1(d) (17 CFR 240.18a-1(d)) as the sum
of the VaR measure, stressed VaR measure, specific risk measure,
comprehensive risk measure, and incremental risk measure of the
portfolio of proprietary positions in accordance with proposed
Commission regulation Sec. 23.102 and proposed Appendix A of
regulation Sec. 23.102. See paragraph (a)(1)(ii)(A)(2) of proposed
Commission regulation Sec. 23.101; 2016 Capital Proposal, 81 FR
91252 at 91310.
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The Commission noted in the 2016 Capital Proposal that the Federal
Reserve Board had adopted quantitative and qualitative requirements for
internal models used by bank holding companies to compute market risk
and credit risk capital charges.\219\ In developing the proposed market
risk and credit risk requirements for covered SDs, including the
proposed quantitative and qualitative internal model requirements, the
Commission incorporated the market risk and credit risk model
requirements adopted by the Federal Reserve Board.\220\ The
Commission's proposed model requirements are also comparable to the
SEC's model requirements for SBSDs and for BDs.\221\ The model
requirements and the process for obtaining Commission or RFA review is
set forth in section II.C.7. of this release.
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\219\ See 2016 Capital Proposal, 81 FR 91252 at 91258; See, 12
CFR 217, subparts E and F.
\220\ See 2016 Capital Proposal, 81 FR 91252 at 91258.
\221\ See 2016 Capital Proposal, 81 FR 91252 at 91278.
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The Commission's 2016 Capital Proposal required a covered SD
electing the Net Liquid Assets Capital Approach to compute its credit
risk charges as if the covered SD were a SBSD subject to SEC rule 18a-
1.\222\ The SEC 2012 Proposed Capital Rule limited the use of credit
risk models to transactions with commercial end users.\223\ The
Commission, however, believed that a covered SD should be able to use
credit risk models to compute capital charges for uncleared swap and
security-based swap transactions with all counterparties, and not just
commercial end users. In this regard, the Commission proposed that
covered SDs that elect the Net Liquid Assets Capital Approach or the
Bank-Based Capital Approach, and FCM-SDs could use models to compute
credit risk charges for swap and security-based swaps counterparties.
Therefore, the Commission proposed to add paragraph (a)(1)(ii)(A)(3) to
regulation 23.101 to allow a covered SD electing the Net Liquid Assets
Capital Approach to use credit risk models to compute credit risk
charges for uncollected variation margin and initial margin from swap
and security-based swap counterparties.
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\222\ See 2016 Capital Proposal, 81 FR 91252 at 91310; Proposed
regulation 23.101(a)(1)(ii).
\223\ See SEC 2012 Proposed Capital Rule, 77 FR 70214 (Nov. 23,
2012) at 70245-46.
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In its final rule adopting capital requirement for SBSDs, the SEC
modified its rule 18a-1 from the proposal to permit SBSDs approved to
use credit risk models to use such models to compute credit risk
capital charges from all classes of swap and security-based swap
counterparties and not just commercial end users.\224\ Therefore, the
Commission has modified the final regulation 23.101 by deleting
paragraph (a)(1)(ii)(A)(3) as the provision is no longer necessary as
the SEC and CFTC rules are aligned in that a covered SD may use an
approved model to compute counterparty credit risk charges for swap and
security-based swap transactions with all counterparties.
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\224\ See 2019 SEC Final Capital Rule, 84 FR 43872 at 43902-93.
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3. Capital Requirement for Covered SDs Electing the Bank-Based Capital
Approach
a. Computation of Minimum Capital Requirement
The 2016 Capital Proposal provided covered SDs with an option of
electing the Bank-Based Capital Approach, which is based on the Federal
Reserve Board's capital requirements for bank holding companies.\225\
The Federal Reserve Board's bank holding company capital requirements
are consistent with the bank capital framework adopted by the
BCBS.\226\ The BCBS framework is an internationally-recognized
framework for setting capital requirements for banks and bank holding
companies, and was developed to provide prudential standards to help
ensure the safety and soundness of bank and bank holding companies. The
Bank-Based Capital Approach also offers a covered SD that is part of
bank holding company structure with potential efficiencies as the
covered SD may maintain financial accounting records in a manner that
provides for the efficient consolidation of the SD into the financial
reporting requirements of the bank-holding company.
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\225\ See paragraph (a)(1)(i) of proposed Commission regulation
Sec. 23.101, 2016 Capital Proposal, 81 FR 91252 at 91310.
\226\ BCBS is the primary global standard-setter for the
prudential regulation of banks and provides a forum for cooperation
on banking supervisory matters. Institutions represented on the BCBS
include the Federal Reserve Board, the European Central Bank,
Deutsche Bundesbank, Bank of France, Bank of England, Bank of Japan,
and Bank of Canada.
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The Commission's Bank-Based Capital Approach was set forth in
proposed regulation 23.101(a)(1)(i), and required a covered SD to
maintain a minimum level of regulatory capital that is equal to or in
excess of the greatest of the following four criteria:
(1) $20 million of common equity tier 1 capital, as defined under
the bank holding company regulations in 12 CFR 217.20, as if the SD
itself were a bank holding company subject to 12 CFR part 217; \227\
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\227\ Common equity tier 1 capital is defined in 12 CFR 217.20
of the Federal Reserve Board's rules. Common equity tier 1 capital
generally represents the sum of a bank holding company's common
stock instruments and any related surpluses, retained earnings, and
accumulated other comprehensive income.
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(2) common equity tier 1 capital, as defined under the bank holding
company regulations in 12 CFR part 217.20, equal to or greater than 8%
of the SD's risk-weighted assets computed under the bank holding
company regulations in 12 CFR part 217 as if the SD were a bank holding
company subject to 12 CFR part 217;
(3) common equity tier 1 capital, as defined under 12 CFR 217.20,
equal to or greater than 8 percent of the sum of:
(a) The amount of ``uncleared swap margin'' (as that term is
defined in proposed regulation 23.100) for each uncleared swap position
open on the books of the SD, computed on a counterparty by counterparty
basis pursuant to regulation 23.154;
(b) the amount of initial margin that would be required for each
uncleared security-based swap position open on the books of the SD,
computed on a counterparty-by-counterparty basis pursuant to proposed
SEC Rule 18a-3(c)(1)(i)(B), without regard to any initial margin
exemptions or exclusions that the rules of the SEC may provide to such
security-based swap positions; and
(c) the amount of initial margin required by a clearing
organization for cleared proprietary futures, foreign
[[Page 57492]]
futures, swaps, and security-based swap positions open on the books of
the SD; or
(4) the capital required by an RFA of which each SD is a member.
Commenters generally supported the proposed Bank-Based Capital Approach
as it represents an internationally recognized capital regime for
establishing capital that is designed to promote the safety and
soundness of banking institutions under standards issued by the BCBS.
One commenter stated that the Bank-Based Capital Approach is a
significant and necessary pillar in the Commission's proposed
regulatory framework as it fosters greater comparability of covered SDs
with bank SDs, provides a risk-sensitive capital methodology for
covered SD business models that are not adequately captured in
traditional net capital calculations, and provides covered SD
subsidiaries of bank holding companies with potential risk management
and operational synergies.\228\ Another commenter supported the Bank-
Based Capital Approach noting that the Commission's proposal of
offering distinct capital approaches recognizes that covered SDs have a
wide range of business models, many of which do not fit easily within
other proposed capital frameworks.\229\ This commenter further stated
that covered SDs that are not dually-registered as SBSDs or FCMs
generally do not maintain custody of customer assets nor are they
subject to insolvency regimes premised on liquidation and the return of
customer assets and, therefore, it makes sense for the Commission not
to apply the Net Liquid Assets Capital Approach or FCM approach which
are premised on the customer profile and insolvency regime applicable
to SBSDs and FCMs, respectively.\230\
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\228\ See MS 3/3/2020 Letter.
\229\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\230\ Id.
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Fixed-Dollar Minimum Capital Requirement Under Bank-Based Capital
Approach
The first criterion under the Commission's Proposal required
covered SDs electing the Bank-Based Capital Approach to maintain a
minimum of $20 million of common equity tier 1 capital. The Commission
believed that given the role that a SD performs in the financial
markets by engaging in swap dealing activities that it was appropriate
to require each SD to maintain a minimum level of capital, stated as an
absolute dollar amount, that does not fluctuate with the level of the
firm's dealing activities to help ensure the safety and soundness of
the SD.
The proposed $20 million of minimum capital also was consistent
with the minimum regulatory capital requirements proposed by the
Commission for SDs that elect the Net Liquid Assets Capital Approach or
the Tangible Net Worth Capital Approach as discussed in sections
II.C.2.a. and II.C.4., respectively, of this release. The proposed $20
million minimum capital requirement also was consistent with the net
capital requirements adopted by the SEC for SBSDs, and was consistent
with the current minimum net capital requirements for OTC derivatives
dealers registered with the SEC.\231\ The Commission did not receive
comment on the proposed $20 million dollar minimum capital requirement,
and is adopting the requirement as proposed.
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\231\ The SEC capital requirements for SBSDs impose a minimum
net capital requirement of $20 million for SBSDs that are not
approved to use internal capital models and a $100 million dollar
tentative net capital and $20 million net capital requirement for
SBSDs that are approved to use internal capital models See 2019 SEC
Final Capital Rule, 84 FR 43872 at 43884. SEC rule 15c3-1(a)(5) (17
CFR 240.15c3-1(a)(5)) currently requires an OTC derivatives dealer
that has obtained approval to use capital models to maintain a
minimum of $100 million of tentative net capital and $20 million of
net capital. See 2019 SEC Final Capital Rule, 84 FR 43872 at 44042,
44052.
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Minimum Capital Based on Risk-Weighted Assets Under Bank-Based Capital
Approach
The second criterion of the minimum capital requirement for covered
SDs electing the Bank-Based Capital Approach required a covered SD to
maintain common equity tier 1 capital equal to or greater than 8% of
the covered SD's risk-weighted assets computed under the bank holding
company regulations in 12 CFR part 217 as if the covered SD was a bank
holding company. In effect, this provision of proposed regulation
23.101(a)(1)(i) imposed a capital approach on a covered SD that is
generally consistent with the capital approach that the Federal Reserve
Board imposes on bank holding companies.\232\ For purposes of the 2016
Capital Proposal, as is also the case for the Federal Reserve Board's
minimum ratio requirement, the assets and off-balance sheet
transactions or exposures of the bank holding company would be weighted
relative to their respective risk.\233\ Thus, under the 2016 Capital
Proposal, the greater the perceived risk of the assets and the off-
balance sheet items, the greater the weighting for the risk and the
greater the amount of capital necessary to cover 8% of the risk-
weighted assets.\234\ The Commission believed it was important to
include this criterion in its minimum capital requirements so that a
covered SD maintained a level of common equity tier 1 capital that was
comparable to the level that the SD would maintain if it were subject
to the capital rules of the Federal Reserve Board.
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\232\ As discussed further below, the Commission's Proposal
differed from the rules of the Federal Reserve Board in that the
Commission's Proposal would require a covered SD to adjust its risk-
weighted assets calculation by including the market risk capital
charges computed in accordance with Commission regulation Sec. 1.17
(17 CFR 1.17) if the covered SD had not obtained approval from the
Commission or from an RFA to use internal market risk models.
\233\ See 12 CFR 217 subparts D, E, and F.
\234\ Large, complex banks also must make further adjustments to
these risk-weighted assets, calculated pursuant to approved models,
for the additional capital they must hold to reflect the market risk
of their trading assets See 12 CFR 217 subpart F. The market risk
requirements generally apply to Federal Reserve Board-regulated
institutions with aggregate trading assets and trading liabilities
equal to 10 percent or more of total assets or one billion dollars
or more.
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Proposed paragraph (a)(1)(i) of regulation 23.101 required a
covered SD electing the Bank-Based Capital Approach to compute its
risk-weighted assets in accordance with the Federal Reserve Board's
capital requirements contained in 12 CFR part 217. The Proposal
included two general approaches to computing risk-weighted assets under
12 CFR part 217. The first approach was for covered SDs that did not
have Commission or RFA approval to calculate their risk-weighted assets
using internal market risk or credit risk models. Proposed regulation
23.103 required these covered SDs to use a standardized, or rules-
based, approach to computing their risk-weighted assets. Under the
standardized approach, the covered SDs would use the credit risk
charges from the Federal Reserve Board's standardized approach under
subpart D of 12 CFR 217 and the standardized market risk charges for
FCMs set forth in regulation 1.17.\235\ As discussed in section
II.B.3.a. above, regulation 1.17 contains the standardized market risk
capital charges that have been imposed on FCMs for many years and is
being amended by this rulemaking to reflect explicit
[[Page 57493]]
standardized capital charges for swap and security-based swap positions
that are aligned with the SEC's standardized market risk capital
charges. Generally, market risk charges are computed under regulation
1.17 by multiplying the notional value or market value of the position
or asset by a fixed percentage set forth in the regulation.\236\ The
market risk charges are then multiplied by a factor of 12.5 and added
to the total risk-weighted assets of the SD.\237\
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\235\ The Federal Reserve Board's standardized approach under
subpart D of 12 CFR 217 applies only to credit risk charges; the
Federal Reserve Board has not adopted standardized market risk
charges. Bank and bank holding companies that are subject to market
risk charges are required to use internal models and, accordingly,
subpart D of 12 CFR 217 does not include a standardized approach for
computing market risk charges. To address this issue, the Commission
proposed that a covered SD that had not obtained Commission or RFA
approval to use internal market risk models must apply the
standardized market risk capital charges contained in Commission
regulation Sec. 1.17 (17 CFR 1.17) in computing its total risk-
weighted assets.
\236\ For example, U.S. Treasuries are subject to capital
charges of between zero and six percent depending on the time to
maturity of each treasury instrument, and readily marketable equity
securities are subject to a 15 percent capital charge. See
Commission regulation Sec. 1.17(c)(5)(v) (17 CFR 1.17(c)(5)(v)),
which references SEC rule 15c3-1(c)(2)(vi) (17 CFR 240.15c3-
1(c)(2)(vi)). SEC rule 15c3-1(c)(2)(vi)(A)(1) (17 CFR 240.15c3-
1(c)(2)(vi)(A)(1)) provides that a BD shall take a capital charge on
U.S. Treasuries of between zero and six percent of the fair market
value of the instrument depending upon the time to maturity. SEC
rule 15c3-1(c)(2)(vi)(J) (17 CFR 240.15c3-1(c)(2)(vi)(J)) provides a
capital charge for equities equal to 15 percent of the fair market
value of the securities.
\237\ The 12.5 multiplication factor is necessary to ensure that
the SD maintains a level of common equity tier 1 capital to cover
the full amount of the market risk charge. Since the SD is required
to maintain common equity tier 1 capital equal to or in excess of 8%
of the risk-weighted assets, the market risk charge is multiplied by
12.5, which effectively requires the SD to hold common equity tier 1
capital in an amount equal to the full amount of the market risk
charge. This approach is consistent with the Federal Reserve Board's
approach to bank holding companies.
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The second approach to computing risk-weighted assets permitted
covered SDs that have Commission or RFA approval to use internal market
risk and credit risk models to use such models to calculate their risk-
weighted assets. The models would have to meet the qualitative and
quantitative requirements set forth in proposed regulation 23.102 and
Appendix A to regulation 23.102 in order to be approved. The
qualitative and quantitative requirements were based on the Federal
Reserve Board's qualitative and quantitative requirements for capital
models in 12 CFR part 217.\238\ The proposed qualitative and
quantitative requirements for the models, and the proposed model
submission process, are discussed in section II.C.7. of this release.
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\238\ Federal Reserve Board model-based capital charges for
credit risk and market risk are set forth in 12 CFR part 217
subparts E and F, respectively.
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The Commission acknowledged in the 2016 Capital Proposal that
limiting a covered SD's ability to use only common equity tier 1
capital to meet its minimum capital requirement based upon 8% of its
risk-weighted assets was a departure from the Federal Reserve Board's
requirements, which allow a bank holding company to meet its minimum
capital requirements with a combination of common equity tier 1
capital, additional tier 1 capital, and tier 2 capital.\239\ The
Commission stated in the 2016 Capital Proposal that it was proposing
the stricter standard as common equity tier 1 capital is a more
conservative form of capital than additional tier 1 or tier 2 capital,
particularly as it relates to the permanence of the capital and its
availability to absorb unexpected losses.\240\ The Commission also
proposed the stricter common equity tier 1 requirement as it did not
propose to include in the SD's minimum capital requirement certain of
the prudential regulators' capital add-ons, including the capital
conservation buffer and the countercyclical capital buffer.\241\
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\239\ Under the Federal Reserve Board's rules, a bank holding
company's total capital must equal or exceed at least 8% of its
risk-weighted assets. In addition, at least six percent of the bank
holding company's capital must be in the form of tier 1 capital, and
at least 4.5 percent of the tier 1 capital must qualify as common
equity tier 1 capital. The remaining two percent of capital may be
comprised of tier 2 capital. Tier 1 capital includes common equity
tier 1 capital and further includes such instruments as preferred
stock. Tier 2 capital includes certain types of instruments that
include both debt and equity characteristics (e.g., certain
perpetual preferred stock instruments and subordinated term debt
instruments). See 12 CFR 217.10.
\240\ See 2016 Capital Proposal, 81 FR 91252 at 91259-60.
\241\ See 12 CFR 217.11. The capital conservation buffer and the
countercyclical capital buffer represent capital ``add-ons'' to the
bank capital requirements and are intended to require entities
subject to the rules to have certain levels of capital in order to
make capital distributions and discretionary bonuses.
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The Commission received comments regarding the proposed limitation
of the type of capital that a covered SD may use under the Bank-Based
Capital Approach in satisfying its 8% of risk-weighted assets to common
equity tier 1 capital ratio requirement. One commenter supported the
proposed limitation noting that the more conservative common equity
tier 1 capital is appropriate given the Commission's Proposal does not
include all of the capital add-ons and supervisory safeguards that are
set forth in the prudential regulators' capital framework.\242\
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\242\ See AFR 5/15/2017 Letter.
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Other commenters stated that the proposed minimum capital
requirement of common equity tier 1 capital equal to or greater than 8%
of risk-weighted assets would impose a capital requirement on covered
SDs that is materially higher and more restrictive than the prudential
regulators' capital requirement for banks and bank holding
companies.\243\ These commenters noted that the prudential regulators'
minimum capital requirements provide that an entity is ``adequately
capitalized'' if its common equity tier 1 capital is equal to or
greater than 4.5% of the SD's risk-weighted assets, and is ``well
capitalized'' if its common equity tier 1 capital is at least 6.5% of
its risk-weighted assets.\244\ These commenters further stated that the
Commission's proposed ``early warning capital requirement'' would
effectively require SDs to maintain common equity tier 1 capital equal
to at least 9.6% (120% x 8%) of risk-weighted assets as entities
subject to the ``early warning capital requirements'' generally ensure
that their regulatory capital exceeds such requirements.\245\ Another
commenter stated that the Proposal may make it difficult for covered
SDs subject to the Commission's capital rule to compete with bank SDs
subject to the capital rules of a prudential regulator, and more
generally would deviate from the more tailored risk-based approach
taken by the prudential regulators.\246\
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\243\ See ISDA 5/15/2017 Letter; MS 5/15/2017 Letter; SIFMA 5/
15/2017 Letter.
\244\ Id.
\245\ Id. The 2016 Capital Proposal required each covered SD
subject to the Bank-Based Capital Approach, the Net Liquid Assets
Capital Approach, or the Tangible Net Worth Capital Approach to
provide written notification to the Commission within 24 hours of
the covered SD's regulatory capital falling below 120 percent of the
SD's minimum requirement. This proposed notice provision, which is
consistent with current FCM requirements in Commission regulation
Sec. 1.12 (17 CFR 1.12), is generally referred to as the ``early
warning capital requirement.'' The proposed ``early warning capital
requirement'' for SDs was included in paragraph (c)(2) of proposed
Commission regulation Sec. 23.105. See 2016 Capital Proposal, 81 FR
91252 at 91318.
\246\ See JBA 3/14/2017 Letter.
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In addition, a commenter requested that the Commission revise its
Bank-Based Capital Approach to recognize subordinated debt as capital
in meeting the 8% of risk-weighted assets capital ratio.\247\ This
commenter noted that prudential regulators' capital requirements permit
a bank or a bank holding company to recognize certain subordinated debt
as capital in meeting the 8% of risk-weighted assets capital ratio
requirement.\248\
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\247\ See SIFMA 5/15/2017 Letter.
\248\ Id.
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The Commission requested additional comment in the 2019 Capital
Reopening on whether the proposed minimum capital requirement based
upon a covered SD's common equity tier 1 capital was appropriate.\249\
The Commission also requested comment on whether a covered SD should be
able to
[[Page 57494]]
use additional tier 1 and tier 2 capital, including subordinated debt,
in addition to common equity tier 1 capital in meeting the 8% of its
risk-weighted assets requirement.\250\
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\249\ See 2016 Capital Proposal, 81 FR 91252 at 91260.
\250\ Id.
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Common Equity Tier 1 Capital
The Commission received comments in response to the 2019 Capital
Reopening generally supporting the minimum capital requirement based on
a percentage of the covered SD's risk-weighted assets, including the
requirement for covered SDs electing the Bank-Based Capital Approach to
maintain common equity tier 1 capital equal to a specific percentage of
the risk-weighted assets. Commenters, however, stated that the proposed
requirement that a covered SD maintain only common equity tier 1
capital in excess of 8% of its risk-weighted assets was not consistent
with prudential regulators' requirements and was higher than the
comparable requirements imposed by the Federal Reserve Board for bank
holding companies.\251\ These commenters noted that the prudential
regulators requirements permit banks to use a combination of common
equity tier 1 capital, additional tier 1 capital, and tier 2 capital in
meeting their regulatory capital requirements.\252\
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\251\ See, e.g., MS 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020
Letter.
\252\ Id.
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Several commenters further noted, consistent with comments received
from the 2016 Capital Proposal, that the Commission was effectively
imposing a requirement for a covered SD electing the Bank-Based Capital
Approach to maintain common equity tier 1 capital in excess of 9.6
percent of the SD's risk-weighted assets due to the proposed ``early
warning capital requirements'' that requires a covered SD to notify the
Commission if its regulatory capital falls below 120 percent of its
minimum requirement.\253\ Commenters further stated that the resulting
9.6% common equity tier 1 capital requirement is not consistent with
any bank-based capital methodology.\254\
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\253\ Id.
\254\ See MS 3/3/2020 Letter.
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Commenters suggested that the Commission align the proposed 8%
common equity tier 1 capital requirement with the Federal Depository
Insurance Corporation's prompt corrective action (``PCA'') framework,
which is calibrated based on the U.S. Basel III risk-weighted average
framework.\255\ Under the PCA framework, a bank is deemed ``adequately
capitalized'' if it maintains common equity tier 1 capital of at least
4.5 percent of the bank's risk-weighted assets, and is deemed ``well
capitalized'' if it maintains common equity tier 1 capital of at least
6.5 percent of the bank's risk-weighted assets.\256\ Commenters
recommended revising the final regulations to provide that a covered SD
that elects the Bank-Based Capital Approach must maintain common equity
tier 1 capital at a level that is not less than 4.5 percent of the SD's
risk-weighted assets, and must maintain common equity tier 1 capital in
excess of 6.5 percent of the SD's risk-weighted assets in computing the
``early warning capital requirement'' under proposed regulation
23.105(c)(2).\257\ Another commenter suggested that the Commission
adopt a risk-weighted asset ratio that is tiered based on the size and
complexity of the covered SD's business (e.g., a 4.5% common equity
tier 1 requirement with the tier 2 capital being eligible for the
remaining 3.5%).\258\
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\255\ Id.
\256\ See 12 CFR 208.43(b) for the Federal Reserve Board's
capital measures and capital levels that are used for determining
the supervisory actions for insured depository institutions that are
not adequately capitalized.
\257\ See IIB/ISDA/SIFMA 3/3/2020 Letter. MS 3/3/2020 Letter at
8.
\258\ See Shell 3/3/2020 Letter.
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The Commission has considered the proposed requirement for a
covered SD electing the Bank-Based Capital Approach to maintain common
equity tier 1 capital equal to or in excess of 8% of the SD's risk-
weighted assets, and has considered the comments that have been
received. The Commission is adopting the requirement as a component of
the final capital rule for covered SDs electing the Bank-Based Capital
Approach, subject to the following modifications. The Commission is
retaining the minimum requirement for a covered SD to maintain capital
at a level equal to or in excess of 8% of the SD's risk-weighted
assets. The Commission is modifying the final regulation, however, to
require that at least 6.5% of the minimum 8% capital requirement must
be common equity tier 1 capital, with the remaining 1.5% to be
comprised of common equity tier 1 capital, additional tier 1 capital,
or tier 2 capital, as defined by the Federal Reserve Board in 12 CFR
217.20. The Commission is further modifying the final rule to provide
that any capital that is in the form of subordinated debt must meet the
conditions adopted by the SEC for qualifying subordinated debt for
SBSDs set forth in rule 18a-1d (17 CFR 240.18a-1d). In addition, a
covered SD may use additional tier 1 and tier 2 capital (including
qualifying subordinated debt) to meet the early warning capital
requirement above the 6.5% of common equity tier 1 capital.
The Commission is adopting these modifications as it believes that
it establishes an appropriate balance between ensuring that a covered
SD maintains an appropriate level of permanent capital in the form of
common equity tier 1 capital and permitting an SD to use other forms of
capital formation, including qualifying subordinated debt. As noted
below, the subordinated debt qualifications require the lender to
subordinate their claims against the covered SD to the claims of all
other creditors, which is comparable to the position of holders of
common equity capital. The subordinated debt regulations further place
restrictions on the ability of the SD to repay the subordinated debt if
it would adversely impact the capital of the SD.\259\ In addition,
final regulation 23.104 imposes limitations on the withdrawal of equity
from a covered SD by actions of its shareholders, including paying
dividends and similar distributions, if such distributions would result
in the SD holding less than 120% of its minimum capital
requirement.\260\ These additional regulatory requirements effectively
ensure that the capital, including capital provided in the form of
subordinated debt, is retained in the covered SD ensuring its safety
and soundness.
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\259\ See, e.g., SEC rule 18a-1d(b)(7) (17 CFR 240.18a-1(b)(7))
which suspends a SBSD's obligation to make a scheduled payment on a
subordinated loan agreement if, after giving effect to the payment
obligation (and to any other payment obligations under other
subordinated debt agreements that are scheduled to be paid on or
before the payment date of the subordinated loan agreement in
question), the SBSD's net capital would fall below 120 percent of
the SBSD's minimum net capital or tentative net capital requirement,
as applicable.
\260\ See final Commission regulation Sec. 23.104.
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The final rule is also consistent with the Commission's capital
rules for FCMs, the SEC's rules for BDs and SBSDs, and the prudential
regulators' rules for banks and bank holding companies, all of which
recognize certain qualifying subordinated debt as capital.\261\ The
final regulations also impose identical terms and conditions on
qualifying subordinated debt under the Bank-Based Capital Approach and
the Net Liquid Assets Capital Approach as covered SDs electing either
approach
[[Page 57495]]
are subject to the subordinated debt provision of SEC rule 18a-1d.\262\
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\261\ See, e.g., Commission regulation Sec. 1.17(h) (17 CFR
1.17), SEC rules 15c3-1d and 18a-1d (17 CFR 240.15c3-1d and 17 CFR
240.18a-1d), and Federal Reserve Board rule 217.20 (12 CFR 217.20)
for rules governing subordinated debt as capital for FCMs, BDS and
SBDS, and banks and bank holding companies, respectively.
\262\ A covered SD that elects the Net Liquid Assets Capital
Approach is permitted under SEC rule 18a-1 (17 CFR 240.18a-1) to
recognize subordinated debt that meets the qualification standards
in SEC rule 18a-1d (17 CFR 240.18a-1d) in meeting its minimum
capital requirements.
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The SEC's qualification conditions in Rule 18a-1d require that the
loan agreement must: (i) Be in writing and have a minimum term of at
least one year; (ii) be a valid and binding obligation enforceable in
accordance with its terms against the SD and the lender; and (iii)
effectively subordinate any right of the lender to receive any payment
with respect to the loan agreement to the prior payment in full of all
claims of all present and future creditors of the covered SD arising
out of any matter occurring prior to the date on which the related
payment obligation matures, except for claims which are the subject of
subordinated loan agreements that rank on the same priority as, or
junior to, the claim of the lender under the subordinated loan
agreement. Rule 18a-1d also contains conditions intended to ensure that
the SBSD does not make payments on subordinated loans if such payments
would reduce the SBSD's net capital below 120% of its minimum capital
requirement. These terms and conditions effectively result in the
subordinated debt having the characteristics of common equity as the
issuances of the subordinated loan rank just above common equity
holders in the event of the insolvency of the covered SD. Therefore,
the Commission believes that it is appropriate to recognize
subordinated debt that meets the conditions of SEC rule 18a-1d to
qualify as tier 2 capital under the Commission's final regulation.
Calculation of Risk-Weighted Assets
As noted above, the Proposal required a covered SD electing the
Bank-Based Capital Approach to compute its risk-weighted assets in
accordance with the Federal Reserve Board's capital requirements
contained in 12 CFR part 217. Covered SDs using the standardized
approach were required to use the credit risk charges from the Federal
Reserve Board's standardized approach under subpart D 12 CFR part 217.
Covered SDs using internal capital models were required to use models
that met the qualitative and quantitative requirements set forth in
proposed regulation 23.102 and Appendix A to regulation 23.102. The
qualitative and quantitative requirements set forth in regulation
23.102 and Appendix A were based on the Federal Reserve Board's
qualitative and quantitative requirements for capital models in 12 CFR
part 217. Federal Reserve Board model-based capital charges for credit
risk and market risk are set forth in 12 CFR part 217 subparts E and F,
respectively.
Commenters noted that the Federal Reserve's capital approach is
currently undergoing significant transformation as it implements the
revised Basel III framework adopted in 2017.\263\ One commenter stated
that the Federal Reserve Board's implementation of certain fundamental
aspects of the Basel III framework, including approaches for credit,
market, and operational risks remain pending, and further noted that
the BCBS is also making further revisions to the credit valuation
adjustment risk framework to further align it with other capital
requirements.\264\ Another commenter stated that there are significant
ongoing efforts to revise specific credit risk and market risk
methodologies, which will likely require at least two, and potentially
several, years to reach finalization.\265\ The commenters stated that
it is essential that the Commission adopt a Bank-Based Capital Approach
that provides covered SDs with certainty of application despite these
and other future changes to the bank capital framework.\266\ The
commenters stated that given the ongoing revisions to the banking
regulators' capital requirements, the Commission should revise its
rules to incorporate the Federal Reserve Board's rules by reference
instead of setting forth explicit capital model provisions and
quantitative and qualitative capital requirements in Appendix A of
regulation 23.102.
---------------------------------------------------------------------------
\263\ IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
\264\ IIB/ISDA/SIFMA 3/3/2020 Letter.
\265\ MS 3/3/2020 Letter.
\266\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
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The commenters also specifically stated that given the current
unsettled nature of the prudential regulators' requirements, covered
SDs electing the Bank-Based Capital Approach that are approved to use
internal market risk and credit risk models should be permitted to
choose whether or not to apply the Federal Reserve Board's provisions
for advanced approaches for Federal Reserve Board-regulated
institutions.\267\ The Commenter further stated that covered SDs should
also be permitted to compute their credit risk-weighted assets using
the current exposure method (``CEM''), the internal models method
(``IMM''), or SA-CCR with certain modifications.\268\
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\267\ Id.
\268\ Id. The CEM, IMM, and SA-CCR approaches for computing
credit risk are set forth in the Federal Reserve Board's capital
rules for bank holding companies, 12 CFR part 217.
---------------------------------------------------------------------------
The Commission has considered the Proposal and the comments
requesting flexibility in adopting the Bank-Based Capital Approach. The
Commission understands that some critical elements of Basel III are
still being revised and adoption by the Federal Reserve Board is an
ongoing process that may span several years, which makes incorporating
specific market risk and credit risk components of the Federal Reserve
Board's rules into Appendix A of regulation 23.102 difficult. In this
process the Federal Reserve Board also may allow for alternative
calculation methods, some transitionally and some permanently, which
further makes specific incorporation of bank capital requirements into
Appendix A challenging.
The Commission does not want to introduce conflicting deadlines,
contradictory guidance, or cause firms to incur duplicative model
implementation costs during this implementation process. Thus, the
Commission is modifying the final rules to incorporate the Federal
Reserve Board's market risk and credits requirements by referencing the
applicable sections of the Federal Reserve Board's regulations in 12
CFR part 217 instead of incorporating specific market risk and credit
risk requirements contained in 12 CFR part 217 into Appendix A of
regulation 23.102. This modification of the rule text will provide
legal certainty to the covered SDs that future changes to the relevant
market risk and credit risk requirements in 12 CFR part 217 will be
appropriately incorporated into the Commission's capital requirements
without further Commission action, such as a rulemaking. The Commission
will retain Appendix A of regulation 23.102 as it will be applicable to
covered SDs electing the Net Liquid Assets Capital Approach or the
Tangible Net Worth Capital Approach to compute market risk and credit
risk capital charges.
The Commission is also modifying the final rule to provide that
where the Federal Reserve Board's rules allow for alternative
calculation methods, the Commission's final rule also allows for the
same alternatives. For example, commenters noted that subpart D of 12
CFR part 217 currently provides that bank holding companies may compute
standardized credit risk charges for OTC
[[Page 57496]]
derivative transactions using either the CEM or SA-CCR calculation
methods. The Commission's final rule permits covered SDs to elect to
use either method, recognizing that both CEM and SA-CCR are part of the
BCBS international capital framework and have been adopted by the
prudential regulators.
Furthermore, the choice of calculation method elected by a covered
SD does not have to be the same as the calculation method the covered
SD's banking parent or affiliate elects to use or is required to use
under the Federal Reserve Board's rules. For example, a covered SD may
elect to use the CEM method notwithstanding that its banking affiliate
uses the SA-CCR method. However, a covered SD must address these
differences in its model application, particularly if it relies upon or
uses model documentation provided by a banking affiliate to prudential
regulators as part of a model approval or oversight process by the
prudential regulators. The covered SD also must inform the Commission
or NFA if another regulator has denied its or its affiliate's use of an
alternative calculation.
In choosing an alternative calculation the non-bank SD must adopt
the entirety of the alternative. The Commission understands that some
alternatives may include charges or deductions for risks not otherwise
part of market and credit risk models described in this rule (e.g.,
operational risk), however, the Commission is not prepared to accept
partial application of alternative calculation methods or to compensate
this inclusion by reducing other charges calculated per this rule
outside of the market and credit risk models.
The Commission is implementing the above revisions to the final
rules by modifying regulation 23.100 to include a definition of the
term ``BHC equivalent risk-weighted assets'' that defines the method
that a covered SD that elects the Bank-Based Capital Approach uses to
compute market risk and credit risk using either models or standardized
charges in computing its regulatory capital. Under the BHC equivalent
risk-weighted assets definition, a covered SD that is not approved to
use models would compute market risk in accordance with the
standardized charges in Commission regulation 1.17 and SEC rule 18a-1,
and would compute credit risk charges in accordance with the
standardized charges using the bank holding company regulations in
subpart D of 12 CFR part 217. Covered SDs approved to use models would
compute market risk in accordance with the bank holding company
requirements set forth in subpart F of 12 CFR part 217, and would
compute credit risk charges in accordance with the bank holding company
requirements in subpart E of 12 CFR part 217. The Commission also is
modifying regulation 23.103 to remove the calculation of market and
credit risk under the Bank-Based Capital Approach as it is now
contained in revised regulation 23.100, and modifying definitions in
regulation 23.100 to define the terms ``advanced approaches Board-
regulated institution'' and ``OTC derivative contract'' to effect the
above revisions to the rule text.
Commenters also requested that the Commission modify the final
rules by providing an adjustment to the Federal Reserve Board's SA-CCR
credit risk calculation when the SD applies SA-CCR in computing its
capital.\269\ One commenter stated that the Federal Reserve Board's SA-
CCR rules set a ``supervisory factor'' for energy derivatives of
between 18%, for oil and natural gas transactions, and 40%, for
electricity transactions.\270\ The commenter represented that when
adopting the calibrations, the Federal Reserve Board calibrated the
supervisory factors to spot prices rather than forward prices. The
commenter stated that SDs active in the oil, natural gas, and
electricity markets are heavily concentrated in forward markets, which
have very different volatilities and credit risk profiles than those of
spot markets.
---------------------------------------------------------------------------
\269\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
\270\ See MS 3/3/2020 Letter.
---------------------------------------------------------------------------
The Commission is not modifying the final regulations to reset the
supervisory factors adopted by the Federal Reserve Board for derivative
transactions. This is an issue that the Commission will assess during
the implementation of the rule.
Minimum Capital Requirement Based on Risk Margin Amount Under Bank-
Based Capital Approach
The third criterion comprising the minimum capital requirement
under the proposed Bank-Based Capital Approach required a covered SD to
maintain common equity tier 1 capital equal to or in excess of 8% of
the sum of: (i) The covered SD's uncleared swap margin requirements for
uncleared swaps transactions; (ii) the initial margin that would be
required for each uncleared security-based swap transaction pursuant to
SEC's proposed Rule 18a-3(c)(1)(i)(B), without regard for any amounts
of security-based swaps that may be exempted or excluded under the
SEC's proposal; (iii) the risk margin required on the covered SD's
cleared futures, foreign futures, and swaps positions; and (iv) the
amount of initial margin required by a clearing organization that
clears the covered SD's proprietary security-based swaps.\271\
---------------------------------------------------------------------------
\271\ See 2016 Capital Proposal, 81 FR 91252 at 91258-59.
---------------------------------------------------------------------------
This requirement was intended to ensure that a covered SD electing
the Bank-Based Capital Approach maintains a minimum level of capital
that is comprehensive with respect to all of the SD's operations and
activities. The Commission believed that the proposed 8% risk margin
amount was an appropriate approach as the minimum capital requirement
was correlated with the ``risk'' of the covered SD's futures, foreign
futures, swaps, and security-based swaps positions as measured by the
margin required on the positions. Specifically, a covered SD's minimum
capital requirement would increase or decrease in proportion to the
number, size, complexity and all risks inherent in the SD's customer,
client, and proprietary derivatives business.\272\
---------------------------------------------------------------------------
\272\ See 2016 Capital Proposal, 81 FR 91252 at 91258.
---------------------------------------------------------------------------
Commenters generally raised the same concerns regarding the 8% risk
margin amount as discussed in detail in section II.C.2.a. above for the
covered SDs electing the Net Liquid Assets Capital Approach.
Specifically, commenters stated the 8% risk margin amount is too high a
percentage and includes too many types of derivatives products.
Commenters also stated that the risk margin amount is not a good
measure of the risk of the positions to the covered SD.
One commenter also stated that the Commission should not adopt the
8% risk margin amount for covered SDs electing the Bank-Based Capital
Approach. One commenter stated that prudential regulators do not have a
minimum capital requirement based on a bank SD's risk margin
amount.\273\
---------------------------------------------------------------------------
\273\ IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------
One commenter stated that if the Commission adopted the risk margin
amount, the Commission should modify the final regulation to permit
covered SDs electing the Bank-Based Capital Approach to include
additional tier 1 capital and tier 2 capital in addition to common
equity tier 1 capital in meeting the risk margin amount.\274\
---------------------------------------------------------------------------
\274\ Id.
---------------------------------------------------------------------------
The Commission has considered the proposed risk margin amount
requirement for covered SDs electing the Bank-Based Capital Approach
and has considered the comments received, and is adopting the
requirement with
[[Page 57497]]
several modifications. The final regulation will require a covered SD
electing the Bank-Based Capital Approach to maintain a combination of
common equity tier 1 capital, additional tier 1 capital, and tier 2
capital in an amount equal to or greater than 8% of the covered SD's
uncleared swap margin. The term ``uncleared swap margin'' is defined in
regulation 23.100, and means the amount of initial margin computed in
accordance with the Commission's uncleared margin rules (regulation
23.154; 17 CFR 23.154) that a SD would be required to collect from each
counterparty for each outstanding swap position of the SD, including
all swap positions that are excluded or exempt from the uncleared
margin rules under regulation 23.150 (17 CFR 23.150), legacy swap
positions, exempt foreign exchange swaps or foreign exchange forwards.
As discussed in section II.C.2.a. above, the Commission believes
that a minimum capital requirement based on initial margin is an
appropriate component of a covered SD's minimum capital requirement.
The intent of the risk margin amount requirement was to ensure that a
covered SD has a sufficient level of capital to meet its obligations as
a SD, and to cover potential operational risk, legal risk, and other
risks, and not just the risks of its trading portfolio. The Commission
believes that the risk margin amount is a minimum capital requirement
that provides a floor based on a measure of the risk of the swap
positions, the volume of positions, the number of counterparties and
the complexity of operations of the covered SD. The risk margin amount
is based on the initial margin that is computed on the proprietary
positions held by the covered SD. Initial margin reflects the degree of
risk associated with the positions, with lower risk positions having
lower initial margin requirements and higher risk positions having
higher initial margin requirements. Therefore, the Commission believes
that because the risk margin amount calculation is directly related to
the volume, size, complexity and risk of the covered SD's uncleared
swap positions, it serves as a good proxy for inherent risk in the SD's
positions, operations, and other risks, and is used to calibrate the
amount of the minimum capital required of a covered SD.
The Commission, however, is not modifying the regulation by
lowering the risk margin amount multiplier from 8% to 2% or to a
different percentage. As discussed in section II.C.2.a. above, the
minimum capital requirement based upon the risk margin amount is
applied in a different manner in the Bank-Based Capital Approach as
compared with the Net Liquid Assets Capital Approach. Under the Bank-
Based Capital Approach, a covered SD is required to maintain balance
sheet equity in excess of 8% of the risk margin on uncleared swap
positions. This approach is a less conservative approach than the Net
Liquid Assets Capital Approach, which requires a covered SD to maintain
current, liquid assets, less market risk and credit risk capital
charges on proprietary positions including swaps and security-based
swaps, in excess of 2% of the risk margin amount on uncleared swaps.
Due to the different approaches, the Commission believes that it is
appropriate to set the risk margin amount multiplier at 8% under the
Bank-Based Capital Approach to help ensure that the minimum capital
requirement ensures the safety and soundness of the covered SD.
The Commission also believes that many of the commenters' concerns
are mitigated by the modifications that the Commission is making to the
final regulation. Consistent with its approach for FCM-SDs and Net
Liquid Assets Capital Approach, the Commission is modifying the final
regulation to exclude cleared and uncleared security-based swap
positions, and proprietary futures, foreign futures, and cleared swap
positions from the risk margin amount calculation.
In addition, as noted above, the Commission will monitor the risk
margin amount after the compliance date of the regulations to assess
whether adjustments are necessary to the regulations to ensure the
safety and soundness of the covered SD. The Commission will use the
information that it obtains from financial reports submitted by covered
SDs and from the Commission's and NFA's ongoing oversight of the SDs to
continually monitor and evaluate the adequacy of the minimum capital
requirements.
Minimum Capital Requirement of a Registered Futures Association Under
Bank-Based Capital Approach
The fourth criterion of the proposed minimum capital requirements
required a covered SD to maintain the minimum level of capital required
by an RFA of which the covered SD is a member. As noted above, the
proposed minimum capital requirement based on membership requirements
of an RFA is consistent with current FCM capital requirements under
regulation 1.17, and reflects Commission regulations that require each
covered SD to be a member of an RFA.\275\ As further noted above, the
Proposal is also consistent with section 17(p)(2) of the CEA, which
provides, in relevant part, that an RFA must adopt rules establishing
minimum capital and other financial requirements applicable to the
RFA's members for which such requirements are imposed by the
Commission.\276\ The Proposal recognizes that the NFA, as the only RFA,
would be required by section 17 of the CEA to adopt capital rules for
covered SDs once the Commission imposes capital requirements on covered
SDs, and would incorporate the NFA minimum capital requirements into
the Commission's regulation.
---------------------------------------------------------------------------
\275\ See Commission regulations Sec. Sec. 1.17(a)(1)(i)(C) and
170.16 (17 CFR 1.17(a)(1)(i)(C) and 170.16).
\276\ See section 17(p)(2) of the CEA, which requires RFAs to
adopt rules establishing minimum capital and other financial
requirements applicable to its members for which such requirements
are imposed by the Commission, provided that such requirements may
not be less stringent than the requirements imposed by the CEA or by
Commission regulations.
---------------------------------------------------------------------------
The Commission received general comments regarding the proposed
requirement that a covered SD must meet the capital rules adopted by
the NFA. Several commenters stated that any future NFA capital rules
for covered SDs should be subject to public comment.\277\ Another
commenter stated that the Commission's efforts to obtain public input
pursuant to the 2016 Capital Proposal and the 2019 Capital Reopening
may be nullified if the NFA adopts capital rules that are different
from the Commission's final rules, and requested that the Commission
require NFA to adopt capital rules that closely mirror the Commission's
final capital rules, or, at the least, require NFA to conduct a
rigorous notice and comment process prior to finalizing its capital
rules.\278\
---------------------------------------------------------------------------
\277\ ED&F Man/INTL FCStone 3/3/2020 Letter; Shell 3/2/2020
Letter.
\278\ See Shell 3/2/2020 Letter.
---------------------------------------------------------------------------
As discussed in section II.C.2.a. above, the Commission believes
that commenters' concerns are largely mitigated by the existing
statutory and Commission regulatory requirements as well as the
internal governance structure of NFA, which was established to comply
with these requirements. Section 17(j) of the CEA requires NFA to file
with the Commission any change in or addition to its rules. Any such
change or addition is effective within 10 days of submission unless NFA
requests, or the Commission notifies NFA of its intent to subject the
filing to, a review and approval process.\279\ Further, NFA's
governance structure ensures that SDs are represented in the
[[Page 57498]]
potential adoption of NFA rules, including capital and financial
reporting rules, that may impact them. As noted in section II.C.2.a.
above, section 17(b)(5) of the CEA and regulation 170.3 require
generally that the rules of an RFA assure fair representation of its
members in the adoption of any rule, in the selection of its officers,
directors, and in other aspects of its administration.\280\ Therefore,
the Commission is adopting this component of the minimum capital
requirements of the Bank-Based Capital Approach as proposed.
---------------------------------------------------------------------------
\279\ See section 17(j) of the CEA (7 U.S.C. 21(j)).
\280\ 7 U.S.C. 21(b)(5) and Commission regulation Sec. 170.3
(17 CFR 1.17). See also, section 17(b)(11) of the CEA (7 U.S.C.
21(b)(11)) which requires that an RFA provide for meaningful
representation on the governing board of such association of a
diversity of membership interests and provides that no less than 20
percent of the regular voting members of[the board be comprised of
qualified nonmembers of or persons not regulated by such
association.
---------------------------------------------------------------------------
Final Minimum Capital Requirement for Covered SDs Electing the Bank-
Based Capital Approach
As noted above, the Commission proposed that a covered SD electing
the Bank-Based Capital Approach must maintain common equity tier 1
capital equal to or greater than the greatest of (i) $20 million, (ii)
8% of the covered SD's risk margin amount, (iii) 8% of the covered SD's
risk-weighted assets, or (iv) the amount of capital required by an RFA.
Also as noted above, the Commission is modifying the final regulation
to permit a covered SD to hold common equity tier 1, additional tier 1,
and tier 2 capital to meet the 8% of the risk margin amount and to meet
the 8% of risk weighted assets. Therefore, the Commission is modifying
the final minimum capital requirement to require a covered SD to
satisfy each of the four minimum capital requirements. This
modification is intended to align the final rule with the original
proposal, which required a covered SD to hold a sufficient amount of
common equity tier 1 capital to meet each of the four minimum capital
requirements. Under the final rule, the covered swap dealer will
continue to have to meet each of the four criteria, but may use capital
other than common equity tier 1 capital to meet such requirements
consistent with the rule.
4. Capital Requirement for Covered SDs Electing the Tangible Net Worth
Capital Approach
The Commission proposed to permit covered SDs that are
``predominantly engaged in non-financial activities,'' as defined
below, to elect a capital requirement based on the SD's tangible net
worth (the ``Tangible Net Worth Capital Approach'').\281\ The term
``tangible net worth'' was proposed to be defined as the net worth of a
covered SD, as determined in accordance with U.S. GAAP, excluding
goodwill and other intangible assets.\282\ The 2016 Capital Proposal
further required a covered SD, in computing its tangible net worth, to
include all liabilities or obligations of a subsidiary or affiliate
that the covered SD guaranteed, endorsed, or assumed either directly or
indirectly to ensure that the tangible net worth of the covered SD
reflects the full extent of the covered SD's potential financial
obligations.\283\ The proposed definition further provided that in
determining net worth, all long and short positions in swaps, security-
based swaps, and related positions must be marked to their respective
market values to ensure that the tangible net worth reflected the
current market value of the covered SD's swap and security-based swap
positions, including any accrued losses on such positions.\284\
---------------------------------------------------------------------------
\281\ See proposed Commission regulation Sec. 23.101(a)(2)(ii),
2016 Capital Proposal, 81 FR 91252 at 91311.
\282\ See proposed Commission regulation Sec. 23.100, 2016
Capital Proposal, 81 FR 91252 at 91309-10.
\283\ See proposed definition of ``tangible net worth'' in
Commission regulation Sec. 23.100, 2016 Capital Proposal, 81 FR
91252 at 91310.
\284\ Id.
---------------------------------------------------------------------------
The Commission further proposed that a covered SD eligible for the
Tangible Net Worth Capital Approach must maintain tangible net worth in
an amount equal to or in excess of the greatest of:
(1) $20 million plus the amount of the covered SD's market risk
exposure requirement and credit risk exposure requirement associated
with the covered SD's swap and related hedge positions that are part of
the covered SD's swap dealing activities;
(2) 8% of the sum of:
(a) The amount of uncleared swap margin (as that term was defined
in regulation 23.100) for each uncleared swap position open on the
books of the covered SD, computed on a counterparty by counterparty
basis pursuant to regulation 23.154 without regard to any initial
margin exemptions or thresholds that the Commission's margin rules may
provide;
(b) the amount of initial margin that would be required for each
uncleared security-based swap position open on the books of the covered
SD, computed on a counterparty by counterparty basis pursuant to 17 CFR
240.18a-3(c)(1)(i)(B) without regard to any initial margin exemptions
or exclusions that the rules of the SEC may provide to such security-
based swap positions; and
(c) the amount of initial margin required by clearing organizations
for cleared proprietary futures, foreign futures, swaps and security-
based swaps positions open on the books of the covered SD; or
(3) The amount of net capital required by the registered futures
association of which the covered SD is a member.
The 2016 Capital Proposal further provided that a covered SD could
use internal models to compute market risk and credit risk capital
charges provided that the models were approved by the Commission or an
RFA.\285\ A covered SD that did not obtain Commission or RFA approval
to use internal models was required to compute standardized market risk
and credit risk charges for its proprietary swaps, security-based
swaps, or other financial positions in accordance with the FCM
standardized market risk and credit risk capital charges set forth
under regulation 1.17, as proposed to be amended.\286\
---------------------------------------------------------------------------
\285\ See proposed Commission regulation Sec. 23.102(a), 2016
Capital Proposal, 81 FR 91252 at 91311.
\286\ See section II.B.3.a above for a discussion of the
standardized market risk and credit risk capital charges for FCMs
and FCM-SDs.
---------------------------------------------------------------------------
The Commission also proposed that to be eligible to use the
Tangible Net Worth Capital Approach, a covered SD's financial
activities must be de minimis in relation to its overall financial and
non-financial activities. Specifically, the 2016 Capital Proposal
provided that the covered SD must be ``predominantly engaged in non-
financial activities.'' The term ``predominantly engaged in non-
financial activities'' was proposed to be defined by referencing the
definition of the term ``financial activities'' under the Federal
Reserve Board's regulations establishing criteria for determining if a
nonbank financial company is ``predominantly engaged in financial
activities'' and therefore, subject to Federal Reserve Board
oversight.\287\
---------------------------------------------------------------------------
\287\ See 12 CFR 242.3.
---------------------------------------------------------------------------
Title I of the Dodd-Frank Act established the Financial Stability
Oversight Council (``FSOC''), which, among other authorities and
duties, may subject a nonbank financial company to supervision by the
Federal Reserve Board and consolidated prudential standards if the FSOC
determines that material financial distress at the nonbank financial
company, or the nature, scope, size, scale, concentration,
interconnectedness, or mix of the company's activities, could pose a
threat to the financial stability of the U.S. Title I of the Dodd-Frank
Act defines a ``nonbank financial company'' to include both a U.S.
nonbank financial
[[Page 57499]]
company and foreign nonbank financial company that, among other things,
are ``predominantly engaged in financial activities.'' For purposes of
Title 1 of the Dodd-Frank Act, a company is considered to be
``predominantly engaged'' in financial activities if either (i) the
annual gross revenue derived by the company and all of its subsidiaries
from financial activities, as well as from the ownership or control of
an insured depository institution, represented 85 percent or more of
the consolidated annual gross revenues of the company; or (ii) the
consolidated assets of the company and all of its subsidiaries related
to financial activities, as well as related to the ownership or control
of an insured depository institution, represent 85 percent or more of
the consolidated assets of the company.
The Commission proposed to adopt this Federal Reserve Board
standard to distinguish covered SDs that are predominantly engaged in
financial activities from covered SDs that are predominantly engaged in
non-financial activities. The Commission, however, modified the test
for purposes of the eligibility of the Tangible Net Worth Capital
Approach to provide that a covered SD would be considered
``predominantly engaged in non-financial activities'' if: (i) The
consolidated annual gross financial revenues of the covered SD in
either of its two most recently completed fiscal years represented less
than 15 percent of the consolidated gross revenue in that fiscal year
(``15% Revenue Test''); and (ii) the consolidated total financial
assets of the covered SD at the end of its two most recently completed
fiscal years represented less than 15 percent of the consolidated total
assets as of the end of the fiscal year (``15% Asset Test'').
The 2016 Capital Proposal also proposed to define the financial
activities covered by the 15% Revenue Test and 15% Asset Test by
reference to the listed financial activities set forth in Appendix A of
12 CFR part 242, which covers an extensive range of financial
activities and services.\288\ The financial activities set forth in
Appendix A of 12 CFR part 242 include, among other things: (i) Lending,
exchanging, transferring, investing for others, or safeguarding money
or securities; (ii) insuring, guaranteeing, or indemnifying against
loss or harm, damage or death in any state; (iii) providing financial,
investment, or economic advisory services; (iv) issuing or selling
interests in a pool; (v) underwriting, dealing in, or making a market
in securities; and (vi) engaging as principal in the investment and
trading of certain financial instruments. The Commission, however,
proposed to explicitly provide that accounts receivable from non-
financial activities, which may meet the definition of financial
activities under 12 CFR part 242, may be excluded by the covered SD
from the computation of its financial activities.\289\ The Commission
stated that the purpose of providing this exclusion was to prevent the
covered SD's non-financial activities from becoming part of the
computation of the covered SD's financial activities merely on the
basis that the non-financial activities result in the covered SD
recognizing receivables.
---------------------------------------------------------------------------
\288\ See definition of ``predominantly engaged in non-financial
activities'' in proposed Commission regulation Sec. 23.100, 2016
Capital Proposal, 81 FR 91252 at 91309.
\289\ Id.
---------------------------------------------------------------------------
The Commission proposed the Tangible Net Worth Capital Approach in
recognition that certain entities that engage predominantly in non-
financial activities may currently or in the future meet the statutory
and regulatory definition of the term ``swap dealer'' and, therefore,
will be required to register as such with the Commission.\290\ The
Commission stated that while these entities may meet the definition of
a ``swap dealer'' they may also be primarily commercial entities
engaged predominantly in non-financial activities.\291\ The Commission
further recognized that covered SDs that are primarily engaged in
commercial activities differ from financial entities in various ways,
including the composition of their respective balance sheets (e.g., the
types of assets they hold), the types of transactions they enter into,
and the types of market participants and swap counterparties that they
deal with. Because of these differences, the Commission stated that
application of the Bank-Based Capital Approach or the Net Liquid Assets
Capital Approach could result in inappropriate capital requirements
that would not be proportionate to the risk taken by such covered SDs,
and proposed to permit these covered SDs to have an option of electing
the Tangible Net Worth Capital Approach.\292\ The Commission, however,
modified the standards established by the Federal Reserve Board as it
believed that covered SDs that engage in anything more than a de
minimis level of financial activities must be subject to either the Net
Liquid Assets Capital Approach or the Bank-Based Capital Approach in
order for the Commission's regulations to achieve the Congressional
mandate that the SD capital requirements ensure the safety and
soundness of the SD.
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\290\ The term ``swap dealer'' is defined by section 1a(49) of
the CEA and Commission regulation Sec. 1.3 (17 CFR 1.3). Regulation
1.3 provides that an entity may apply to limit its designation as an
SD to specified categories of swaps or specified activities in
connection with swaps.
\291\ See 2016 Capital Proposal, 81 FR 91252 at 91255.
\292\ Furthermore, as an SD, the firm is subject to the
Commission's final swaps margin requirements.
---------------------------------------------------------------------------
The Commission received comments generally supporting the proposed
Tangible Net Worth Capital Approach, but also stating that the
qualifying criteria were overly narrow and entity specific.\293\
Commenters generally noted that a parent entity that is ``predominantly
engaged in non-financial activities'' as defined by the regulation
would not be permitted in any practical way to establish a covered SD
subsidiary that would qualify to use the Tangible Net Worth Capital
Approach as the swaps activity of the SD subsidiary would be considered
financial activities.\294\ Another commenter stated that commercial
firms often establish subsidiaries to perform centralized risk
management operations for the full commercial enterprise, including
entering into swap transactions, and that such subsidiaries should have
the ability to elect a Tangible Net Worth Capital Approach.\295\
Commenters further noted that the proposed Tangible Net Worth Capital
Approach would discriminate against corporate entities that are
predominantly engaged in non-financial activities but elect to maintain
their swap dealing activities in separate legal entities.\296\ Several
commenters suggested that the Commission should address these concerns
by modifying the Proposal to permit a covered SD to elect the Tangible
Net Worth Capital Approach if the SD or its parent meets the qualifying
criteria of ``predominantly engaged in non-financial activities.''
\297\
---------------------------------------------------------------------------
\293\ See, e.g., Letter from Phillip Lookadoo, and Jeremy
Weinstein, International Energy Credit Association (May 15, 2017)
(IECA 5/15/2017 Letter); Letter from Scott Earnest, Shell Trading
Risk Management LLC (May 15, 2017) (Shell 5/15/2017 Letter); Letter
from David McIndoe, Commercial Energy Working Group (May 15, 2017)
(CEWG 5/15/2017 Letter); and Letter from Michael P. LeSage, Cargill
Risk Management, a unit of Cargill, Inc. (May 15, 2017) (Cargill 5/
15/2017 Letter).
\294\ See IECA 5/15/2017 Letter; Shell 5/15/2017 Letter; CEWG 5/
15/2017 Letter.
\295\ See Letter from National Corn Growers Association and
National Gas Supply Association, (May 15, 2017) (NCGA/NGSA 5/15/2017
Letter).
\296\ See, e.g., Shell 5/15/2017 Letter.
\297\ See IECA 5/15/2017 Letter; CEWG 5/15/2017 Letter; NCGA/
NGSA 5/15/2017 Letter.
---------------------------------------------------------------------------
In reopening the comment period in 2019, the Commission requested
further
[[Page 57500]]
comment on the Tangible Net Worth Capital Approach based upon issues
raised in the 2016 Capital Proposal.\298\ The Commission requested
comment on whether a covered SD that does not meet the ``predominantly
engaged in non-financial activities'' standard should be eligible to
use the Tangible Net Worth Capital Approach if its parent entity, or
the ultimate parent of its consolidated ownership group, satisfies the
qualifying standards.\299\ The Commission further requested comment on
whether a covered SD that relies on a parent entity to satisfy the
``predominantly engaged in non-financial activities'' criteria should
be required to obtain parent guarantees, or some other form of
financial support, for its swaps obligations.\300\
---------------------------------------------------------------------------
\298\ See 2019 Capital Reopening, 84 FR 69664 at 69674-75.
\299\ Id.
\300\ Id.
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The Commission also requested comment in the 2019 Capital Reopening
on whether a covered SD that was primarily engaged in commodity swaps
should be permitted to use the Tangible Net Worth Capital Approach
notwithstanding that its parent entity does not meet the
``predominantly engaged in non-financial activities'' requirements
(i.e., the parent is primarily engaged in financial activities).\301\
Finally, the Commission requested comment regarding modifications that
commenters believed the Commission should consider to the 15% Asset
Test and/or the 15% Revenue Test, and requested that commenters explain
why such modifications were necessary to achieve the purpose and
objective of the Tangible Net Worth Capital Approach.\302\
---------------------------------------------------------------------------
\301\ Id.
\302\ Id.
---------------------------------------------------------------------------
The Commission received comments in response to the 2019 Capital
Reopening, and the commenters continued to generally support a Tangible
Net Worth Capital Approach.\303\ Several commenters, however, continued
to express the concern that the eligibility criteria, as expressed in
the 15% Asset Test and the 15% Revenue Test, are not broad enough and
should be expanded to provide more covered SDs with the ability to
elect the Tangible Net Worth Capital Approach.\304\ One commenter
stated that the Commission should revise the qualifications to permit
more covered SDs to elect the Tangible Net Worth Capital Approach,
which the commenter viewed as a more suitable approach than the Bank-
Based Capital Approach and the Net Liquid Assets Capital Approach.\305\
---------------------------------------------------------------------------
\303\ See, e.g., IIB/SIFMA/ISDA 3/3/2020 Letter; MS 3/3/2020
Letter; CEWG 3/3/2020 Letter; Letter from Jennifer Fordham, National
Corn Growers Association/Natural Gas Supply Association (March 3,
2020) (NCGA/NGSA 3/3/2020 Letter); ED&F Man/INTL FCStone 3/3/2020
Letter; and Shell 3/3/2020 Letter.
\304\ See, e.g., Shell 3/3/2020 Letter; CEWG 3/3/2020 Letter; MS
3/3/2020 Letter; IIB/SIFMA/ISDA 3/3/2020 Letter; NCGA/NGSA 3/3/2020
Letter.
\305\ See NCGA/NGSA 3/3/2020 Letter. The NCGA/NGSA suggested
that the Commission base the eligibility of the Tangible Net Worth
Capital Approach based on the definition of the term ``financial
entity'' contained in section 2(h)(7)(C)(i)(VIII) of the CEA (7
U.S.C. 2(h)(7)(C)(i)(VIII)).
---------------------------------------------------------------------------
Other commenters stated that the Commission should revise the
eligibility criteria for the Tangible Net Worth Capital Approach to
provide that a covered SD may use such capital approach if it is part
of a holding company or corporate structure that is itself
``predominantly engaged in non-financial activities'' and satisfies the
15% Asset Test and the 15% Revenue Test.\306\ Several of these
commenters noted that parent entities that are non-financial entities
often ``ring-fence'' financial activities (including swap dealing
activities and treasury functions) in affiliates that are stand-alone
legal entities, and that the Commission's Proposal effectively prevents
such stand-alone entities from being eligible for the Tangible Net
Worth Capital Approach as they are not ``predominantly engaged in non-
financial activities.'' \307\ A commenter stated that centralizing
financial functions into a single subsidiary provides efficiencies for
some holding companies that are primarily involved in non-financial
businesses, such as energy production or agriculture, and that the
Commission's rules should be corporate-structure neutral.\308\ An
additional commenter stated that the ultimate parent level is the
proper level at which to determine whether a corporate enterprise, and
its subsidiaries, is predominantly engaged in non-financial
activity.\309\ Another commenter stated that a covered SD that
otherwise qualifies for and elects the Tangible Net Worth Capital
Approach should not be required to obtain a parent guarantee for
obligations arising from its swaps activities.\310\
---------------------------------------------------------------------------
\306\ See Shell 3/3/2020 Letter; CEWG 3/3/2020 Letter; NCGA/NGSA
3/3/2020 Letter.
\307\ See Shell 5/15/2017 Letter; NCGA/NGSA 3/3/2020 Letter.
\308\ See NCGA/NGSA 3/3/2020 Letter.
\309\ See CEWG 3/3/2020 Letter.
\310\ See Shell 3/3/2020 Letter.
---------------------------------------------------------------------------
The Commission also received comments that the eligibility criteria
for the Tangible Net Worth Capital Approach should be modified to
permit a covered SD to use such approach if the SD's swap dealing
activity is focused on agricultural and exempt swap transactions (a
``commodity-focused covered SD''), even if the covered SD is part of a
financial holding company or a corporate parent that provides general
financial services.\311\ Two entities submitted a joint comment stating
that the Commission's capital rules should recognize unique issues of
small, commodity-focused covered SDs by expanding the eligibility
criteria for the Tangible Net Worth Capital Approach to include smaller
covered SDs with portfolios predominantly centered around
counterparties that qualify for the hedging end user exception under
section 2(h)(7) of the CEA.\312\ The joint comment stated that smaller
commodity-focused covered SDs do not present the type of
interconnectedness and systemic risk to the broader financial markets
in comparison to other covered SDs, in part due to (i) relatively lower
trading volumes (i.e., market impact); and (ii) the non-financial and
hedging nature of their customer base.\313\ The joint commenters
further stated that a significant percentage of the customer base and
trading activities of smaller commodity-focused covered SDs may qualify
for the hedging end user exception under section 2(h)(7) of the CEA,
entering into swap transactions for the purpose of hedging physical
commodity risk. The commenters claim that as a result of the end user
exception from clearing and margin, smaller commodity-focused covered
SDs may not collateralize these relationships fully or the extent they
would otherwise be required when dealing with financial entities or
financial end users, and that they would be required to internalize
capital charges for all uncollateralized exposures, placing burdensome
costs on these SDs, their market presence, and ultimately commercial
end user customers.\314\ The commenters suggest that the Commission
should modify the final rule by adopting an additional qualifying test
for smaller commodity-
[[Page 57501]]
focused covered SDs with portfolios predominantly centered on
counterparties that are commercial end users.\315\
---------------------------------------------------------------------------
\311\ See ED&F Man/INTL FCStone 3/3/2020 Letter; MS 3/3/2020
Letter; CEWG 3/3/2020 Letter.
\312\ See ED&F Man/INTL FCStone 3/3/2020 Letter.
\313\ Id. To demonstrate the nature of their customer base as
commercial end users, and the relative size of their trading
activities, the two commenters represent that as of March 3, 2020,
the two firms have not come into scope for complying with the
Commission's margin requirement for uncleared swap transactions.
\314\ Id.
\315\ Id.
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One commenter stated that it agreed with comments filed in response
to the 2016 Capital Proposal, which supported an expansion of the
eligibility for the Tangible Net Worth Capital Approach to covered SDs
that provide access to physical hedging markets.\316\ Commenters also
suggested that the Commission should modify the ``predominantly engaged
in non-financial activities'' criteria by, for instance, providing that
covered SDs whose swaps notional amounts are at least 85 percent
concentrated in commodity reference assets (e.g., agricultural and
exempt commodities) are eligible for the Tangible Net Worth Capital
Approach.\317\
---------------------------------------------------------------------------
\316\ See ED&F Man/INTL FCStone 3/3/2020 Letter (citing Letter
from Christine Stevenson, BP Energy Company (May 15, 2017), Letter
from William Dunaway, INTL FCStone Inc. (May 15, 2017), and Shell 5/
15/2017 Letter).
\317\ See MS 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020 Letter;
CEWG 3/3/2020 Letter.
---------------------------------------------------------------------------
Commenters also suggest modifications to the 15% Assets Test and
15% Revenue Test. One commenter stated the respective tests should
consider the assets and revenue derived from trading and investing in
physical commodities to be non-financial in nature.\318\ This commenter
further suggested that all hedges of commercial risk should be
considered non-financial in nature as the activity is more indicative
of an entity being a commercial end user rather than an entity engaged
in activity that is financial.\319\ Another commenter stated that the
Commission should exclude financial hedges of physical commodity,
interest rate, or other corporate risks from being considered
``financial activities'' for purposes of the 15% Assets Test and the
15% Revenue Test.\320\ This commenter asserted that the use of
financial derivatives to manage commercial risk is common for non-
financial entities and is not indicative of an entity being engaged in
financial activity.\321\ The commenter further stated that the
Commission should consider assets and revenue derived from trading and
investing in physical commodities to be non-financial in nature as
including such activity as ``financial in nature'' under the Federal
Reserve Board's definition of that term, was not because such activity
is financial, but because certain banks need the ability to transact in
physical commodity markets to support their financial derivatives
activity.\322\
---------------------------------------------------------------------------
\318\ See Shell 3/3/2020 Letter. See also, CEWG 3/3/2020 Letter
representing that the inclusion by the Federal Reserve Board of
trading and investing in physical commodities in the definition of
activities that are ``financial in nature'' was because certain
banks need the ability to transact in physical commodity markets to
support their derivatives activity.
\319\ Id.
\320\ See CEWG 3/3/2020 Letter.
\321\ Id.
\322\ Id.
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The Commission has considered the comments received on the proposed
Tangible Net Worth Capital Approach and is adopting the regulations as
proposed, subject to the following modifications. The Commission is
modifying the definition of the term ``predominantly engaged in non-
financial activities'' in regulation 23.100 to effectively extend the
eligibility of the Tangible Net Worth Capital Approach to covered SDs
that are subsidiaries of parent entities that are commercial
enterprises. Specifically, the definition in regulation 23.100 is
modified to provide that a swap dealer is predominantly engaged in non-
financial activities if: (1) The swap dealer's consolidated annual
gross financial revenues, or if the swap dealer is a wholly owned
subsidiary, then the swap dealer's consolidated parent's annual gross
financial revenues, in either of its two most recently completed fiscal
years represents less than 15 percent of the swap dealer's consolidated
gross revenue in that fiscal year, and (2) the consolidated total
financial assets of the swap dealer, or if the swap dealer is wholly
owned subsidiary, the consolidated total financial assets of the swap
dealer's ultimate parent, at the end of its two most recently completed
fiscal years represents less than 15 percent of the swap dealer's
consolidated total assets as of the end of the fiscal year. The
modifications to the definition of the term ``predominantly engaged in
non-financial activities'' will permit a covered SD that either
directly satisfies the 15% Asset Test and the 15% Revenue Test, or is a
subsidiary of an ultimate parent entity that satisfies the 15% Asset
Test and the 15% Revenue Test, to elect the Tangible Net Worth Capital
Approach.
The Commission is adopting this modification as it recognizes that
certain corporate entities that are predominantly engaged in
nonfinancial activities establish separate legal entities to operate as
financial affiliates to act on behalf of itself and the other
affiliates of the corporate enterprise. The Commission believes that by
allowing the ultimate consolidated parent entity to conduct the test it
provides a better indication as to whether the overall entity is
commercial in nature or financial in nature, and whether the covered SD
should be viewed as a commercial SD or financial SD. The Commission
does not believe that covered SDs that are separately established
subsidiaries of commercial entities should be precluded from electing
the Tangible Net Worth Capital Approach as it was not the intent of the
Proposal to prohibit a commercial enterprise from establishing
financial subsidiaries that otherwise meet the definition of a swap
dealer due to their support of the activities of their parent entity,
affiliates, and their respective commercial customers from electing a
Tangible Net Worth Capital Approach.
The Commission is not modifying the final rule to require a covered
SD that is eligible to elect the Tangible Net Worth Capital Approach as
a result of its parent satisfying the ``predominantly engaged in non-
financial activities'' standard to obtain any specific financial
support or guarantees from its parent. The test to determine whether a
SD can elect the Tangible Net Worth Capital Approach at the ultimate
parent level is only to determine whether the consolidated entity is
commercial in nature; however, the final Tangible Net Worth Capital
Approach requires the covered SD to maintain its own regulatory capital
in the form of tangible net worth equal to or greater than $20 million
plus the amount of market risk charges and credit risk charges
associated with the covered SD's swaps and related hedge positions that
are part of the its swap dealing activities. In addition, the covered
SD is required to reflect its positions in swaps, security-based swaps,
and related positions at fair market value, which ensures that all
market-to-market losses are deducted from the SD's tangible net worth.
The tangible net worth is intended to ensure that a covered SD has an
appropriate level of financial resources available to directly meet its
obligations as they arise, which will ensure the safety and soundness
of the covered SD. Furthermore, covered SDs electing the Tangible Net
Worth Capital Approach are subject to the risk management requirements
of Commission regulation 23.600, which requires the SD, among other
things, to assess its liquidity resources and outlays on a daily basis,
including margin obligations, to ensure that it has both the financial
resources and liquidity to meet its financial obligations to swap
counterparties.
The Commission also is not modifying the final regulation to allow
commodity-focused covered SDs that are direct or indirect subsidiaries
of global financial holding companies to
[[Page 57502]]
elect the Tangible Net Worth Capital Approach. As noted above, the
Commission proposed the Tangible Net Worth Capital Approach in
recognition that not all covered SDs would be financial firms and able
to satisfy the Net Liquid Assets Capital Approach or the Bank-Based
Capital Approach due to the measurement of illiquid assets necessary to
commercial activities. The Commission limited the availability of the
Tangible Net Worth Capital Approach to covered SDs that are not
predominantly engaged in financial activities. Further, as discussed
above, the Commission believes that it is appropriate to extend the
Tangible Net Worth Capital Approach to accommodate covered SDs that are
direct or indirect subsidiaries of holding companies or corporate
parent entities that are not predominantly engaged in financial
activities, in order to allow such holding companies or corporate
parent entities to establish separate SD subsidiaries to provide
financial services for the corporate group, including engaging in swaps
on behalf of the corporate group. In such situations, the covered SD is
established to act on behalf of the commercial parent entity by, for
example, entering into swaps with commercial end users that are seeking
to manage their commercial risks with swaps, and to offset the risks
incurred by its commercial affiliates by entering into swaps with
counterparties, including other SDs or financial end users.
Covered SDs that are subsidiaries of financial holding companies or
corporate entities, however, present different issues. While the
covered SD may engage in commodity-focused swaps and may also engage in
trading of physical commodities, it is doing so as a subsidiary of a
financial parent entity. The Commission has generally perceived greater
risk from global financial entities than it does from commercial
enterprises, and, for this reason does not believe that it would be
appropriate to extend the more limited capital treatment of the
Tangible Net Worth Capital Approach to such covered SDs. Therefore, the
Commission is adopting the Tangible Net Worth Capital Approach as
proposed, without requiring parent guarantee and subject to the limited
modification to eligibility discussed above, in order to be neutral as
to the overall corporate structure employed by commercial entities.
5. Capital Requirements for Covered MSPs
The Commission proposed to establish a minimum capital requirement
for covered MSPs as directed by section 4s(e) of the CEA.\323\ An MSP
is defined as a person that is not a swap dealer and that: (i)
Maintains a substantial position in swaps, excluding positions held to
hedge or mitigate commercial risk; (ii) has outstanding swaps that
create ``substantial counterparty exposures that could have serious
adverse effects on the financial stability of the U.S. banking system
or financial markets;'' or (iii) is a financial entity that is highly
leveraged, is not subject to capital requirements of a prudential
regulator, and has a substantial position in swaps, including positions
used to hedge and mitigate commercial risk.\324\
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\323\ See 2016 Capital Proposal, 81 FR 91252 at 91264-65. There
currently are no MSPs provisionally registered with the Commission.
\324\ See Commission regulation Sec. 1.3 (17 CFR 1.3). There
currently are no MSPs provisionally registered with the Commission.
---------------------------------------------------------------------------
Proposed regulation 23.101(a)(2)(ii) required a covered MSP to
maintain the greater of (i) positive tangible net worth, or (ii) the
amount of capital required by the RFA of which the covered MSP was a
member. The term ``tangible net worth'' was proposed to be defined as
the net worth of a covered MSP as determined in accordance with US
GAAP, excluding goodwill and other intangible assets. The Proposal
further required a covered MSP in computing its tangible net worth to
include all liabilities or obligations of a subsidiary or affiliate
that the covered MSP guarantees, endorses, or assumes, either directly
or indirectly, to ensure that the tangible net worth reflects the full
extent of the covered MSP's potential financial obligations. The
proposed definition further provided that in determining net worth, all
long and short positions in swaps, security-based swaps and related
positions must be marked to their market value to ensure that the
tangible net worth reflects the current market value of the covered
MSP's swaps and security-based swaps, including any accrued losses on
such positions.
A positive tangible net worth standard was proposed for MSPs,
rather than an alternative approach, including the Net Liquid Assets
Capital Approach, Bank-Based Capital Approach, or Tangible Net Worth
Capital Approach, as the Commission anticipated that entities that
register as MSPs may be engaging in a range of business activities that
are different from, and broader than, the activities of covered SDs. In
addition, covered MSPs are expected to use swaps for different purposes
(e.g., hedging or investing) than covered SDs, which generally engage
in swaps as a dealing activity. Covered MSP's also may engage in
commercial activities that require the holding of a substantial amount
of fixed assets or engage in financial activities that are beyond swap
dealing activities, which results in the holding of assets that are not
consistent with the general Net Liquid Assets Capital Approach or the
Bank-Based Capital Approach, such as fixed assets or intangible assets.
The 2016 Capital Proposal also considered the impact of the final
margin rules for uncleared swap transactions in developing the proposed
positive tangible net worth requirement for covered MSPs. Covered MSPs
subject to the Commission's margin regulations are required to post and
collect initial margin and variation margin with SDs, other MSPs, and
financial end users (subject to certain thresholds and minimum transfer
amounts).\325\ The exchanging of variation margin and the exchange of
initial margin by covered MSPs and certain of their counterparties
would substantially reduce the uncollateralized exposures that the
covered MSPs and the counterparties have to each other, which mitigates
the possibility that covered MSPs could destabilize the financial
markets or present systemic risk. Lastly, the Commission's proposed
covered MSP capital standards are comparable with the SEC's capital
standards for MSBSPs subject to the SEC's capital requirements, and are
intended to require a covered MSP to maintain a sufficient level of
assets to meet its obligations to counterparties and creditors and to
help ensure the safety and soundness of the covered MSP.\326\
---------------------------------------------------------------------------
\325\ See 17 CFR part 23, subpart E (Capital and Margin
Requirements for Swap Dealers and Major Swap Participants).
\326\ See 17 CFR 240.18a-2.
---------------------------------------------------------------------------
The Commission requested additional comment on the proposed capital
requirements for covered MSPs in the 2016 Capital Proposal.
Specifically, the Commission requested comment on whether the positive
tangible net worth capital requirement was an appropriate standard for
MSPs; whether the Net Liquid Assets Capital Approach or the Bank-Based
Capital Approach would be a more appropriate method for establishing
capital requirements for covered MSPs; and whether other capital
approaches should be considered for covered MSPs.\327\ The Commission
further requested comment on whether the positive tangible net worth
capital requirement should include a minimum fixed-dollar amount
requirement, for example, equal to $20 million or some other amount,
and
[[Page 57503]]
whether the positive tangible net worth capital requirements should
include a requirement for a covered MSP to maintain positive tangible
net worth in an amount in excess of the market risk and credit risk
charges on the covered MSP's swap and security-based swap
positions.\328\ The Commission did not receive comments addressing
these issues.
---------------------------------------------------------------------------
\327\ See 2016 Capital Proposal, 81 FR 91252 at 91264-25.
\328\ Id.
---------------------------------------------------------------------------
The Commission has considered the proposed capital requirements for
covered MSPs, and is adopting the capital requirements as proposed. The
Commission believes that it is appropriate to impose a capital
requirement on a covered MSP that requires such entity to maintain the
greater of (i) positive tangible net worth, or (ii) the amount of
capital required by an RFA of which the covered MSP is a member. The
Commission also recognizes that the positive tangible net worth capital
requirement is a less rigorous requirement than the Net Liquid Assets
Capital Approach or the Bank-Based Capital Approach. The Commission
believes, however, that the positive tangible net worth capital
requirement is appropriate to help ensure the safety and soundness of
the covered MSP.
Under the final rule as adopted, a covered MSP is required to
maintain the greater of (i) positive tangible net worth, or (ii) the
minimum amount of capital required by an RFA of which the covered MSP
is a member.\329\ The final rule further requires a covered MSP to mark
its swaps, security-based swaps and related positions to their market
values in computing its tangible net worth, and to include in its
liabilities obligations of a subsidiary or affiliate that the covered
MSP guarantees, endorses, or assumes either directly or indirectly, to
ensure that the tangible net worth of the covered MSP reflects the
extent of such potential financial obligations.\330\
---------------------------------------------------------------------------
\329\ See paragraph (a)(2) of Commission regulation Sec.
23.101, as adopted.
\330\ See definition of the term ``tangible net worth'' in
Commission regulation Sec. 23.100, as adopted.
---------------------------------------------------------------------------
As noted above, there are no MSPs currently provisionally-
registered with the Commission, and only two firms have ever
provisionally-registered as MSPs. Therefore, the Commission has limited
experience with MSPs and such experience does not provide reliable
information or data on how such firms may be structured or operate in
future. This lack of information and data makes establishing a more
tailored capital requirement beyond the positive tangible net worth
requirement challenging. Accordingly, the Commission will monitor any
future developments with MSPs and assess the appropriateness of the
positive tangible net worth capital requirement to such firms to
ensuring the safety and soundness of the MSPs. The Commission will
consider any rule amendments that may be necessary based upon the
information and data that it will receive from any registered MSP. In
addition, the final capital rule provides that an MSP must also
maintain a level of capital as established by the RFA of which it is a
member. This provision is consistent with section 17 of the CEA, which
provides that an RFA must establish minimum capital requirements for
members that are at least as stringent as applicable capital
requirements adopted by the Commission. This provision authorizes NFA,
as the only RFA, to adopt capital requirements for its member MSPs that
are higher than the Commission's MSP capital requirement. This provides
an additional level of assurance that the Commission or NFA can adjust,
if necessary, capital requirements relative to the business activities
of any MSPs that the Commission in the future believes present systemic
risk.
6. Requirements for Market Risk and Credit Risk Models
The Commission's Proposal recognized that internal market risk and
credit risk capital models, including value-at-risk (``VaR'') models,
can provide a more effective means of measuring economic risk from
complex trading strategies involving swaps, security-based swaps, and
other proprietary positions than the standardized market risk and
credit risk charges set forth in regulation 1.17. In order to use
internal capital models to compute its capital, the covered SD or FCM-
SD must obtain the approval of the Commission or an RFA of which it was
a member.
In developing the specific proposed market risk and credit risk
models requirements, including the proposed quantitative and
qualitative requirements of the models discussed below, the Commission
incorporated the market risk and credit risk model requirements adopted
by the Federal Reserve Board for bank holding companies, including the
value at risk (``VaR''), stressed VaR, specific risk, incremental risk,
and comprehensive risk qualitative and quantitative standards and
requirements. The Commission's proposed qualitative and quantitative
requirements for capital models also are comparable to the SEC's
existing capital model requirements for ANC Firms and the capital model
requirements adopted for SBSDs.
a. VaR Models
Proposed regulation 23.102 required that a VaR model's quantitative
criteria include the use of a VaR-based measure that incorporates a 99
percent, one-tailed confidence interval.\331\ The VaR-based measure
must be based on a price shock equivalent to a ten business-day
movement in rates or prices. Price changes estimated using shorter time
periods must be adjusted to the ten-business-day standard. The minimum
effective historical observation period for deriving the rate or price
changes is one year, and data sets must be updated at least quarterly
or more frequently if market conditions warrant. The Commission noted
that for many types of positions it would be appropriate for a covered
SD or FCM-SD to update its data positions more frequently than
quarterly. In all cases, a covered SD or FCM-SD must have the
capability to update its data sets more frequently than quarterly in
anticipation of market conditions that require such updating.
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\331\ 2016 Capital Proposal, 81 FR 91252, 91269-72.
---------------------------------------------------------------------------
The covered SD or FCM-SD also would not need to employ a single
internal capital model to calculate its VaR-based measure. A covered SD
or FCM-SD may use any generally accepted approach, such as variance-
covariance models, historical simulations, or Monte Carlo simulations,
based on the nature and size of the positions the model covers. The
internal capital model must use risk factors sufficient to measure the
market and credit risk inherent in all positions. The risk factors must
address the risks including interest rate risk, credit spread risk,
equity price risk, foreign exchange risk, and commodity price risk. For
material positions in the major currencies and markets, modeling
techniques must incorporate enough segments of the yield curve--in no
case less than six--to capture differences in volatility and less than
perfect correlation of rates along the yield curve.
The internal capital model may incorporate empirical correlations
within and across risk categories, provided that the covered SD or FCM-
SD validates and demonstrates the reasonableness of its process for
measuring correlations. If the internal capital model does not
incorporate empirical correlations across risk categories, the covered
SD or FCM-SD must add the separate measures from its internal capital
models for the
[[Page 57504]]
appropriate risk categories as listed above to determine its aggregate
VaR-based measure of capital.
The VaR-based measure must include the risks arising from the
nonlinear price characteristics of options positions or positions with
embedded optionality and the sensitivity of the fair value of the
positions to changes in the volatility of the underlying rates, prices
or other material factors. A covered SD or FCM-SD with a large or
complex options portfolio must measure the volatility of options
positions or positions with embedded optionality by different
maturities and/or strike prices, where material.
The internal capital model also must be subject to backtesting
requirements that must be calculated no less than quarterly. A covered
SD or FCM-SD must compare its daily VaR-based measure for each of the
preceding 250 business days against its actual daily trading profit or
loss, which includes realized and unrealized gains and losses on
portfolio positions as well as fee income and commissions associated
with its activities. If the quarterly back-testing shows that the
covered SD's or FCM-SD's daily net trading loss exceeded its
corresponding daily VaR-based measure, a back-testing exception has
occurred. If a covered SD or FC-SD experiences more than four back-
testing exceptions over the preceding 250 business days, it is
generally required to apply a multiplication factor in excess of three
when it calculates its VaR-based capital requirements.
The qualitative requirements proposed would specify, among other
things, that: (i) Each VaR model must be integrated into the covered
SD's or FCM-SD's daily internal risk management system; (ii) each VaR
model must be reviewed periodically by the firm's internal audit staff
and annually by a third party service provider; and (iii) the VaR
measure computed by the model must be multiplied by a factor of at
least three but potentially a greater amount if there are exceptions to
the measure resulting from quarterly backtesting results.
A covered SD or FCM-SD would also be subject to on-going
supervision by staff of the Commission and RFA with respect to its
internal risk management, including its use of VaR models.
b. Stressed VaR Models
The Commission proposed that covered SDs or FCM-SDs approved to use
VaR models to compute market risk deductions also must include a
stressed VaR component in the calculation. The stressed VaR measure
supplements the VaR measure, as the VaR measure's inherent limitations
produced an inadequate amount of capital to withstand the losses
sustained by many financial institutions in the financial crisis of
2007-2008.\332\ The stressed VaR measure also should contribute to a
more appropriate measure of the risks of a covered SD's or an FCM-SD's
positions as stressed VaR is intended to account for more volatile and
extreme price changes.
---------------------------------------------------------------------------
\332\ See Revisions to the Basel II market risk framework,
published by the Basel Committee on Banking Supervision for an
explanation of the implementation of the stressed VaR requirement.
---------------------------------------------------------------------------
The 2016 Capital Proposal required a covered SD or FCM-SD to use
the same model that it uses to compute its VaR measure for its stressed
VaR measure. The model inputs however would be calibrated to reflect
historical data from a continuous 12-month period that reflects a
period of significant financial stress appropriate to the covered SD's
or FCM-SD's portfolio. The stressed VaR measure must be calculated at
least weekly and be no less than the VaR measure. The Commission
further noted that it expected that the stressed VaR measure would be
substantially greater than the VaR measure.
The Commission also required that the stress tests take into
account concentration risk, illiquidity under stressed market
conditions, and other risks arising from the covered SD's or FCM-SD's
activities that may not be captured adequately in the covered SD's or
FCM-SD's internal VaR models. For example, it may be appropriate for
the covered SD or FCM-SD to include in its stress testing large price
movements, one-way markets, nonlinear or deep out-of-the-money
products, jumps-to-default, and significant changes in correlation.
Relevant types of concentration risk include concentration by name,
industry, sector, country, and market.
The Proposal also provided that a covered SD or FCM-SD must
maintain policies and procedures that describe how it determines the
period of significant financial stress used to compute its stressed VaR
measure and be able to provide empirical support for the period used.
These policies and procedures must address: (i) How the covered SD or
FCM-SD links the period of significant financial stress used to
calculate the stressed VaR-based measure to the composition and
directional bias of the covered SD's or FCM-SD's portfolio; and (ii)
the covered SD's or FCM-SD's process for selecting, reviewing, and
updating the period of significant financial stress used to calculate
the stressed VaR measure and for monitoring the appropriateness of the
12-month period in light of the covered SD's or FCM-SD's current
portfolio. Before making material changes to these policies and
procedures, a covered SD or FCM-SD must obtain approval from the
Commission or RFA. The Commission or the RFA also may require a covered
SD or FCM-SD to use a different period of stress to compute its
stressed VaR measure.
c. Specific Risk Models
The Commission proposed to allow covered SDs or FCM-SDs to model
their specific risk. Under the Proposal, the specific risk model must
be able to demonstrate the historical price variation in the portfolio,
be responsive to changes in market conditions, be robust to an adverse
environment, and capture all material aspects of specific risk for its
positions. The Proposal required that a covered SD's or FCM-SD's models
capture event risk (such as the risk of loss on equity or hybrid equity
positions as a result of a financial event, such as the announcement or
occurrence of a company merger, acquisition, spin-off, or dissolution)
and idiosyncratic risk, and capture and demonstrate sensitivity to
material differences between positions that are similar but not
identical, and to changes in portfolio composition and concentrations.
If a covered SD or FCM-SD calculates an incremental risk measure for a
portfolio of debt or equity positions under paragraph (I) of proposed
23.102 Appendix A, the covered SD or FCM-SD is not required to capture
default and credit migration risks in its internal models used to
measure the specific risk of these portfolios.
The Commission noted in the Proposal that it understood that not
all debt, equity, or securitization positions (for example, certain
interest rate swaps) have specific risk. Therefore, the Commission
proposed that there would be no specific risk capital requirement for
positions without specific risk. A covered SD or FCM-SD, however, must
have clear policies and procedures for determining whether a position
has specific risk.
The Commission also stated in the Proposal that it believed that a
covered SD or FCM-SD should develop and implement VaR-based models for
both market risk and specific risk. A covered SD's or FCM-SD's use of
different approaches to model specific risk and general market risk
(for example, the use of different models) would be reviewed to ensure
that the overall capital requirement for market risk is
[[Page 57505]]
commensurate with the risks of the covered SD's or FCM-SD's positions.
d. Incremental Risk Models
The Commission proposed an incremental risk requirement for covered
SDs or FCM-SDs that measures the specific risk of a portfolio of debt
positions using internal models. Incremental risk consists of the
default risk and credit migration risk of a position. Default risk
means the risk of loss on a position that could result from the failure
of an obligor to make timely payments of principal or interest on its
debt obligation, and the risk of loss that could result from
bankruptcy, insolvency, or similar proceeding. Credit migration risk
means the price risk that arises from significant changes in the
underlying credit quality of the position. A covered SD or FCM-SD also
may include portfolios of equity positions in the incremental risk
model with the prior permission from the Commission or RFA, provided
that the covered SD or FCM-SD consistently includes such equity
positions in how it internally measures and manages the incremental
risk for such positions at the portfolio level. Default is assumed to
occur with respect to an equity position that is included in its
incremental risk model upon the default of any debt of the issuer of
the equity position.
e. Comprehensive Risk Models
The 2016 Capital Proposal required a covered SD or FCM-SD to
compute all material price risks of one or more portfolios of
correlation trading positions using an internal model. The Commission
required the model to measure all price risk consistent with a one-year
time horizon at a one-tail, 99.9 percent confidence level, under the
assumption either of a constant level of risk or of constant positions.
The Commission stated that it expected that the covered SD or FCM-SD
remains consistent in its choice of constant level or risk or
positions, once it makes a selection. Also, the covered SD's or FCM-
SD's choice of a liquidity horizon must be consistent between its
calculation of its comprehensive and incremental risk.
The Commission also required a covered SD's or FCM-SD's
comprehensive risk model to capture all material price risk, including,
but not limited to: (i) The risk associated with the contractual
structure of cash flows of each position, its issuer, and its
underlying exposures (for example, the risk arising from multiple
defaults, including the ordering of defaults in tranched products);
(ii) credit spread risk, including nonlinear price risks; (iii)
volatility of implied correlations, including nonlinear price risks
such as the cross-effect between spreads and correlations; (iv) basis
risks; (v) recovery rate volatility as it relates to the propensity for
recovery rates to affect tranche prices; and (vi) to the extent that
the comprehensive risk measure incorporates benefits from dynamic
hedging, the static nature of the hedge over the liquidity horizon. The
Commission noted that additional risks that are not explicitly
discussed but are a material source of price risk must be included in
the comprehensive risk measure.
The Commission also required a covered SD or FCM-SD to have
sufficient market data to ensure that it fully captures the material
price risks of the correlation trading positions in its comprehensive
risk measure. Moreover, a covered SD or FCM-SD must be able to
demonstrate that its model is an appropriate representation of
comprehensive risk in light of the historical price variation of its
correlation trading positions. A covered SD or FCM-SD also would be
required to inform the Commission and RFA if the covered SD or FCM-SD
plans to extend the use of a model that has been approved to an
additional business line or product type.
The Proposal required that the comprehensive risk measure must be
calculated at least weekly. In addition, a covered SD or FCM-SD must at
least weekly apply to its portfolio of correlation trading positions a
set of specific stressed scenarios that capture changes in default
rates, recovery rates, and credit spreads, and various correlations. A
covered SD or FCM-SD must retain and make available to the Commission
and the RFA the results of the stress testing, including comparisons
with capital generated by the covered SD's or FCM-SD's comprehensive
risk model. A covered SD or FCM-SD must promptly report to the
Commission or the RFA any instances where the stress tests indicate any
material deficiencies in the comprehensive risk model.
f. Credit Risk Models
The 2016 Capital Proposal required covered SDs or FCM-SDs seeking
to obtain Commission or RFA approval to use internal models to compute
credit risk to submit credit risk models that satisfy the quantitative
and qualitative requirements set forth in Appendix A to proposed
regulation 23.102. With respect to uncleared derivatives contracts, a
covered SD or FCM-SD would need to determine an exposure charge for
each counterparty to its uncleared derivatives positions. The exposure
charge for a counterparty that is insolvent, in a bankruptcy
proceeding, or in default of an obligation on its senior debt, is the
net replacement value of the uncleared derivatives contracts with the
counterparty (i.e., the net amount of uncollateralized current exposure
to the counterparty). The counterparty exposure charge for all other
counterparties is the credit equivalent amount of the covered SD's or
FCM-SD's exposure to the counterparty multiplied by an applicable
credit risk-weight factor multiplied by 8%. The credit equivalent
amount is the sum of the covered SD's or FCM-SD's (i) maximum potential
exposure (``MPE'') multiplied by a backtesting determined factor; and
(ii) current exposure to the counterparty. The MPE amount is a charge
to address potential future exposure and is calculated using the VaR
model as applied to the counterparty's positions after giving effect to
a netting agreement, taking into account collateral received, and
taking into account the current replacement value of the counterparty's
positions.
The Commission in its margin requirements (see Commission
regulations 23.150 through 23.161) set forth the requirements for
eligible collateral for uncleared swaps. In order to account for
collateral in its VaR model for the credit risk charges, the Commission
stated that it expected a covered SD or FCM-SD to account only for the
collateral that complies with Commission regulation 23.156 and is held
in accordance with regulation 23.157 for uncleared swaps that are
subject to the Commission's margin rules. A covered SD or FCM-SD would
be able to take into consideration in its VaR calculation collateral
that does not comply with regulation 23.156 and is not held in
accordance with regulation 23.157, for uncleared swaps that are not
subject to the Commission's margin rules.
The Commission proposed to allow covered SDs or FCM-SDs to use
internal methodologies to determine the appropriate credit risk-weights
to apply to counterparties, if it has received the Commission's or the
RFA's approval. A higher percentage credit risk-weight factor would
result in a larger counterparty exposure charge amount. The Commission
stated that it expected that the counterparty credit risk-weight should
be based on an assessment of the creditworthiness of the counterparty.
The Commission stated that its proposed approach to calculating
credit risk charges is appropriate given that its requirements are
based on a method of
[[Page 57506]]
computing capital charges for credit risk exposures in the
international capital standards for banking institutions. Since credit
risk is the risk that a counterparty could not meet its obligations on
an OTC derivatives contract in accordance with agreed terms (such as
failing to pay), the considerations that inform a covered SD's or FCM-
SD's assessment of a counterparty's credit risk should be broadly
similar across the various relationships that may arise between the
dealer and the counterparty. Therefore, the Commission believes that
its approach is a reasonable model, as the SEC also uses a similar
approach for its ANC BDs and SBSDs using models.
The Commission also proposed that covered SDs or FCM-SDs that are
subject to the Bank-Based Capital Approach requirement could also
request Commission or RFA approval to use the Federal Reserve Board's
internal ratings-based and advanced measurement model approaches to
compute risk-weighted assets for the credit exposures listed in subpart
E of 12 CFR 217. The covered SD or FCM-SD would have to include such
exposures in its application to the Commission and RFA, and explain how
its proposed models are consistent with the Federal Reserve Board's
model criteria in subpart E of 12 CFR 217.
The Commission received several comments concerning the use of
internal capital models. One commenter expressed a strong concern
regarding the 2016 Capital Proposal's potential heavy reliance on the
use of internal models.\333\ The commenter stated that a reliance on
internal models can permit regulated entities to manipulate risk
controls to increase their own profits at the cost of increasing risks
to the public. The commenter pointed out that analysis of the financial
crisis experience evidenced manipulation of models to reduce capital
charges. While the commenter acknowledged post-crisis refinements to
internal model requirements, both in technique and governance, it
argued that resource limitations at regulators, as well as continuing
pressure from industry, may limit regulators' ability to prevent
weakening standards and model misuse. The commenter thus advocated for
strong limitations and floors to counterbalance the use of internal
models.\334\
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\333\ See AFR 5/15/17 Letter.
\334\ Id.
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The Commission appreciates the commenter's concerns regarding
models generally, and the need for the Commission to maintain strong
limitations and floors. In this regard, the Commission is providing
that only capital models that satisfy specified quantitative and
qualitative requirements set forth in the regulations will be approved
for use by covered SDs. Such requirements are consistent with the
standards established by the BCBS and SEC for banking institutions and
BDs, respectively. In addition, the Commission plans to work with NFA
to establish a comprehensive ongoing examination program over the
capital models used by covered SDs, which will be designed to identify
and address issues with model performance through such means as back-
testing results. These steps should assist with mitigating concerns
regarding model performance.
Other commenters generally supported the Commission's Proposal to
permit internal capital models in lieu of standardized market and
credit risk capital charges.\335\ Another commenter stated that it
strongly supports permitting SDs the flexibility to use internal
models, when appropriate.\336\
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\335\ See, e.g., ISDA 5/15/17 Letter; SIFMA 5/15/17 Letter; MS
5/15/17 Letter.
\336\ See IFM 5/15/17 Letter.
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Two commenters stated that the detailed quantitative and
qualitative requirements for market risk and credit risk models set
forth in Appendix A of proposed regulation 23.102 do not reflect the
requirements of all of the models that a bank or bank holding company
may use for market risk and credit calculations under the capital rules
of the Federal Reserve Board.\337\ One of the commenters stated that
the prudential regulators have undertaken an extensive effort to revise
U.S. Basel III risk-weighted asset standards, which has includes
significant ongoing efforts to revise specific credit risk and market
risk methodologies that will require several years to finalize.\338\
One of the commenters stated that the differences between the Federal
Reserve Board rules and the requirements of Appendix A would require a
covered SD electing the Bank-Based Capital Approach to submit a model
application that contains more information than the information
required by the Federal Reserve Board.\339\ The commenters also state
that the calculations of market risk and credit risk under some of the
Federal Reserve Board rules differ from the calculation requirements
under proposed Appendix A of regulation 23.102. The commenters
recommended that the Commission modify proposed regulation 23.102 and
appendix A to allow a Bank-Based Capital Approach to use models
approved to calculate market risk and credit risk exposures if the
model satisfies the relevant Federal Reserve Board requirements for
market risk and credit risk models, as appropriate. The commenters also
recommended that the Commission permit a covered SD that has obtained
approval to use credit risk models to calculate its credit risk
exposure using the Federal Reserve Board's advance approaches capital
framework, contained in subpart E of 12 CFR part 217, and further
permit a covered SD that has obtained approval to use market risk
models to calculate its market risk using the Federal Reserve Board's
rules contained in subpart F of 12 CFR part 217. The commenters stated
that the above modifications would allow covered SDs electing the Bank-
Based Capital Approach to calculate market risk and credit risk
consistently with how bank SDs and many foreign SDs calculate their
exposures for capital purposes.
---------------------------------------------------------------------------
\337\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
\338\ Id.
\339\ IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------
The Commission recognizes that the Federal Reserve Board's capital
rules are continuing to evolve and will evolve further in the future as
global banking regulators continue to harmonize capital requirements
under the Basel capital framework. The Commission proposed the Bank-
Based Capital Approach in recognition that it reflected a global
banking capital regime that was designed for safety and soundness. The
proposed approach also provided covered SDs that are non-bank
subsidiaries of bank holding companies the ability to use capital
models approved by prudential regulators for their bank affiliates.
The Commission understands that model requirements set forth in
proposed Appendix A of regulation 23.102 do not reflect fully the
market risk and credit risk options available at this time to banking
organizations under the rules of the Federal Reserve Board. The
Commission also understands that each of the market risk and credit
risk options under the Federal Reserve Board's rules are, and will
continue to be, based on Basel capital requirements, and thus
appropriate for calculating market risk or credit risk for covered SDs.
Therefore, the Commission is modifying regulation 23.102 to both
clarify and expand the market risk and credit risk models that may be
used by a covered SD such that the requirement aligns with requirements
of the Federal Reserve Board. Specifically, the Commission is modifying
paragraph (c) of regulation 23.102 to provide that a covered SD's
application for market risk models must include the information
[[Page 57507]]
specified in Federal Reserve Board's rules contained in subpart F of 12
CFR part 217, and the information required under subpart E of 12 CFR
part 217 for credit risk models. The Commission believes that the
modifications are appropriate in that they provide model requirements
that are identical to the Federal Reserve Board's requirements and, by
incorporating the Federal Reserve Board's rules by reference, address
concerns raised regarding the ongoing revisions to the rules as Basel
enhancements continue to be adopted.
7. Model Approval Process for Covered SDs and FCM-SDs
The Commission's Proposal required each covered SD and FCM-SD to
submit an application for approval to use internal capital models to
compute market risk or credit risk capital charges to the Commission
and to the RFA of which the SD or FCM-SD was a member.\340\ The
Proposal provided that a covered SD's or FCM-SD's application must be
in writing and must be filed with the Commission and with an RFA in
accordance with applicable filing requirements. Proposed Appendix A to
regulation 23.102 required the application to include: (i) A list of
categories of positions that the covered SD or FCM-SD holds in its
proprietary accounts and a brief description of the methods the covered
SD or FCM-SD would use to calculate market risk and credit risk
charges; (ii) a description of the mathematical models to be used to
price positions and to compute market risk and credit risk; (iii) a
description of how the covered SD or FCM-SD would calculate current
exposure and potential future exposure for its credit risk charges, and
(iv) a description of how the covered SD or FCM-SD would determine
internal credit risk-weights of counterparties, if applicable. The
Commission or RFA also may require a covered SD or FCM-SD to supplement
its application with additional information necessary for a proper
evaluation.\341\
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\340\ See 2016 Capital Proposal, 81 FR 91252 at 91269-70. FCMs
and FCM-SDs that also are registered BDs would have to obtain SEC
approval as an ANC Firm in order to use market risk and credit risk
models in lieu of taking standardized capital charges. See
Commission regulation Sec. 1.17(c)(6)(i), as adopted.
\341\ See 2016 Capital Proposal, 81 FR 91252 at 91269-70.
---------------------------------------------------------------------------
The Proposal also provided that the Commission or RFA could deny
the application or approve the application, subject to any conditions
or limitations that the Commission or RFA may require, if such denial
or approval is found to be in the public interest. In making a public
interest determination, the Commission will consider whether the
applicant's models meet the quantitative and qualitative requirements,
and assess the governance structure regarding the development,
operation, and ongoing monitoring of the models. The Commission will
further assess the qualification of personnel with the responsibility
for operating the models and the personnel with responsibility for
supervising the daily operations and reporting to senior management.
The Commission's assessment is intended to determine that the use of
capital models does not impair the overall safety and soundness of the
covered SD or FCM-SD. The Commission also will consider the potential
benefits that models provide by more appropriately reflecting market
and credit risk as compared to standardized capital charges, which
encourages FCM-SDs and covered SDs to provide markets to market
participants and provides for a more efficient use of FCM-SD and
covered SD capital.
A covered SD or FCM-SD also would be required to cease using the
models if: (i) The models are altered or revised materially, or if the
SD's or FCM-SD's internal risk management is materially changed, and
such changes have not been submitted to the Commission and RFA for
approval; (ii) the Commission or RFA determines that the models are no
longer sufficient or adequate to compute market or credit risk charges;
(iii) the SD or FCM-SD fails to comply with the regulations governing
the use of models; or (iv) the Commission by written order finds that
permitting the SD or FCM-SD to continue to use the internal models is
no longer appropriate.
The Commission requested comment in the 2016 Capital Proposal on
all aspects of the proposed model review process, including the
viability of the proposed model review process given the number of
provisionally-registered covered SDs, the number of capital models that
may be required to be approved for each provisionally-registered
covered SD, and the complexity of the models that may be submitted for
approval.\342\ The Commission also requested comment on whether the
regulation should include a process for the automatic approval or
temporary approval of capital models that had been reviewed and
approved by a prudential regulator or an appropriate foreign
regulator.\343\
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\342\ See 2016 Capital Proposal, 81 FR 91252 at 91272-73.
\343\ Id.
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Commenters generally stated that it was necessary for the
Commission to develop an efficient approach for the review and approval
of internal models and noted that covered SDs or FCM-SDs that did not
have model approval at the compliance date would be at a significant
competitive disadvantage relative to covered SDs and FCM-SDs that had
the approval to use models at the compliance date. In this connection,
one commenter stated that in no event should a covered SD be required
to use the proposed standardized capital charges while awaiting model
approval at the compliance date.\344\ Another commenter requested that
the Commission clarify that no covered SD would be required to use the
proposed standardized capital charges while awaiting model
approval.\345\
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\344\ See ISDA 5/15/17 Letter.
\345\ See IFM 5/15/17 Letter.
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Other commenters suggested various approaches that the Commission
should adopt to ensure that covered SDs and FCM-SDs have the ability to
use capital models at the compliance date. One commenter stated that
capital models should be deemed ``provisionally approved'' while under
review by the Commission or NFA at the compliance date.\346\ Several
commenters stated that the Commission should automatically approve
market risk models and credit risk models of covered SDs or FCM-SDs
that have already been approved by a prudential regulator, the SEC, or
certain foreign regulators.\347\ One commenter stated that Commission's
final rule should provide for the recognition of internal capital
models used throughout corporate families if such models have been
approved by a prudential regulator, the SEC, or a foreign regulator in
a jurisdiction that has adopted the Basel capital requirements,
provided that the relevant regulatory authority has ongoing periodic
assessment power with regard to the model and provides the CFTC and the
NFA with appropriate information.\348\
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\346\ See ISDA 5/15/17 Letter.
\347\ See, e.g., FIA 5/15/17 Letter; SIFMA 5/15/17 Letter. See
also, ABN/ING/Mizuho/Nomura 1/29/2018 Letter.
\348\ See ISDA 5/15/17 Letter.
---------------------------------------------------------------------------
The Commission invited interested persons to provide additional
comment on the model approval process in the 2019 Capital Reopening.
Commenters generally reiterated their views that the Commission needed
to adopt an efficient and effective model review process that
recognizes the complexity of the undertaking, and ensures that all
covered SDs and FCM-SDs that want to use models have authorization to
use such models at the compliance date in
[[Page 57508]]
order to avoid competitive disadvantages for firms not permitted to use
models.\349\ One commenter stated that the failure to create and
implement a flexible capital model approval process and timeline
creates a competitive disadvantage for smaller covered SDs (including
smaller commodity-focused covered SDs) relative to bank and bank
holding company-affiliate SDs.\350\ The commenter noted that many
larger SDs currently operate with approved models, and noted that
smaller SDs do not have off-the-shelf or pre-approved internal models
that can be used or leveraged for capital compliance purposes, and
anticipate significant expense and resource will be necessary for the
development of counterparty credit risk and market risk model
procedures, processes, and systems.\351\ One commenter stated that
firms submitting models for the first time must be provided with
sufficient time to complete the approval process.\352\
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\349\ See, e.g., NCGA/NGSA 3/3/2020 Letter; CEWG 3/3/2020
Letter; FIA-PTG 3/3/2020 Letter.
\350\ See ED&F Man/INTL FCStone 3/3/2020 Letter.
\351\ Id.
\352\ See FIA-PTG 3/3/2020 letter.
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Another commenter stated that commodity-focused covered SDs should
be subject to models that focus on risks associated with the physical
commodity market, and the capital model should not need to account for
non-applicable risks.\353\ The commenter requested that the Commission
confirm that a commodity-focused covered SD's capital model needs only
to account for the positions and risks relevant to the applicable
business and does not need to address every risk and requirement set
forth in proposed Appendix A to regulation 23.102.\354\
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\353\ See CEWG 3/3/2020 Letter.
\354\ Id.
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Commenters also expressed the view that the Commission should
provide automatic model approval or provisional model approval to SDs
and FCM-SDs that use models that have been reviewed and approved by the
SEC, a prudential regulator, or a qualified foreign regulator. One
commenter also stated that the Commission should provide provisional
approval for models submitted by covered SDs in good faith, subject to
further review and approval if necessary.\355\
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\355\ See NCGA/NGSA 3/3/2020 Letter. The NCGA/NGSA also stated
that the Commission's capital rules should allow for the use of
unencumbered cash to be considered part of a covered SD's capital
base even when the cash is swept into a corporate omnibus account
and held overnight at a financial institution. The Commission
acknowledges that under the proposed Tangible Net Worth Capital
Approach, unencumbered cash deposits, including cash transferred to
an affiliate, would be considered a tangible asset and part of the
capital base. See also, CEWG 3/3/2020 Letter.
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NFA expressed its willingness to undertake the review of covered
SDs and covered FCM-SDs capital models for compliance with the
regulatory requirements.\356\ NFA noted that it currently has a team
with significant model experience that has been focusing on the review,
approval, and ongoing monitoring of covered SD's initial margin models
for uncleared swaps. NFA stated that it would leverage the experience
it has gained in reviewing and approving initial margin models, and
would allocate similar resources to the review of covered SDs' internal
capital models for compliance with the Commission's requirements.
---------------------------------------------------------------------------
\356\ See Letter from Carol Wooding, National Futures
Association (March 2, 2020) (NFA 3/2/2020 Letter).
---------------------------------------------------------------------------
NFA also commented, however, that the capital model review process
will be significantly more complex than the process conducted for
initial margin models. The additional complexity is attributable in
part to the lack of an industry-wide, standardized internal capital
model and the fact that each covered SD may have several models under
the proposed capital rules to address various aspects of market risk
(e.g., VaR models and stressed VaR models). The review process is
further challenged in that the Commission did not propose a multi-year
compliance schedule that would allow capital models to be phased-in
over a sufficiently long period of time comparable to the now six-year
phase-in schedule for initial margin requirements for uncleared
swaps.\357\
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\357\ Id. The Commission's margin rules for uncleared swap
transactions are subject to a phase-in period that extended from
September 1, 2016 to September 1, 2021. See Commission regulation
Sec. 23.161 (17 CFR 23.161).
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NFA estimated that as many as 51 covered SDs (from 21 corporate
families) could be subject to the Commission's capital rules and may
seek model review and approval prior to the compliance date. NFA also
commented that it would need to build systems and processes to receive
the requisite model information from covered SDs and FCM-SDs, and that
its review would need to occur over a period of time given the
complexity of the market and credit risk models. To address these
concerns, NFA suggested several modifications that the Commission could
make to the process of reviewing and approving capital models.
Specifically, NFA suggested that a covered SD electing a Bank-Based
Capital Approach that uses the internal market and credit risk capital
models previously reviewed by a prudential regulator for an affiliated
SD (e.g., a bank holding company) be permitted to use such models
without a formal review or approval of the covered SD's capital models
prior to the compliance date. NFA also stated that the Commission
should consider implementing a similar process for covered SDs that use
internal market risk and credit risk models that have been reviewed or
approved for the covered SD's use or for use by an affiliate of the
covered SD by a foreign regulator in a jurisdiction that has
implemented the Basel III capital standards. NFA stated that for
covered SDs or covered FCM-SDs that are permitted to use capital models
without a pre-compliance date review and approval as outlined above, it
would review the SDs' or FCM-SDs' overall capital compliance, including
their use of models after the compliance date through NFA's examination
process and ongoing compliance monitoring program.
NFA commented that if the above framework is implemented, it will
work with the Commission to develop a pre-compliance date model review
and approval process, including appropriate information gathering and
certification requirements for covered SDs with models that have not
been reviewed by a prudential or qualified foreign regulator, as well
as an appropriate post-compliance date model review and monitoring
process. NFA stated that it is committed post compliance date to
monitor the overall governance and use of market and credit risk models
by all covered SDs that are subject to a model pre-approval process or
post-compliance model review including, at a minimum, assessing model
performance test results and monitoring for compliance with the
Commission's SD capital rules.
NFA further estimated that if the above framework is adopted that
as many as 12 covered SDs that are provisionally-registered may require
immediate capital model review. These 12 covered SDs have not obtained
direct regulatory approval to use capital models and are not part of
corporate families that have obtained any other regulatory approval to
use capital models. NFA also estimated that it will take approximately
15 months to review and approve capital models for these 12 covered
SDs.
NFA also recommended a modification to the final rule language. NFA
stated that to make the post-compliance date framework effective, since
NFA will not formally approve a
[[Page 57509]]
covered SD's use of market and credit risk models previously reviewed
by a prudential regulator a qualified foreign regulator, it believed
that it is important that the Commission and/or NFA reserve the
authority to require that a covered SD cease at any time using internal
models if the covered SD is not in compliance with the Commission's
capital requirements. To address this issue, NFA recommended that the
Commission modify regulation 23.102(e) to clarify the Commission's and
NFA's authority to rescind a covered SD's use of models that were not
formally ``approved'' prior to the requirements compliance date.\358\
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\358\ NFA noted that proposed Appendix A to Commission
regulation Sec. 23.102, which provides that the Commission or an
RFA may revoke a covered SD's internal market and credit risk
models. NFA stated that this provision of Appendix A should be
modified to clarify that the Commission or an RFA may revoke a
covered SD's ability to use internal market and credit risk models
that have been approved by a prudential regulator or qualified
foreign regulator. See NFA 3/2/2020 Letter.
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The Commission has considered the Proposal and the comments
received, and is adopting the model approval process as proposed with
several modifications discussed below. The Commission recognizes the
substantial resources that are necessary in order to effectively and
efficiently review and approve capital models submitted by covered SDs,
and further recognizes that Commission staff would not be able to
perform such reviews in a reasonable period of time. Therefore, final
regulations 1.17(c)(6)(v) and 23.102 provides two alternative
approaches for FCM-SDs and covered SDs, respectively. An FCM-SD or a
covered SD may submit an application to the Commission for approval to
use internal models to compute market risk and credit risk capital
charges in lieu of standardized charges. In the alternative, an FCM-SD
or a covered SD may submit an application to NFA (as an RFA) to use
internal models provided that the Commission has made a determination
that NFA's process to approve internal models is consistent with the
Commission's approval process and NFA's approval would be accepted as
an alternative means of compliance with the Commission's model
requirements and approval as contained in Regulation 23.102.\359\
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\359\ At this time, NFA is the only RFA.
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In this release, the Commission is setting forth a process for
determining whether the NFA's standard and process for reviewing and
approving an FCM-SD's and a covered SD's capital models is comparable
to those of the Commission's. As part of the Commission's assessment,
the Commission will perform a review of the NFA's FCM-SD and covered SD
capital requirements for consistency with the Commission's
requirements. The Commission also will assess the sufficiency of the
NFA's planned model review process and procedures to ensure that such
processes and procedures are adequate for providing NFA with an
appropriate basis for determining whether an FCM-SD's or a covered SD's
capital models satisfy the NFA's model requirements. Based on these
assessments, the Commission will issue a determination that the NFA's
approval of an FCM-SD's or a covered SD's capital models may serve as
an alternative means of complying with the Commission's model approval
requirement. The Commission is delegating authority to issue the
determination to the Director of the Division of Swap Dealer and
Intermediary Oversight under the revisions to regulation 140.91.
Due to limited Commission resources, the Commission anticipates
that FCM-SDs and covered SDs will seek model approval from the NFA in
order to help ensure a timely review. As noted in its comment letter,
NFA has devoted substantial efforts to obtain the personnel and other
resources necessary to perform the review, approval, and ongoing
assessment of FCM-SDs' and covered SDs' models to calculate initial
margin for uncleared swaps, and plans to leverage these resources and
experience in its review and assessment of capital models.
In addition, as noted in section II.B.2. above, NFA is required by
section 17(p) of the CEA to adopt capital requirements for SDs that are
at least as stringent as the Commission's capital requirements for
covered SDs. In this regard, the Commission has approved NFA Compliance
Rule 2-49, which incorporates the Commission's part 23 rules into NFA's
rules. Therefore, the capital and financial reporting requirements set
forth in this final rulemaking will become NFA requirements 60 days
after the publication of this Federal Register release (the effective
date). The NFA SD capital requirements will include the options for
market risk and credit risk models and will require SDs to obtain NFA
approval to use such models under the NFA SD capital rules.\360\
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\360\ The Commission also revised paragraph (c) of Appendix A of
final regulation 23.102 to provide that a covered SD that files a
model application with the Commission may request confidential
treatment under the Freedom of Information Act. Paragraph (c) of
Appendix A does not apply to applications filed with the NFA, which
is not subject to the Freedom of Information Act.
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The Commission further acknowledges that the model review process
will require a period of time that will prevent the Commission or NFA
from reviewing and approving models for all covered SDs that seek model
approval prior to the compliance date of the regulations. The
Commission also recognizes that a process that results in some covered
SDs receiving approval to use capital models while the capital models
of other covered SDs are under review at the compliance date solely due
to the inability of the Commission or NFA to complete the necessary
review would place the non-model covered SDs at a substantial
competitive disadvantage.
To address this issue, the Commission is modifying regulation
23.102 by providing a new paragraph (f) to provide that a covered SD
may use capital models after filing an application for model approval
with the Commission, and pending approval by the Commission or the NFA,
provided that the covered SD submits a certification to the Commission
and to NFA certifying that the models have been approved for use by the
covered SD, or an affiliate of the covered SD, by the SEC, a prudential
regulator, a foreign regulatory authority in a jurisdiction that the
Commission has found to be eligible for substituted compliance under
Commission regulation 23.106, or a foreign regulatory authority whose
capital adequacy requirements are consistent with the BCBS bank capital
requirements. The certification must be signed by the covered SD's
Chief Executive Officer, Chief Financial Officer, or other appropriate
official with knowledge of the covered SD's capital requirements and
the capital models, and must include a representation that the models
are in substantial compliance with Commission's model requirements.
The final rule further requires a covered SD to revise its
certification to address any material changes or revisions to the
models, or to reflect any regulatory restrictions placed on the models
by the regulatory authority that approved the models. The covered SD is
also required to cease using the models if the regulatory authority
that previously approved the models for use by the SD, or by the SD's
affiliate, withdraws its approval prior to the Commission or NFA
approving the models.
To clarify, the covered SD is not required to submit a model
application to NFA with its certification. NFA will
[[Page 57510]]
obtain any necessary documentation and model information as part of its
ongoing examination and monitoring of the covered SD, including the
information necessary to approve the models of the covered SD.
The covered SD will be subject to the Commission's and NFA's
supervision and ongoing monitoring pending the Commission's or NFA's
final determination to approve or not approve the application. This
supervision and monitoring will include the review of the models
performance and compliance with Commission requirements through
examination and review of periodic reports, including back-testing
results.
The Commission is not, however, adopting a process to permit FCM-
SDs to use capital models pending the Commission's or NFA's approval.
FCM-SDs must have approval in order to use capital models. The
Commission is making this distinction as FCM-SDs carry customer and
noncustomer funds, and act as intermediaries in the futures markets by
performing daily settlement cycles on behalf of customers and
noncustomers, and guaranteeing their customers' and noncustomers'
financial performance to clearing organizations and other FCMs. As
noted above, capital models have the potential to substantially reduce
the market risk and credit risk capital charges that an FCM must take
relative to the standardized charges. The Commission believes that
given the important role that FCMs perform in the futures markets, and
in order to provide greater protection to customers and their funds,
that FCM-SDs must have model approval prior to using such models to
compute their adjusted net capital. Furthermore, the Commission notes
that currently the only FCM-SDs provisionally-registered with the
Commission are four ANC Firms that have existing approvals to use
capital models and may continue to use such models after the compliance
date of these rules.
The 2016 Capital Proposal also included proposed amendments to the
Commission's delegation of authority to the Director of the Division of
Swap Dealer and Intermediary Oversight contained in regulation 140.91.
The proposed amendments delegated to the Director the authority of the
Commission to approve capital models submitted to the Commission under
regulation 23.102 and Appendix A. The authority to revoke a previously
approved model was not delegated to the Director. The Commission did
not receive comments on the proposed amendments to the delegation of
authority under regulation 140.91 and, for the reasons discussed in the
2016 Capital Proposal, is adopting the amendments substantially as
proposed.
8. Liquidity Requirements for Covered SDs and FCM-SDs
The 2016 Capital Proposal required FCM-SDs and covered SDs electing
the Bank-Based Capital Approach or the Net Liquid Assets Capital
Approach to satisfy specific liquidity requirements.\361\ The 2016
Capital Proposal did not proposed liquidity requirements for covered
SDs electing the Tangible Net Work Capital Approach, covered MSPs, bank
SDs, or bank MSPs.
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\361\ See 2016 Capital Proposal, 81 FR 91252 at 91273-75.
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Proposed regulation 23.104(a)(1) required covered SD electing the
Bank-Based Capital Approach to meet the liquidity requirements
established by the Federal Reserve Board for banking entities.
Specifically, proposed regulation 23.104(a)(1) required covered SDs to
comply with the liquidity coverage ratio requirements set forth in 12
CFR part 249, and apply such requirements as if the covered SD were a
bank holding company subject to 12 CFR part 249.\362\ The proposed
liquidity coverage ratio required the SD to maintain each day an amount
of high quality liquid assets (``HQLAs''), as defined in 12 CFR 249.20,
that is no less than 100 percent of the SDs total net cash outflows
over a prospective 30 calendar-day period (the ``HQLA Proposal'').\363\
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\362\ Id.
\363\ See 12 CFR 249.10. Federal Reserve Board rules require a
regulated institution to maintain a liquidity coverage ratio of HQLA
to net cash outflows that is equal to or greater than 1.0 on each
business day.
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The Commission proposed several adjustments to the liquidity
coverage ratio to better reflect the business of an SD. For example,
the Commission proposed to permit a covered SD to consider cash
deposits that are readily available to meet the general obligations of
the SD as a level 1 liquid asset in computing its liquidity coverage
ratio.\364\ The Commission also proposed modifying the liquidity
coverage ratio so that covered SDs organized and domiciled outside of
the U.S. could recognize certain foreign deposited assets in computing
its liquidity coverage ratio. Finally, the Commission's Proposal
required a covered SD to maintain a contingency funding plan component,
as well as, certain internal senior management notifications and
approvals.\365\
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\364\ See proposed Commission regulation Sec. 23.104(a)(1);
2016 Capital Proposal, 81 FR 91252 at 91317.
\365\ See proposed Commission regulation Sec. 23.104; 2016
Capital Proposal, 81 FR 91252 at 91317-18.
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Proposed regulation 23.104(b) required covered SDs electing the Net
Liquid Assets Capital Approach and FCM-SDs to adopt a liquidity stress
test requirement that addressed the types of liquidity outflows
experienced by SEC-registered BDs that are ANC Firms in times of stress
(the ``LST Proposal''). Under the Commission's proposed LST Proposal, a
covered SD or FCM-SD would be required to perform a liquidity stress
test at least monthly that took into account certain assumed conditions
lasting for 30 consecutive days. The results of the liquidity stress
test would be reviewed by senior management periodically. The covered
SD or FCM-SD also would be required to have a contingency funding plan
to address potential liquidity issues.
In proposing these requirements, the Commission intended to address
the potential risk that a covered SD or FCM-SD may not be able to meet
both expected and unexpected current and future cash flow and
collateral needs as a result of adverse events impacting the covered
SD's or FCM-SD's daily operations or financial condition. Further, the
proposed liquidity requirements were consistent with those that had
been proposed at the time for SBSDs by the SEC and the existing
liquidity requirements adopted by the Federal Reserve Board for bank
holding companies.\366\
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\366\ See SEC proposed rule 18a-1(f), 77 FR 70213 (Nov. 23,
2012), and 12 CFR part 249.
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The Commission received comments on the proposed HQLA Proposal and
the LST Proposal. One commenter suggested that covered SDs should be
able to elect either the HQLA Proposal or the LST Proposal, without
regard to the SD's chosen capital approach.\367\ Another commenter
stated that the requirements of the HQLA Proposal and the LST Proposal
should be revised to be more similar to each other given that both
approaches have the comparable regulatory objective of helping to
ensure that a covered SD or FCM-SD has sufficient access to liquidity
to meet its obligations during periods of expected and unexpected
market activity.\368\ The commenter specifically noted that the LST
Proposal's definition of liquidity reserves is materially narrower than
the HQLA Proposal's definition of HQLA, and that the Commission should
expand the definition under the LST Proposal to match the definition
under the HQLA
[[Page 57511]]
Proposal so as to recognize the full range of assets that are actually
available to a firm to support its liquidity needs.\369\
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\367\ See, e.g., MS 5/15/17 Letter.
\368\ See SIFMA 5/15/17 Letter.
\369\ Id.
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Commenters also raised the concept of a third alternative, which
would be the application of a more qualitative than quantitative
requirement applicable to covered SDs that are subsidiaries of bank
holding companies and already subject to comprehensive overall
liquidity risk management program requirements at a parent level.
The Commission requested additional comments regarding the proposed
liquidity requirements in the 2019 Capital Reopening. The Commission
requested specific comment on whether it was necessary for the proposed
SD capital rules to include additional liquidity requirements given
that the Commission had previously adopted a risk management program
set forth in regulation 23.600 for both bank SDs and covered SDs that
includes liquidity requirements.
The Commission received comments in response to the 2019 Capital
Reopening. Several commenters suggested that the Commission defer
adopting separate and distinct quantitative liquidity requirements as
part of the SD capital rule given that the SD risk management program
adopted by the Commission in regulation 23.600 requires a covered SD to
assess liquidity risk.\370\ One commenter stated that the Commission
should not adopt the proposed specific liquidity requirement as SDs
have a diversity of business models, making standard quantitative
liquidity requirements difficult to apply across SDs. The commenter
further stated that the Commission should instead rely on the
qualitative liquidity requirements in regulation 23.600, and evaluate
the sufficiency of the liquidity program based on the specific business
and associated risks of the covered SD.\371\ The commenter noted that
regulation 23.600 is tailored specifically to address liquidity needs
associated with posting margin and performing on swap transactions. In
this regard, the commenter stated that a covered SD is required under
regulation 23.600 to measure liquidity needs on a daily basis, assess
procedures to liquidate non-cash collateral in a timely manner without
significant effect on price, and apply appropriate collateral haircuts
that accurately reflect market risk and credit risk, as well as
requiring a covered SD to establish and enforce a system of risk
management policies and procedures to monitor and manage market and
credit risk associated with its dealing activities. The commenter
further stated that the requirements of regulation 23.600 achieve the
objective of ensuring SD liquidity in a flexible manner, without
imposing a separate and standardized quantitative approach for firms
that have different operations.
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\370\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter;
Shell 3/3/2020 Letter.
\371\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
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One commenter noted that many covered SDs engage in multiple
business lines, not just swap dealing, which may be subject to separate
regulatory frameworks which address liquidity risk. For example, a
dual-registered BD/SD would be subject to either the Net Liquid Assets
Capital Approach or the FCM approach if the SD is also a registered
FCM, which is a liquidity-based capital requirement that requires the
entity to take net capital deductions for nonmarketable or otherwise
illiquid assets.\372\ In addition, this commenter noted that a
quantitative standard applicable at a covered SD level may trap liquid
assets within the covered SD and make such assets unavailable at the
SD's holding company level.\373\ The commenter stated that this may
make the holding company and other affiliates of the covered SD less
resilient by removing the flexibility to liquidate assets held at the
covered SD and deploy the cash where and when it is needed most.\374\
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\372\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter;
Shell 3/3/2020 Letter.
\373\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\374\ Id.
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Commenters also noted that many of the covered SDs are directly or
indirectly already subject to various forms of quantitative liquidity
requirements due to their status as subsidiaries of large U.S. bank
holding companies. One commenter stated that liquidity coverage ratios
and Federal Reserve regulation YY-mandated internal liquidity stress
testing programs apply and operate on a consolidated basis across large
U.S. bank holding companies, ensuring that liquidity risks arising in
covered SDs are addressed in consolidated liquidity requirements. This
commenter further noted that U.S. bank holding companies subject to
Recovery and Resolution Planning requirements are required to consider
funding and liquidity requirements of SDs that are ``material operating
entities'', which may result in a requirement to preposition liquidity
and funding in a covered SD.
The Commission has considered the comments received and assessed
the additional proposed liquidity requirements and has determined to
defer the adoption of final rules at this time. As noted by the
Commission in the 2019 Capital Reopening and by many of the commenters,
regulation 23.600 currently imposes liquidity requirements on covered
SDs. Regulation 23.600 requires each SD to establish, document,
maintain, and enforce a system of written risk management policy and
procedures designed to monitor and manage the risk associated with the
covered SD's swaps activities. A covered SD' risk management policies
and procedures must take into account market, credit, foreign currency,
legal, operational, settlement, and any other applicable risks in
addition to liquidity risk. With respect to liquidity risk, the risk
management policies and procedures must, at a minimum, monitor and/or
manage the daily measurement of liquidity needs and include an
assessment of the procedures to liquidate non-cash collateral in a
timely manner and without significant effect on the price realized for
the non-cash collateral.
Moreover, staff's review of covered SDs' risk exposure reports has
revealed that there is a wide disparity in how covered SDs establish
their liquidity risk management policies and procedures, and assess
their liquidity needs. This disparity is in part due to the variety of
provisionally-registered SDs under the Commission's jurisdiction. Some
covered SDs are subsidiaries of much larger parent organizations, many
of which are banking entities, that are subject to sophisticated
liquidity risk management policies and procedures at both the parent
and subsidiary levels. Other covered SDs are not part of a large bank
holding company or financial organization and have different, less
sophisticated liquidity policies and procedures that are more suited to
the type of swaps activities that they engage in with counterparties.
Given the diversity of the provisionally-registered SDs, the Commission
believes that it is not advisable to impose a single, mandated method
of measuring liquidity needs at a covered SD, and the Commission has
determined to defer the adoption of detailed quantitative liquidity
requirements at this time. Commission staff will monitor covered SDs'
liquidity as part of its ongoing monitoring of the financial reporting
submitted by covered SDs and will reassess the appropriateness of
recommending to the Commission additional liquidity risk management
requirements that are a supplement to, enhancement of, or replacement
of, the
[[Page 57512]]
current liquidity risk management requirements in regulation 23.600.
Such additional liquidity requirements would be based upon the
Commission staff's assessment and experience with actual liquidity
practices and procedures used by covered SDs and would be tailored to
address any potential deficiencies or lapses in liquidity risk
management.
9. Equity Withdrawal Restrictions for Covered SDs and Covered MSPs
The 2016 Capital Proposal proposed to prohibit certain withdrawals
of equity capital from covered SDs.\375\ The restrictions were based
upon existing equity withdrawal restrictions for FCMs set forth in
regulation 1.17(e). The Proposal generally provided that the capital of
a covered SD, or any subsidiary or affiliate of the covered SD that has
any of its liabilities or obligations guaranteed by the covered SD, may
not be withdrawn by action of the covered SD or by its equity holders
if the withdrawal, and any other similar transactions scheduled to
occur within the succeeding six months, would result in the covered SD
holding less than 120 percent of the minimum regulatory capital that
the covered SD is required to hold pursuant to proposed regulation
23.101. The Proposal also included an exception permitting the covered
SD to pay required tax payments and reasonable compensation to equity
holders of the SD.
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\375\ See 2016 Capital Proposal, 81 FR 91252 at 91275.
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In addition to the equity withdrawal restrictions, proposed
regulation 23.104(d) authorized the Commission to issue an order to
restrict for up to 20 business days the withdrawal of capital from a
covered SD, or to prohibit the covered SD from making an unsecured loan
or advance to any stockholder, partner, member, employee or affiliate
of the covered SD. The Proposal further authorized the Commission to
issue an order restricting or prohibiting the withdrawal of capital if,
based upon the information available, the Commission concludes that the
withdrawal, loan or advance may be detrimental to the financial
integrity of the covered SD, or may unduly jeopardize the covered SD's
ability to meet its financial obligations to counterparties or to pay
other liabilities which may cause a significant impact on the markets
or expose the counterparties and creditors of the covered SD to
loss.\376\
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\376\ Id. The Proposal further provided that the covered SD may
request a hearing on the order, which must be held within two
business days of the date of the written request by the covered SD.
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As noted in the Proposal, the proposed equity withdrawal
restrictions discussed above are consistent with existing equity
withdrawal restrictions imposed on FCMs and BDs, and with equity
withdrawal restrictions adopted by the SEC for SBSDs.\377\ In addition,
the grant of authority to the Commission to issue an order temporarily
restricting certain unsecured loans or advances is consistent with the
existing Commission authority under regulation 1.17(g)(1) for FCMs and
with the SEC's authority over BDs and SBSDs.\378\ Further, the
Commission proposed to make the existing language of 1.17(g)(1) as
applicable to FCMs more consistent with same language contained in
final SEC equity withdrawal restrictions for BDs and SBSDs, and
received no comments thereon.
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\377\ Equity withdrawal restrictions for FCMs are set forth in
Commission regulation Sec. 1.17(e) (17 CFR 1.17(e)), and for BDs
are set forth in SEC rule 15c3-1(e)(2) (17 CFR 240.15c3-1(e)(2)).
SEC equity withdrawal restrictions for SBSDs are contained in SEC
rule 18a-1(h)(2) (17 CFR 240.18a-1(h)(2)).
\378\ See SEC rule 15c3-1(e)(3) (17 CFR 240.15c3-1(e)(3)) for
BDs and rule 18a-1(h)(3) (17 CFR 240.18a-1(h)(3)) for SBSDs.
---------------------------------------------------------------------------
The Commission did not receive comments on the proposed equity
withdrawal requirements. The Commission has considered the Proposal and
for the reasons set out in the 2016 Proposal is adopting them with a
minor modification. The equity withdrawal restrictions were proposed in
paragraphs (c) and (d) of regulation 23.104. The Commission is
redesignating paragraphs (c) and (d) of regulation 23.104 as paragraphs
(a) and (b) in the final rule to reflect the removal of the proposed
liquidity requirements in proposed regulation 23.104(a) and (b) as
discussed above. The Commission is further adopting the amendment to
1.17(g)(1) as proposed to make the language of the FCM equity
withdrawal order restriction consistent with the same language as
effective for BDs and SBSDs, and now regulation 23.104 for SDs.
10. Leverage Ratio Requirements for Covered SDs
The Commission requested comment in the 2019 Capital Reopening as
to whether it would be appropriate for the Commission, at a future date
after notice and comment, to revise the covered SD capital requirements
by adopting a leverage ratio for SDs in lieu of the proposed percentage
of the risk margin amount, if adopted as final. The Commission also
requested comment on the cost, if any, in terms of additional required
capital that a leverage ratio requirement would impose on a covered SD
relative to the Net Liquid Assets Capital Approach, Bank-Based Capital
Approach, and Tangible Net Worth Capital Approach, and how the adoption
of a leverage ratio requirement would affect the efficiency,
competitiveness, integrity, safety and soundness, and price discovery
of the swap markets.\379\
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\379\ See 2019 Capital Reopening, 84 FR 69664 at 69669.
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Commenters generally opposed the adoption of a leverage ratio. One
commenter stated that while leverage ratios have been argued to serve
as effective backstops to guard against miscalculations of market risk
or credit risk, leverage ratios are very blunt instruments that create
perverse incentives.\380\ This commenter noted that a leverage ratio
would discourage a covered SD from maintaining a reserve of safer,
lower-yielding, securities and cash positions, despite the liquidity
and safety and soundness benefits of such instruments.\381\ The
Commission is not adopting a leverage ratio as part of its capital
requirements at this time.
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\380\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
\381\ Id.
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D. Swap Dealer and Major Swap Participant Financial Recordkeeping,
Reporting and Notification Requirements.
Section 4s(f) of the CEA requires SDs and MSPs to make any reports
regarding transactions and positions, as well as any reports regarding
financial condition, that the Commission adopts by rule or
regulation.\382\ Consistent with section 4s(f), the Commission proposed
new regulation 23.105, which require SDs and MSPs to satisfy current
books and records requirements, ``early warning'' and other
notification filing requirements, and periodic and annual financial
report filing requirements with the Commission and with any RFA of
which the SDs and MSPs are members.
---------------------------------------------------------------------------
\382\ 7 U.S.C. 6s(f).
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The notice and financial reporting requirements proposed by the
Commission differentiate covered SDs and covered MSPs from bank SDs and
bank MSPs.\383\ For covered SDs and covered MSPs, the Commission
proposed a financial reporting, notification and recordkeeping approach
that was modelled after the existing reporting regimes followed by FCMs
and BDs, and that was proposed by the SEC for SBSDs. Where applicable,
the Commission proposed flexibility for foreign-domiciled SDs and MSPs
recognizing that a significant number of these SDs and MSPs would
likely be subject to existing financial
[[Page 57513]]
reporting requirements. For bank SDs and bank MSPs, the Commission
proposed more limited requirements as the financial condition of these
entities will be predominantly supervised by the applicable prudential
regulator and subject to its capital and financial reporting
requirements.
---------------------------------------------------------------------------
\383\ See proposed Commission regulation Sec. 23.105(a)(2);
2016 Capital Proposal, 81 FR 91252 at 91318.
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The recordkeeping, reporting and notification requirements in the
2016 Capital Proposal were intended to facilitate effective oversight
over the Commission's capital requirements and improve internal risk
management, via requiring robust internal procedures for creating and
retaining records central to the conduct of business as an SD or
MSP.\384\ The 2016 Capital Proposal proposed to require covered SDs and
covered MSPs to, among other things: (i) Maintain current ledgers and
other similar records summarizing transactions affecting their assets,
liabilities, income, and expenses; (ii) file notices of certain events
with the Commission, including notices of failing to comply with the
applicable minimum capital requirements; (iii) file monthly unaudited
and annual audited financial statements with the Commission; and (iv)
provide the Commission with additional information as requested.\385\
The Proposal also required bank SDs and bank MSPs to file certain
information with the Commission. Such information included: (i)
Quarterly statements of financial condition, regulatory capital
computations, and aggregate swaps position information; (ii) notice
filings, including notice of a failure to maintain the minimum
applicable capital requirement; and (iii) additional information as
requested by the Commission.\386\
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\384\ See 2016 Capital Proposal, 81 FR 91252 at 91295.
\385\ See Proposed Commission regulation Sec. 23.105; 2016
Capital Proposal, 81 FR at 91252 at 91318-22.
\386\ Id.
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The Commission received several detailed comments regarding the
2016 proposed financial reporting, notification and recordkeeping
requirements. Several commenters noted the importance of harmonizing
the Commission's financial reporting and notification requirements with
the requirements of other regulators, namely the SEC and the prudential
regulators.\387\ Commenters generally supported the Commission's
approach of permitting non-U.S. SDs and MSPs to use International
Financial Reporting Standards (``IFRS'') in lieu of U.S. GAAP in the
preparation of required financial statements, but some asked that the
Commission remove the foreign domicile requirement to use IFRS.\388\
Several commenters to the Proposal also expressed concern that the 60-
day timeline for annual certified financial statement reporting was not
practical for many large non-financial companies as they are typically
permitted to provide audited financial statements within 90 days of the
end of their fiscal year.\389\ Other commenters expressed concern for
the weekly position reporting requirements.\390\ Several covered SDs
that are subsidiaries of non-financial public companies requested that
the posting period for public disclosures be extended or eliminated
altogether, noting that additional time would be necessary to allow for
internal and external auditors to review the information.\391\
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\387\ See SIFMA 5/15/17 Letter.
\388\ See, e.g., Shell 5/15/17 Letter; BPE 5/15/17 Letter.
\389\ See, e.g., Shell 5/15/17 Letter; Cargill 5/15/17 Letter.
\390\ See MS 5/15/17 Letter at 9; SIFMA 5/15/17 Letter at 29.
\391\ See Shell 5/15/17 Letter; NCGA/NGSA 5/15/2017 Letter; and
CEWG 5/15/2017 Letter.
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In the 2019 Capital Reopening, the Commission asked several
additional questions in response to these comments. The Commission
specifically asked whether the IFRS requirement should be expanded to
include a broader set of eligible covered SDs and whether the annual
audit reporting timelines for certain covered SDs should be lengthened
to 90 days.\392\ The Commission also asked whether it should harmonize
certain requirements, including the public disclosure timelines of bank
SDs, with the finalized reporting, notification and recordkeeping
requirements of SBSDs adopted by the SEC.\393\
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\392\ See 2019 Capital Reopening, 84 FR 69664 at 69678 (Dec. 19,
2019).
\393\ Id. See also, Recordkeeping and Reporting Requirements for
Security-Based Swap Dealers, Major Security-Based Swap Participants,
and Broker-Dealers, 84 FR 68550 (Dec. 16, 2019).
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The Commission received several comments in response to the
questions.\394\ Certain commenters stated that the Commission should
permit non-U.S. covered SDs and U.S. covered SDs that are subsidiaries
of non-U.S. parent companies to use IFRS, one stating that there would
be no material difference in its financial statements if they were
produced under IFRS versus GAAP.\395\ Several commenters did not
believe that the Commission should adopt the weekly margin position
reporting requirements, citing that information required under the
reporting is duplicative of information received or proposed to be
received under the Commission proposed part 45 data requirements.\396\
Several commenters also stated that the Commission should harmonize
public disclosure requirements with those adopted by the SEC for stand-
alone SBSDs.\397\ One commenter stressed that the Commission should not
adopt any financial reporting requirements for bank SDs, and that
covered SDs following the Bank-Based Capital Approach should be
subjected to the same reporting timeline (45 days after quarter end) as
a bank.\398\
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\394\ Shell Trading 3/3/2020 Letter; NCGA/NGSA 3/3/2020 Letter;
IIB/ISDA/SIFMA 3/3/2020 Letter.
\395\ See Shell 3/3/2020 Letter at 3: CEWG 3/3/2020 Letter at 5-
6; NCGA/NGSA 3/3/2020 at 6-7; IIB/ISDA/SIFMA 3/3/2020 Letter at 52.
\396\ See NCGA/NGSA 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020
Letter at 53.
\397\ See CEWG 3/3/2020 Letter at 6; IIB/ISDA/SIFMA 3/3/2020
Letter.
\398\ See IIB/ISDA/SIFMA 3/3/2020 Letter at 50-51.
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After considering those comments and in light of the final
financial reporting, notification and recordkeeping requirements for
MSBSP and SBSDs adopted by the SEC,\399\ the Commission is adopting the
recordkeeping, notice and financial reporting requirements as proposed
with the following modifications.
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\399\ Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and
Broker-Dealers, 84 FR 68550 (Dec. 16, 2019).
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1. Routine Financial Reporting and Recordkeeping Requirements
Proposed regulation 23.105(b) required a covered SD or a covered
MSP to prepare current ledgers or other similar records showing or
summarizing each transaction affecting its asset, liability, income,
expense, and capital accounts.\400\ The accounts must be classified in
accordance with U.S. GAAP provided, however, that if the covered SD or
covered MSP is organized under the laws of a foreign jurisdiction and
is not otherwise required to prepare its records or financial
statements in accordance with U.S. GAAP, the SD or MSP may prepare the
required records in accordance with IFRS issued by the International
Accounting Standards Board.\401\ The Commission also proposed to
require covered SDs and covered MSPs to file periodic financial
[[Page 57514]]
reports with the Commission and with the SDs' or MSPs' RFA.\402\ In
proposed regulation 23.105(d)(2) and (e)(3), the monthly unaudited and
annual audited financial statements must also be prepared in accordance
with U.S. GAAP, provided, however, that the Commission proposed to
permit covered SDs or covered MSPs that are organized and domiciled
outside of the U.S., and otherwise are not required to prepare
financial statements in accordance with U.S. GAAP, to prepare the
financial statements in accordance with IFRS or another local
accounting standard, after requesting approval by the Commission, which
is discussed below, in lieu of U.S. GAAP.\403\
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\400\ These proposed requirements are based upon existing FCM
and BD financial recordkeeping and reporting requirements.
Commission regulation Sec. 1.18 (17 CFR 1.18) requires each FCM to
prepare and keep current ledgers or other similar records which show
or summarize, with appropriate references to supporting documents,
each transaction affecting its asset, liability, income, expense and
capital accounts. SEC rule 17a-3 (17 CFR 240.17a-3) requires a BD to
make and maintain comparable ledgers and other similar records
reflecting its assets, liabilities, income and expenses.
\401\ FCMs are required to classify accounts only in accordance
with U.S. GAAP.
\402\ As noted in the proposal, these periodic financial
reporting requirements are consistent with existing requirements for
FCMs and BDs. See Commission regulation Sec. 1.10 (17 CFR 1.10),
which requires FCMs to submit unaudited monthly and audited annual
financial reports to the Commission and to the FCMs' respective
designated self-regulatory organization. SEC rule 17a-5 (17 CFR
240.17a-5) directs BDs to file unaudited monthly reports and annual
audited reports with the SEC.
\403\ See proposed Commission regulations Sec. Sec.
23.105(d)(2) and (e)(3), 2016 Capital Proposal, 81 FR at 91252 at
91319. Commission regulation Sec. 1.10 (17 CFR 1.10) provides that
FCMs must present its unaudited monthly reports and audited annual
reports in accordance with U.S GAAP.
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Commenters generally supported the Commission's approach of
permitting non-U.S. covered SDs and covered MSPs to use IFRS in lieu of
U.S. GAAP in the preparation of required financial statements. However,
several commenters requested that the proposed regulation be modified
to permit U.S.-based covered SDs that are subsidiaries of non-U.S.
parent entities to prepare required financial statements in accordance
with IFRS.\404\ These commenters stated that U.S. covered SDs that are
subsidiaries of foreign-based holding companies may prepare their
financial statements in accordance with IFRS as the subsidiary is
consolidated with the parent in producing the parent's consolidated
financial statements, and further stated that requiring U.S. GAAP
financial statements in such situations would impose unnecessary costs
on covered SDs without providing substantial enhancements to the
regulatory objectives.\405\ Three commenters to the 2019 Capital
Reopening stated that the Commission should permit non-U.S. covered SDs
and U.S. covered SDs that are subsidiaries of non-U.S. parent companies
to use IFRS, one stating that there would be no material difference in
its financial statements if they were prepared in accordance with IFRS
versus U.S. GAAP.\406\
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\404\ See, e.g., Shell 5/15/17 Letter; BPE 5/15/17 Letter.
\405\ Id.
\406\ See Shell 3/3/2020 Letter at 3: CEWG 3/3/2020 Letter at 5-
6; NCGA/NGSA 3/3/2020 at 6-7; IIB/ISDA/SIFMA 3/3/2020 Letter at 52.
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The Commission is adopting regulation 23.105(b), (d)(2) and (e)(3)
as proposed with the exception of a modification to the eligibility
requirement for the use of IFRS to address concerns raised by
commenters. The Commission is generally comfortable with both U.S. GAAP
and IFRS accounting standards for covered SDs and covered MSPs,
especially as both standards continue to move towards greater
convergence. However, the Commission's preference continues to be U.S.
GAAP, and therefore, the Commission is requiring that covered SDs or
covered MSPs that are not included in the exception described below,
must prepare their financial statements in accordance with U.S. GAAP.
In response to commenters, the Commission has removed the requirement
that an eligible covered SD or covered MSP must be domiciled outside
the U.S in order to be permitted to use IFRS. However, all covered SDs
and covered MSPs that are also registered as FCMs or BDs must continue
to prepare their financial statements in accordance with U.S. GAAP and
are not eligible to use IFRS. The Commission notes that foreign
domiciled covered SD or covered MSP may also apply under final
regulation 23.106 for a Capital Comparability Determination and has
retained language in regulation 23.105(o) to make clear that such a
determination could consider different, yet comparable financial
reporting requirements including the use of a local accounting standard
other than U.S. GAAP or IFRS.
The Commission proposed in regulation 23.105(d)(1) to require a
covered SD or covered MSP to file a monthly unaudited financial report
within 17 business days of the close of business each month, and
proposed in regulation 23.105(e)(1) to require a covered SD or covered
MSP to file an annual audited financial report within 60 days of the
close of the SD's or MSP's fiscal year-end date. Proposed regulation
23.105(e)(2) required the annual financial statements to be audited by
a public accountant that is in good standing in the accountant's home
country jurisdiction.\407\
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\407\ The monthly unaudited and the annual audited financial
reports must be prepared in the English language and denominated in
U.S. dollars. The proposal also required that the monthly unaudited
and annual audited financial reports include: (1) A statement of
financial condition; (2) a statement of income or loss; (3) a
statement of cash flows; (4) a statement of changes in ownership
equity; (5) a statement of the applicable capital computation; and
(6) any further materials that are necessary to make the required
statements not misleading. Proposed Regulation 23.105(e)(4)(iii)
would further require that the annual audited financial statements
also include any necessary footnote disclosures. See 2016 Capital
Proposal, 81 FR 91252 at 91320.
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The 2019 Capital Reopening asked several questions regarding
whether it would be appropriate to expand the 60-day annual audit
reporting requirement.\408\ In response, the Commission received
several comments advocating for extending the financial reporting
timelines in general, not just the 60-day audit requirement. One
commenter requested that the Commission permit covered SDs that elect
to use the Bank-Based Capital Approach to submit quarterly reports, as
opposed to monthly, and that such reports should be filed within 45
days of the end of the quarter, as is currently required of banks and
bank holding companies by regulations of prudential regulators.\409\
Another commenter supported the proposition that monthly financial
reporting be eliminated for non-bank covered SDs.\410\ Other commenters
supported an extension of the annual audited financial statement
requirement from 60 to 90 days after the end of the covered SD's fiscal
year.\411\
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\408\ 2019 Capital Reopening at 69679.
\409\ See IIB/ISDA/SIFMA 3/3/2020 Letter at 52.
\410\ See NCGA/NGSA 3/3/2020 at 6.
\411\ See NCGA/NGSA 3/3/2020 at 6.
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As noted in the Proposal, the timing of the proposed financial
reporting requirements is consistent with the existing requirements for
FCMs, which is harmonized with that required of BDs and SBSDs by the
SEC.\412\ Timely financial reporting is the Commission's primary method
for routine monitoring for compliance with the Commission's capital
rule across multiple registrants. The Commission does not expect this
timing to be operationally challenging for non-commercial covered SDs,
as many of these registrants already prepare financial reports within
the organization on a routine basis. In addition, several of these
firms are expected to be dually registered with the SEC as either a
SBSD or BD, and will be subject to a monthly financial reporting
requirement and 60-day reporting timeline for annual audited financial
statements.\413\
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\412\ See Commission regulation Sec. 1.10(b) (17 CFR 1.10(b)),
and 17 CFR 240.17a-5, and 240.18a-7.
\413\ See 17 CFR 240.18a-7(a)(1) and (c)(5).
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On the other hand, covered SDs eligible to use the Tangible Net
Worth Capital Approach and who are not dually-registered with the SEC
could engage in a wide variety of business
[[Page 57515]]
operations and may be closely held corporations, partnerships or
subsidiaries thereof. These covered SDs may not be subject to routine
reporting requirements and could require longer periods to perform
year-end audit requirements based on the composition of their balance
sheet and financial statements. Therefore, the Commission is modifying
the timeline for commercial firms by moving the monthly unaudited
requirement to a quarterly requirement, and expanding the annual audit
timeline for these firms to 90 days. This expanded approach will only
be available to covered SDs that elect the Tangible Net Worth Capital
Approach under regulation 23.101(a)(2).
The Commission notes that regardless of a covered SD's reporting
timeline or elected approach, compliance with the Commission's capital
rule is an ``at all times'' requirement. As such, covered SDs should
routinely monitor their capital position and notify the Commission and
its RFA of material changes in accordance notification requirements
discussed herein. In this regard, regulation 23.105(h) provides that
the Commission or RFA may, by written notice, require any covered SD or
covered MSP to file financial or operational information to the
Commission or RFA.\414\ Accordingly, covered SDs and covered MSPs
eligible to file financial information on a quarterly basis in
accordance with regulation 23.105(d), may be required by the Commission
or RFA to furnish such information on a monthly or more frequent basis
as provided by such notices under regulation 23.105(h). As such,
covered SDs and covered MSPs should therefore maintain their books and
records in a manner capable of furnishing such information upon request
by the Commission or RFA under a written notice issued under regulation
23.105(h) and to be able to demonstrate compliance with notification
requirements under regulation 23.105(c). Therefore, the Commission is
adopting the financial reporting process and timelines for covered SDs
as proposed in regulation 23.105(d)(1), 23.105(e)(1), and 23.105(h)
with the modifications discussed above for covered SDs and covered MSPs
eligible to use the Tangible Net Worth Capital Approach and regarding
furnishing additional reports as requested by the Commission or RFA.
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\414\ As discussed in the 2016 Capital Proposal, the
Commission's intention is to require all covered SDs and covered
MSPs to file financial reports and notices required under regulation
23.105 with both the Commission and the RFA. As noted, this is
consistent with the existing approach under Commission regulations
Sec. Sec. 1.10 and 1.12 (17 CFR 1.10 and 1.12) applicable to FCMs
and IBs. Regulation 23.105(h) and elsewhere in regulations
23.105(c), (d), and (e), have been modified to clarify such
reporting requirements.
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The Commission also proposed in regulation 23.105(d)(3), (4) and
(e)(5) to permit a covered SD or covered MSP that is registered with
the Commission as an FCM or registered with the SEC as a BD to satisfy
the Commission's SD or MSP financial statement reporting requirements
by submitting a CFTC Form 1-FR-FCM or its applicable SEC Financial and
Operational Combined Uniform Single (``FOCUS'') Report in lieu of the
specific financial statements required under proposed regulation
23.105.\415\ Similarly, the Commission proposed to permit covered SDs
and covered MSPs dually registered with the SEC as either SBSDs or
MSBSPs to comply with the Commission's financial reporting and
notification requirements under regulation 23.105 by filing
simultaneously with the Commission all applicable notices or reports
required under the SEC's rules.\416\ This proposed framework is
consistent with the Commission's long history of permitting SEC
registrants to meet their financial statement filing obligations with
the Commission by submitting a FOCUS Report in lieu of CFTC Form 1-FR-
FCM and reduces the burden on dually registered firms by not requiring
two separate financial reporting requirements.
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\415\ FCMs are required to file monthly unaudited and annual
audited Forms 1-FR-FCM with the Commission and with their designated
self-regulatory organization. The Forms 1-FR-FCM include, among
other information, a statement of financial condition, a statement
of income or loss, a statement of changes in ownership equity, a
statement of liabilities subordinated to the claims of general
creditors, a statement of the computation of regulatory minimum
capital, and any further information as may be necessary to make the
required statements not misleading. See Commission regulation Sec.
1.10(d) (17 CFR 1.10(d)). SEC FOCUS Reports are required to contain,
among other statements and information, a statement of financial
condition, a statement of income or loss, a statement of changes in
ownership equity, a statement of liabilities subordinated to the
claims of general creditors, and a statement of the computation of
regulatory minimum capital. See SEC rule 17a-5 (17 CFR 240.17a-5).
\416\ See Commission regulation Sec. 23.105(c)(5) (17 CFR
23.105(c)(5)) referencing proposed 17 CFR 240-18a-8 for notification
requirements for SBSDs and MSBSPs. See Sec. 23.105(d)(3) and Sec.
23.105(e)(5) (17 CFR 23.105(d)(3) and 23.105(e)(5)) referencing
proposed 17 CFR 240.18a-7, for monthly and annual financial
reporting requirements for SBSDs and MSBSPs.
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The SEC finalized reporting requirements which require SBSDs and
MSBSPs to file a FOCUS form X-17A-5 Part II, no longer requiring a
separate FORM SBS as proposed.\417\ The Commission is not changing its
approach permitting dual registrants the ability to file SEC forms in
lieu of the financial reporting and notification requirements of the
CFTC. Accordingly, regulation 23.105(d) and (e) have been modified to
permit these dual registered covered SDs to file FOCUS reports as
discussed in lieu of the Commission's financial reporting requirements.
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\417\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and
Broker-Dealers, 84 FR 68550 (December 16, 2019). See SEC rule 18a-7
(17 CFR 240.18a-7), 84 FR 68550 at 68662-67; SEC rule 18a-10 (17 CFR
240.18a-10), 84 FR 68550 at 68668-69.
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The Commission has made further technical modifications to the
general financial reporting requirements to align them with existing
rules for FCMs and dually-registered SBSDs and BDs. The Commission is
making these modifications to prevent different treatment between
dually-registered SDs and stand-alone SDs. The Commission is modifying
regulation 23.105(d) to remove the statement of cash flows, as this
schedule is not necessary to assess the financial condition and safety
and soundness of the covered SD, nor required of existing FCMs under
regulation 1.10 or for BDs under 17 CFR 240.17a-5. For the same
reasons, regulation 23.105(d) is also modified to include a statement
of changes in liabilities subordinated to the claims of general
creditors and references to the annual audited or certified financial
report throughout regulation 23.105 have been renamed annual financial
report. The Commission has also included references to SEC rule Sec.
240.17a-5 to paragraphs (d)(3) and (e)(5) of regulation 23.105, as
SBSDs and MSBSPs which are dually-registered BDs file financial reports
in accordance with that rule.
The Commission did not receive comments on the other aspects not
discussed herein in regards to regulation 23.105(d) and (e) and is
adopting such provisions substantially as proposed.
2. Swap Dealer and Major Swap Participant Notice Requirements
The 2016 Capital Proposal required SDs and MSPs to file certain
regulatory notices with the Commission and with the RFA of which the
SDs or MSPs are members if certain defined events occurred.\418\
Certain of the notice provisions applied solely to covered SDs and
covered MSPs, while other notice provisions applied solely to bank SDs
and bank MSPs. The Commission also proposed notice provisions that
applied to all registered SDs and MSPs. The proposed notice provisions
were based on the existing notice provisions
[[Page 57516]]
applicable to FCMs, and are intended to require registrants to provide
the Commission and RFA with notice of certain events that may indicate
that the registrants are experiencing an actual or a potential adverse
event, affecting their financial or operational condition.\419\ Upon
filing of a notice, the Commission or an RFA would initiate an inquiry,
including engaging directly with the SD or MSP as necessary, to assess
if the notice is an indication of potential issues with the registrant
regarding its ability to meet its obligations to customers,
counterparties, clearing organizations, creditors, and the marketplace
in general.
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\418\ See 2016 Capital Proposal, 81 FR 91252 at 91277-78.
\419\ See Commission regulation Sec. 1.12 (17 CFR 1.12), which
requires FCMs to file notices with the Commission and with the FCMs'
designated self-regulatory organizations of certain events,
including a firm being undercapitalized or failing to maintain
current books and records.
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The Commission proposed in regulation 23.105(c) to require a
covered SD or a covered MSP to provide the Commission and RFA with
immediate written notice when the firm is: (i) Undercapitalized; (ii)
fails to maintain capital at a level that is in excess of 120 percent
of its minimum capital requirement; or (iii) fails to maintain current
books and records. Proposed regulation 23.105(c) also required a
covered SD or covered MSP, as applicable, to provide notice to the
Commission and to an RFA within 24 hours of: (i) Failing to comply with
the liquidity requirements under proposed regulation 23.104, (ii)
experiencing a 30 percent reduction in capital as compared to the last
reported capital in a financial report filed with the Commission, or
(ii) failing to post or collect initial margin for uncleared swap and
security-based swap transactions or exchange variation margin for
uncleared swap or security-based swap transactions as required by the
Commission's uncleared swaps margin rules or the SEC's uncleared
security-based margin rules, respectively, if the total amount that has
not been exchange is equal to or greater than: (1) 25 percent of the
SD's or MSP's required capital under final regulation 23.101 calculated
for a single counterparty or group of counterparties that are under
common ownership or control; or (2) 50 percent of the SD's or MSP's
required capital under final regulation 23.101 calculated for all of
the SD's counterparties.\420\
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\420\ See Commission regulations Sec. Sec. 23.152 and 23.153
(17 CFR 23.152 and 23.153).
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Proposed regulation 23.105(c) also required a covered SD or covered
MSP to provide the Commission and an RFA with a minimum two days
advance notice of an intention to withdraw capital by an equity holder
that would exceed 30 percent of the SD's or MSP's excess regulatory
capital.\421\ Finally, the proposal required a covered SD or covered
MSP that is dually-registered with the SEC as an SBSD or MSBSP to file
with the Commission and with its RFA a copy of any notice that the SBSD
or MSBSP is required to file with the SEC under SEC Rule 18a-8 (17 CFR
240.18a-8). SEC Rule 18a-8 requires SBSDs and MSBSPs to provide written
notice to the SEC for comparable reporting events as proposed by the
Commission in regulation 23.105(c), including if a SBSD or MSBSP is
undercapitalized or fails to maintain current books and records.\422\
The Commission proposed to require covered SDs and covered MSPs that
are dually-registered with the SEC to file copies with the Commission
of notices filed with the SEC under Rule 18a-8 to allow the Commission
to be aware of any events that may indicate that the SD or MSP is
unable to meet its operational or financial obligations on an ongoing
basis.
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\421\ The term `regulatory capital'' is defined in proposed
Commission regulation Sec. 23.100 and means the relevant capital
approach applicable to the SD under proposed Commission regulation
Sec. 23.101. See 2016 Capital Proposal, 81 FR 91252 at 91309-11.
\422\ See 17 CFR 240.18a-8.
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The Commission did not receive comments on the proposed notice
provisions in regulation 23.105(c). The Commission has considered the
proposal, and is adopting the SD and MSP notice requirements as
proposed, with a modification to eliminate the notice provision
relating to liquidity requirements that the Commission did not adopt.
3. Swap Dealers and Major Swap Participants Subject to the Capital
Rules of a Prudential Regulator
The Commission proposed limited financial reporting for bank SDs
and bank MSPs that are subject to the capital requirements of a
prudential regulator, as these SDs and MSPs are already subject to
existing financial reporting requirements by such prudential regulator.
As such, the Commission did not propose to require a bank SD or bank
MSP to file monthly unaudited or annual audited financial statements
with the Commission or with the RFA of which the SD or MSP is a member.
The Commission also did not propose to require such bank SDs or bank
MSPs to file notifications contained in Regulation 23.105(c) with the
Commission or with an RFA. The Commission did, however, propose to
require bank SDs and bank MSPs to file quarterly unaudited financial
reports. The Commission also proposed certain regulatory notices that
bank SDs and bank MSPs must file with the Commission and with an RFA.
Under the Proposal, bank SDs and bank MSPs were required to file
financial reports and specific position and margin information with the
Commission and with the RFA of which the SDs and MSPs are members
within 17 business days of the end of each calendar quarter. The
financial reports and specific position information that would be
required under this requirement was set forth in a separate Appendix B
to proposed Regulation 23.105(p). The information required on Appendix
B was intended to be identical to that required by the SEC for SBSDs
subject to the capital rules of a prudential regulator.\423\ These
quarterly unaudited reports filed with the Commission were largely
based on existing ``call reports'' that the bank SDs and bank MSPs are
required to file with their respective prudential regulator.\424\
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\423\ See 2016 Capital Proposal, 81 FR 91252 at 91279.
\424\ See proposed Commission regulation Sec. 23.105(p) and
Appendix B; 2016 Capital Proposal, 81 FR 91252 at 91321-22 and
91329-32. See also, Consolidated Reports of Condition and Income for
a Bank with Domestic and Foreign Offices (``call reports''); 12
U.S.C. 324; 12 U.S.C. 1817; 12 U.S.C. 161; and 12 U.S.C. 1464. The
proposed financial reporting requirement was consistent with the SEC
proposed filing requirement for SBSDs that are subject to the
capital rule of a prudential regulator. See proposed SEC rule 17 CFR
240.18a-8. Specifically, the Commission proposed that the SDs and
MSPs submit to the Commission Appendix B of proposed Commission
regulation Sec. 23.105, which is largely based on the SEC's
proposed Form SBS part 2 and part 5.
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In addition, proposed regulation 23.105(p) required bank SDs and
bank MSPs to file certain notices with the Commission and their RFA
following the occurrence of certain events. Proposed regulation 23.105
(p)(3)(i) required a bank SD or bank MSP to file a notice with the
Commission and with an RFA if the SD or MSP filed a notice of change of
its reported capital category with the Federal Reserve Board, the OCC,
or the FDIC. Proposed regulation 23.105(p)(3) also required a bank SD
that is a foreign bank to notify the Commission if the SD files a
notice of a change in its capital category or a notice of falling below
its minimum capital requirement with a prudential regulator or with its
home country supervisor.\425\ Proposed regulation 23.105(p)(3) also
required a bank SD or bank MSP to file notices in the event the SD or
MSP fails to post or collect initial margin for uncleared swap
transactions
[[Page 57517]]
or post or collect uncleared swap variation margin as required under
the respective prudential regulators' rules subject to certain
thresholds.\426\ Finally, proposed regulation 23.105(p) also included
an identical oath and affirmation provisions and electronic filing
requirements for bank SDs and bank MSPs as the Commission proposed
under paragraphs (f) and (n) of regulation 23.105 for covered SDs and
covered MSPs.
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\425\ These notices are identical to those finalized for SBSDs
by the SEC in 17 CFR 240.18a-8(c).
\426\ These notices are identical to those required for SDs and
MSPs subject to the capital rules of the Commission and proposed
under 23.105(c). See 2016 Capital Proposal, 81 FR 91252 at 91318.
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The 2019 Capital Reopening noted that the SEC finalized its
recordkeeping, reporting and notification requirements for SBSDs and
MSBSPs, which include requiring SBSDs and MSBSPs subject to the capital
rules of a prudential regulator to report quarterly unaudited financial
information and provide notices of change in its capital category or
falling below its minimum capital requirement with the a prudential
regulator.\427\ The 2019 Capital Reopening asked whether it was
appropriate to make specific changes to proposed regulation 23.105(p)
Appendix B in this regard, and to make such schedule align with that
finalized by the SEC under Form X-17a-5 FOCUS Part IIC.\428\
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\427\ See 17 CFR 240.18a-7(a)(2) and 240.18a-8(c).
\428\ 2019 Capital Reopening, 84 FR 69664 at 69680.
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Several commenters noted that the 17 business day timeline for the
quarterly unaudited financial reporting requirement for bank SDs and
bank MSPs was inconsistent with existing banking requirements which
permit between a 30-day or 45 calendar day timeline depending on size.
In addition, the SEC amended their requirements for SBSDs subject to
the capital rules of a prudential regulator to 30 calendar days, making
slight adjustments to the schedules in order to make them more
consistent with existing call reports.
As noted previously, the Commission wishes to harmonize the
reporting requirements for bank SDs and bank MSPs to the maximum extent
practicable. The Commission is modifying final regulation 23.105(p) to
require a 30 calendar day reporting timeline comparable to that
required by SBSD subject to the capital rules of a prudential
regulator. The Commission is also adopting the notification
requirements relating to the notices of change in capital category or
failing below its minimum capital requirement with a prudential
regulator. The Commission, however, is not adopting the additional
requirements relating to posting and collecting of initial and
variation margin under certain thresholds as these notices are not
required for SBSDs subject to the rules of a prudential regulator. The
Commission further notes in this regard that bank SDs and bank MSPs are
also not subject to the Commission's rules for uncleared margin. The
Commission is making technical amendments to the Appendix B to align
the schedule with that required of SBSD subject to the capital
requirements of a prudential regulator under FORM x-17a-5 FOCUS Part
IIC, which have been aligned primarily with FFIEC Form 031.
4. Public Disclosures
The Commission proposed to require covered SDs and covered MSPs to
provide public disclosure on their website of required financial
reporting, including a statement of financial condition and of the
amount of minimum regulatory capital required and the amount of
regulatory capital of the SD or MSP no less than quarterly, with the
same information provided from an audited financial statement no less
than annually.\429\ The Commission also proposed to require bank SDs
and bank MSPs to make publically available no less than quarterly
similar financial information.\430\ In both instances, the proposed
public disclosures were required to be posted to the SD's or MSP's
website within ten business days after the SD or MSP is required to
file the financial information with the Commission.
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\429\ See Proposed Commission regulation Sec. 23.105(i)(3);
2016 Capital Proposal, 81 FR 91252 at 91320.
\430\ See Proposed Commission regulation Sec. 23.105(p)(7);
2016 Capital Proposal, 81 FR 91252 at 91322.
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The Commission noted in the 2016 Capital Proposal that its approach
was consistent with the financial reporting information the Commission
had previously determined should not qualify as exempt from the Freedom
of Information Act for FCMs.\431\ For bank SDs and bank MSPs, the
Commission noted the Proposal was consistent with publically available
information provided by bank entities in call reports.\432\
---------------------------------------------------------------------------
\431\ See 2016 Capital Proposal, 81 FR 91252 at 91277.
\432\ Id.
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Several covered SDs that are subsidiaries of public companies
requested that the posting period on firm's website be extended from
ten days to 20 days for the quarterly information, noting that
additional timeframe would be necessary to allow for internal and
external auditors to review the information.\433\ One commenter stated
that public disclosure of financial reports will be onerous for
commercial covered SDs, while others requested elimination of public
disclosures by bank SDs.\434\
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\433\ See Shell 5/15/17 Letter; NCGA/NGSA 5/15/2017 Letter; CEWG
5/15/2017 Letter.
\434\ See Shell 5/15/17 Letter; SIFMA 5/15/17 Letter; MS 5/15/17
Letter.
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In the 2019 Capital Reopening, the Commission asked questions
regarding the practicality of moving the posting deadline from ten
business days to 30 calendar days to be consistent with the final
requirements adopted by the SEC for SBSDs. Further, the Commission
asked whether it was appropriate to remove the public disclosure
requirement for bank SDs and bank MSPs under the rationale that this
information is already provided to the public on a timely basis as a
result of separate disclosure requirements imposed by the prudential
regulators.\435\ In response, commenters confirmed that a longer period
for public disclosure would be preferred and that imposing an
additional Commission requirement for bank SDs is duplicative and would
override existing balances that were struck.\436\ One commenter
suggested harmonizing the public disclosure requirement for stand-alone
SDs with the biannual requirement required by the SEC for stand-alone
SBSD.\437\ Another commenter recommended that an exemption be provided
for commercial firms which meet a certain threshold of minimum
capital.\438\
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\435\ See 2019 Capital Reopening, 84 FR 69664 at 69680,
questions 13-a and 13-b.
\436\ See NCGA/NGSA 3/3/2020 Letter at 6; IIB/ISDA/SIFMA 3/3/
2020 Letter at 52.
\437\ See Shell 3/3/2020 Letter at 4.
\438\ See Cargill 3/3/2020 Letter at 3.
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The Commission believes that is best to harmonize public disclosure
requirements to the maximum extent practicable with that required of
SBSDs by the SEC. Thus, the Commission is not adopting public
disclosure requirements for bank SDs and bank MSPs as these SDs and
MSPs will already be providing public disclosures of key financial
information as part of the ``call report'' process. Covered SDs and
covered MSPs will be required to bi-annually make available on its
website basic financial information 30 calendar days following when
such information is filed with the Commission. This approach will
harmonize the Commission's public disclosure requirements with those
required of the stand-alone SBSDs under 17 CFR 240.18a-7(b). Therefore,
the Commission is not adopting proposed regulation 23.105(p)(7)
[[Page 57518]]
regarding public disclosures requirements for bank SDs and bank MSPs.
The Commission is adopting regulation 23.105(i) as proposed with
modification to the timelines as discussed above.
5. Electronic Filing Requirements for Financial Reports and Regulatory
Notices
Proposed regulation 23.105(n) required all notifications and
financial statement filings submitted to the Commission pursuant to
regulation 23.105 to be filed in an electronic manner using a user
authentication process approved by the Commission. Proposed regulation
23.105(f) and (p) required each filing made pursuant to Regulation
23.105 include an oath or affirmation signed by an appropriate SD or
MSP personnel that the information provided in the filing was true and
correct. The Commission notes that many SDs and MSPs are already
familiar with the Commission approved WinJammer filing system
maintained jointly by NFA and Chicago Mercantile Exchange. WinJammer
currently allows Commission registrants that are authorized to use the
electronic system to file financial reports and notices with the
Commission and NFA simultaneously. The Commission views this system, as
well as other future Commission approved systems, as the most effective
way to ensure that the filings required under proposed regulation
23.105 would be submitted promptly and directly to the Commission.
One commenter to the 2016 Proposal asked that the Commission
provide clarity with the requirements of the oath or affirmation.\439\
Another commenter, while generally supportive of the proposed
requirements, encouraged the Commission to either adopt standard forms
or mandate that the financial filings be accomplished in a form and
manner prescribed by an RFA.\440\ This commenter further suggested that
the Commission consider the SEC's final adopted forms as a starting
point for the Commission's forms and encouraged the Commission to
parallel any financial reporting requirements for prudentially
regulated SDs and those relying on substituted compliance with the
SEC's filing requirements for these firms.\441\
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\439\ SIFMA 5/15/17 Letter at 28.
\440\ NFA 3/2/2020 Letter at 6, 7.
\441\ Id.
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As with other requirements regarding financial reporting for SDs
and MSPs, the Commission wishes to harmonize these rules to the maximum
extent practicable with that adopted by the SEC. The Commission expects
that those registrants that are dually-registered with the SEC as
either BDs or SBSDs, including those that are also subject to the
capital rules of a prudential regulator, would fully comply with the
Commission's reporting requirements by filing forms adopted by the SEC.
Accordingly, to ensure that bank SD or bank MSP duly registered with
the SEC will not be subject to two separate filing requirements, the
Commission is amending 23.105(p) by including a provision that a bank
SD or bank MSP may file a Form X-17A-5 FOCUS Part IIC in lieu of the
forms required under 23.105(p).
The Commission wishes to add clarity that while it is adopting
specific schedules in Appendix A and B with regard to swap position
information, it is not adopting a standard form for the other routine
monthly or annual filing requirements as discussed above.\442\
Nonetheless, the Commission may approve additional procedures developed
by an RFA, which could include standard forms or procedures necessary
to carry out the Commission's filing requirements. The Commission notes
that an RFA is required to adopt minimum capital, segregation, and
other financial requirements applicable to its members, in accordance
with section 17(p)(2) of the CEA. In this regard, each self-regulatory
organization, which includes an RFA, must have minimum financial and
related reporting requirements that are the same as or more stringent
than the Commission's requirements.\443\ The Commission is not
modifying the proposed language related to the oath or affirmation that
financial reports be true and correct. This language is identical to
that required in regulation 1.10(d)(4) and that is required by the SEC
in 240.17a-5(e)(2) and 240.18a-7(d)(1). In order to ensure that the
oath and affirmation is harmonized with SEC for duly registered SBSDs,
the Commission is modifying the application of the oath or affirmation
to only apply to financial reports, and not to notice or other filings
as proposed. For the same reasons, the Commission is modifying the
language that for corporations, the oath and affirmation must be signed
by the duly authorized officer. The Commission is adopting all other
aspects of regulation 23.105(f) and (p) as proposed.
---------------------------------------------------------------------------
\442\ Please note that due to changes in Federal Register
publication requirements, the appendices that had been referred to
as Appendix A to section 23.105 and Appendix B to section 23.105 in
previous documents are being published in this final rule as
Appendix B to Subpart E of Part 23 and Appendix C to Subpart E of
Part 23, respectively.
\443\ See also Commission regulation Sec. 1.52 (17 CFR 1.52).
---------------------------------------------------------------------------
6. Swap Dealer and Major Swap Participant Reporting of Position
Information
Proposed regulation 23.105(l) required each covered SD or covered
MSP to file monthly swap and security-based swap position information
with the Commission and with the RFA of which the SD or MSP is a
member. This information was proposed to be reported using Appendix A
to regulation 23.105, and was based upon the information proposed to be
filed with the SEC by SBSDs.\444\ Accordingly, covered SDs or covered
MSPs that are dually-registered as SBSDs would be subject to file the
same position information with both regulators. In this regard, all
covered SDs or covered MSPs were permitted under proposed 23.105(d)(3)
to file SEC forms in lieu of the Commission's financial reporting
requirements.
---------------------------------------------------------------------------
\444\ See SEC proposed Form SBS part 4.
---------------------------------------------------------------------------
The position information that was proposed in regulation 23.105(l)
would include a covered SD's or covered MSP's: (i) Current net exposure
by the top 15 counterparties, and all other counterparties combined;
(ii) total exposure by the top 15 counterparties, and all others
combined; and, (iii) the internal credit rating, gross replacement
value, net replacement value, current net exposure, total exposure, and
margin collected for the top 36 counterparties. The covered SD or
covered MSP would also have to provide current exposure and net
exposure by country for the top 10 countries. The Commission also
proposed in 23.105(m) to require covered SDs and MSPs to file with the
Commission information about their custodians that hold margin for
uncleared swaps pursuant to regulations 23.152 and 23.153 and the
aggregate amounts of margin held at such custodians, as well as, the
aggregate amount required to be posted and collected pursuant to such
rules. The Commission indicated this information will be necessary
component of its financial surveillance program to monitor the
financial condition and positions of SDs and MSPs.
In the 2019 Capital Reopening, the Commission noted that a
commenter had raised issue with the fact that the proposed appendices
did not contain accompanying form instructions, despite having defined
terms in both
[[Page 57519]]
column headings and rows.\445\ In this regard, the Commission asked
whether it would be appropriate to incorporate by reference the form
instructions published alongside of finalized SEC form X-17a-5 FOCUS
Part II and IIC on the proposed appendices to regulation 23.105.
Further, the Commission asked whether it was appropriate to modify the
proposed Appendices to align certain column headings and rows to that
finalized by the SEC in their aforementioned forms.
---------------------------------------------------------------------------
\445\ See 2019 Capital Reopening, 84 FR 69664 at 69680 footnote
121, citing to SIFMA 5/17/17 Letter.
---------------------------------------------------------------------------
The Commission received one comment in support of adding the
explanatory note incorporating by reference the form instructions
published by the SEC.\446\ Therefore, the Commission is making
technical modifications to the Appendix A to align the schedules with
that required of SBSDs under Form X-17a-5 FOCUS Report Part II and
incorporate by reference their form instructions. In this regard, the
headings of Schedules 2, 3, and 4 of Appendix A have been modified to
indicate that these will be required to be completed by Covered SDs
authorized to use models. Much of the information on these schedules is
required under regulation 23.105(k), and is consistent with that
required by the SEC under their form schedules. In addition, Schedule 1
of Appendix A contains general position information and utilizes
identical column and row headings as the comparable SEC schedule and
applies generally to all covered SDs. All other aspects of regulation
23.105(l) and the incorporated Appendix A are being adopted as
proposed. The Commission did not receive comment on the monthly
custodian reporting in regulation 23.105(m) and is adopting as
proposed.
---------------------------------------------------------------------------
\446\ IIB/ISDA/SIFMA 3/3/2020 Letter at 50, fn. 108.
---------------------------------------------------------------------------
7. Reporting Requirements for Swap Dealers and Major Swap Participants
Approved To Use Internal Capital Models
The Commission proposed reporting requirements for covered SDs that
have received approval from the Commission or from an RFA under
proposed regulation 23.102(d) to use internal models to compute market
risk capital charges or credit risk capital charges. The Commission's
proposed requirements for the collection of model information are
largely based on existing requirements for ANC Firms under regulation
1.17 and the rules of the SEC, and on SEC rules for SBSDs and BDs.
Regulation 23.105(k) required a covered SD to file, on a monthly
basis, a listing of each product category for which the covered SD does
not use an internal model to compute market risk deductions, and the
amount of the market risk deduction; a graph reflecting, for each
business line, the daily intra-month VaR; the aggregate VaR for the SD;
for each product for which the SD uses scenario analysis, the product
category and the deduction for market risk; and, credit risk
information on swap, mixed swap, and security-based swap exposures,
including: (A) Overall current exposure, (B) current exposure listed by
counterparty; (C) the 10 largest commitments listed by counterparty,
(D) the SD's maximum potential exposure listed by counterparty for the
15 largest exposures; (E) the SD's aggregate maximum potential
exposure, (F) a summary report reflecting the SD's current and maximum
potential exposures by credit rating category, and (G) a summary report
reflecting the SD's current exposure for each of the top 10 countries
to which the SD is exposed.
Regulation 23.105(k) also required each covered SD approved to use
internal capital models to submit a report identifying the number of
business days for which the actual daily net trading loss exceeded the
corresponding daily VaR and the results of back-testing of all internal
models used to compute allowable capital, including VaR, and credit
risk models, indicating the number of back-testing exceptions. All of
the information required to be submitted to the Commission or RFA under
proposed regulation 23.105(k) would be required to be filed within 17
days of the close of each month, with the exception of the report
identifying the number of business days for which the actual daily net
trading loss exceeded the corresponding daily VaR, which would be
required on a quarterly basis.
The Commission did not receive comment on the proposed reporting
requirements for covered SDs and MSPs who have been approved to use
models under regulation 23.102(d). The Commission also notes that such
reporting requirements are identical to that finalized by the SEC for
SBSDs and MSBSDs who have been approved to use models to calculate
their market and credit risk charges under the SEC's rules. As such,
the Commission is adopting regulation 23.105(k) with slight technical
amendments to align such requirements with that finalized by the SEC.
8. Weekly Position and Margin Reporting
The Commission proposed weekly reporting of position and margin
information for the purposes of conducting risk surveillance of SDs and
MSPs. This requirement would apply to SDs and MSPs subject to the
capital and margin rules of either the Commission or a prudential
regulator. Similar reporting is currently provided on a daily basis by
DCOs for cleared swaps.\447\
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\447\ Commission regulation Sec. 39.19(c)(1) (17 CFR
39.19(c)(1)).
---------------------------------------------------------------------------
Proposed regulation 23.105(q)(1) would require SDs and MSPs to
report position information, in a format specified by the Commission,
(i) by counterparty, and (ii) for each counterparty, by the following
asset classes--commodity, credit, equity, and foreign exchange or
interest rate. Under the uncleared margin rules, these are asset
classes within which margin offsets may be taken.\448\
---------------------------------------------------------------------------
\448\ 17 CFR 23.154(b)(2)(v).
---------------------------------------------------------------------------
Proposed regulation 23.105(q)(2) would require SDs and MSPs to
report margin information, in a format specified by the Commission,
showing: (i) The total initial margin posted by the SD or MSP with each
counterparty; (ii) the total initial margin collected by the SD or MSP
from each counterparty; and (iii) the net variation margin paid or
collected over the previous week with each counterparty.
Several commenters noted that the weekly position requirement was
duplicative of information provided as part of the Commission's Part 45
program.\449\ Other commenters noted ambiguities in the Commission's
proposed requirements and indicated that any weekly reporting
requirement would likely be very costly to implement.\450\
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\449\ See ISDA 5/15/2017 Letter; Cargill 5/15/2017 Letter.
\450\ See INTL FCStone 5/15/2017 Letter; CEWG 5/15/2017 Letter;
BPE 5/15/2017 Letter; SIFMA 5/15/2017 Letter.
---------------------------------------------------------------------------
As noted in the Proposal, the Commission currently uses positon and
margin information filed by DCOs to identify and to take steps to
mitigate the risks posed to the financial system by participants in
cleared markets including DCOs, clearing members, and large
traders.\451\ In addition, the Commission has collected specific
transactional swap data as part of its Part 45 program and uses such
data in various surveillance and oversight
[[Page 57520]]
functions.\452\ The Commission has recently proposed revisions to the
Part 45 data collection, including several additional fields, such as
initial and variation margin.\453\ Therefore, the Commission at this
time believes that imposing an additional weekly position reporting
requirement for SDs and MSPs would be duplicative of these efforts. The
Commission will revisit the need for a separate weekly position and
margin reporting requirement once the routine financial reporting
requirements of SDs and MSPs are effective. Accordingly, the Commission
is not adopting the weekly position and margin reporting requirements
in proposed regulation 23.105(q) at this time.
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\451\ See 2016 Capital Proposal, 81 FR 91252 at 91279-80.
\452\ See 85 FR 21578 at 21579, 21584.
\453\ See 85 FR 21578 at 21649-51.
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E. Comparability Determinations for Eligible Covered SDs and Covered
MSPs
The Commission proposed a substituted compliance framework that
would permit covered SDs and covered MSPs that were organized and
domiciled in a foreign jurisdiction to rely on compliance with their
applicable home country regulator's capital and financial reporting
requirements in lieu of meeting all or parts of the Commission's
capital adequacy and financial reporting requirements.\454\ The
availability of substituted compliance was conditioned upon the
Commission issuing a determination that the relevant foreign
jurisdiction's capital adequacy and financial reporting requirements
are comparable with the Commission's corresponding capital adequacy and
financial reporting requirements (i.e., a ``Capital Comparability
Determination''). Furthermore, FCM-SDs and dually-registered FCM/MSPs
(``FCM-MSPs'') were not eligible for substituted compliance as FCMs are
required to comply with the capital and financial reporting
requirements in part 1 of the Commission's regulations.\455\
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\454\ See 2016 Capital Proposal, 81 FR 91252 at 91280-81.
\455\ Two FCMs currently are organized and domiciled outside of
the U.S., and neither is provisionally-registered as an SD or MSP.
Accordingly, the Commission does not view the inability of an FCM-SD
or an FCM-MSP to avail itself of substituted compliance to present
any issues to registrants.
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The proposed Capital Comparability Determination framework
established a standard of review for determining whether some or all of
the relevant foreign jurisdiction's capital adequacy and financial
reporting requirements are comparable with the Commission's
corresponding capital adequacy and financial reporting requirements.
This framework, as detailed below, is generally consistent with the
approach adopted by the Commission in assessing substituted compliance
of the margin rules for covered SDs engaging in cross-border uncleared
swap transactions.
Proposed regulation 23.106 provided that any eligible covered SD or
covered MSP, and any foreign regulatory authority that has direct
supervisory authority with respect to capital and financial reporting
over one or more eligible covered SDs or covered MSPs, is permitted to
request a Capital Comparability Determination. The Commission further
proposed that eligible covered SDs and covered MSPs may coordinate with
their home country regulators in order to simplify and streamline the
process for obtaining a Capital Comparability Determination.\456\
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\456\ The Commission also confirms that a trade association or
similar organization may submit a Capital Comparability
Determination on behalf of one or more eligible covered SDs or
covered MSPs.
---------------------------------------------------------------------------
Persons requesting a Capital Comparability Determination are
required to submit to the Commission: (i) Copies of the relevant
foreign jurisdiction's capital and financial reporting requirements
(including English translations of any foreign language documents);
(ii) descriptions of the objectives of the relevant capital and
financial reporting requirements and how such requirements are
comparable to, or different from, the Commission's capital and
financial reporting requirements (e.g., the Net Liquid Assets Capital
Approach and Bank-Based Capital Approach), international standards such
as Basel bank capital requirements, if applicable; and, (iii)
descriptions of how such requirements address the elements of the
Commission's capital and financial reporting rules. A person requesting
a Capital Comparability Determination is further required to identify
the regulatory provisions that correspond to the Commission's capital
and financial reporting requirements (and, if necessary, identify
whether the foreign jurisdiction's capital requirements do not address
a particular element). A person requesting the determination is also
required to provide a description of the ability of the relevant
foreign regulatory authority or authorities to supervise and enforce
compliance with the applicable capital and financial reporting
requirements, and to provide any other information and documentation
the Commission deems appropriate.
The proposal identified certain key factors that the Commission
would consider in making a Capital Comparability Determination.
Specifically, the Commission would consider: (i) The scope and
objectives of the relevant foreign jurisdiction's capital requirements;
(ii) how and whether the relevant foreign jurisdiction's capital
adequacy requirements compare to international Basel capital standards
for banking institutions or to other standards such as those used for
securities brokers or dealers; (iii) whether the relevant foreign
jurisdiction's capital requirements achieve comparable outcomes to the
Commission's corresponding capital requirements; (iv) the ability of
the relevant regulatory authority or authorities to supervise and
enforce compliance with the relevant foreign jurisdiction's capital
adequacy and financial reporting requirements; and (v) any other facts
or circumstances the Commission deems relevant. The Commission further
stated that a foreign capital regime may be deemed comparable in some,
but not all, elements of the Commission's capital and financial
reporting requirements.
Proposed regulation 23.106 further provided that any covered SD or
covered MSP that, in accordance with a Capital Comparability
Determination, complies with a foreign jurisdiction's capital and
financial reporting requirements, would be deemed in compliance with
the Commission's corresponding capital adequacy and financial reporting
requirements. Accordingly, the failure of such an SD or MSP to comply
with the relevant foreign capital and financial reporting requirements
may constitute a violation of the Commission's capital adequacy and
financial reporting requirements. In addition, all covered SDs and
covered MSPs relying on substituted compliance would remain subject to
the Commission's examination and enforcement authority regardless of
the Commission issuing a Capital Comparability Determination.
The Commission also retained the authority to impose any terms and
conditions it deems appropriate in issuing a Capital Comparability
Determination and to further condition, modify, suspend, terminate or
otherwise restrict any Capital Comparability Determination it had
issued in its discretion. Such revisions or termination of the Capital
Comparability Determination could result from, for example, changes in
foreign laws or regulatory oversight. In this regard, the Capital
Comparability Determinations issued by the Commission would require
that the Commission be notified of any material changes to information
submitted in support of a Capital
[[Page 57521]]
Comparability Determination, including, but not limited to, changes in
the relevant foreign jurisdiction's supervisory or regulatory regime.
Commenters generally supported the Commission's proposed
substituted compliance framework.\457\ One commenter stated that less
than full acceptance of foreign regulation by the Commission would
result in substantially increased costs to non-U.S. covered SDs and to
U.S. covered SDs with non-U.S. parent entities.\458\
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\457\ See, e.g., ISDA 5/15/2017 Letter; SIFMA 5/15/2017 Letter;
MS 5/15/2017 Letter; JBA 3/14/2017 Letter; Letter from Sarah Miller,
Institute of International Bankers (May 15, 2017) (IIB 5/15/2017
Letter); IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter; Letter
from Atsushi Hirayama, International Bankers Association of Japan
(February 27, 2020) (IBAJ 2/27/2020 Letter); and NFA 3/2/2020
Letter.
\458\ See SIFMA 5/15/2017 Letter.
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Several commenters stated that the Commission should streamline or
simplify the proposed substituted compliance process for certain non-
U.S. covered SDs. In this regard, one commenter requested that the
Commission grant automatic qualification for substituted compliance
with the Commission's capital rules for any non-U.S. covered SD that is
subject to Basel-compliant home country capital requirements
administered by a regulatory authority that is either in a G20
jurisdiction or is a member of the BCBS or IOSCO.\459\ Another
commenter requested that the Commission exempt non-US covered SDs from
the substituted compliance approval process in cases where the covered
SDs are subject to capital standards in their home countries that the
Federal Reserve Board has determined in the context of foreign banking
organizations to be consistent with the Basel III standards.\460\ One
commenter stated that the Commission should clarify that a non-U.S. SD
that qualifies for substituted compliance with the Commission's capital
requirements can also meet any relevant Commission notification
requirements in proposed regulation 23.105(c) by meeting comparable
home country notice requirements.\461\
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\459\ See IIB 5/15/2017 Letter.
\460\ See JBA 3/14/2017 Letter.
\461\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
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One commenter also requested that the Commission's assessment of
the capital framework of a foreign jurisdiction be performed in a
holistic manner, as opposed to narrowly focusing on a line-by-line
comparison of regulatory requirements.\462\ In addition, one commenter
stated that the Commission issue Capital Comparability Determinations
well in advance of the compliance date, which will help alleviate
potential issues with eligible covered SDs having to seek capital model
approval.\463\
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\462\ See IBAJ 2/27/2020 Letter.
\463\ See NFA 3/2/2020 Letter.
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NFA also requested that the Commission revise proposed regulation
23.106(a)(4), which provides that a covered SD that intends to comply
with the capital adequacy and financial reporting requirements of a
foreign jurisdiction that has received a Capital Comparability
Determination to file a notice to that effect with NFA, and further
requires NFA to confirm that the covered SD may comply with some or all
of the requirements of the foreign jurisdiction in lieu of the
Commission's requirements.\464\ NFA suggested that the requirement be
revised to require that a non-U.S. covered SD make only a notice filing
similar to the substituted compliance process for margin and entity-
level requirements.\465\
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\464\ Id.
\465\ Id.
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The Commission has reviewed the proposed substituted compliance
framework and considered the comments received and is adopting the
framework with several modifications as discussed below. There
currently are 24 non-U.S. covered SDs provisionally registered with the
Commission. These 24 non-U.S. covered SDs are located in a total of 7
foreign jurisdictions, with 12 SDs located in the United Kingdom. The
Commission also understands that many, if not all, of the 24 non-U.S.
covered SDs are subject to regulatory requirements in their respective
home country jurisdictions, including capital and financial reporting
requirements.
The Commission's approach to substituted compliance is a
principles-based, holistic approach that focuses on whether the foreign
regulations are designed with the objective of ensuring overall safety
and soundness of the non-U.S. covered SD in a manner that is comparable
with the Commission's overall capital and financial reporting
requirements and is not based on a line-by-line assessment or
comparison of a foreign jurisdiction's regulatory requirements with the
Commission's requirements. The Commission also will seek to address
applications for Capital Comparability Determinations in as expeditious
manner, which should provide adequate notice to market participants of
its determination prior to the compliance date of these rules.
The Commission is retaining the requirement in proposed regulation
23.106(a)(2) that requires a person to submit a written request to
Commission for a Capital Comparability Determination. The Commission is
not revising the framework to permit certain non-U.S. covered SDs to
satisfy their CFTC regulatory requirements through a process of
automatic qualification of substituted compliance with the capital or
financial reporting requirements of a foreign jurisdiction, including
foreign jurisdictions that are compliant with Basel capital standards.
The Commission believes that appropriate capital and financial
reporting are fundamental to the Commission's statutory mandate of
promoting the safety and soundness of covered SDs, and helping to
ensure that such firms meet their financial obligations to swap
counterparties. Accordingly, the Commission believes that a non-U.S.
covered SD seeking to comply with the Commission's capital and
financial reporting requirements must submit information that
demonstrates how the foreign regulatory requirements achieve comparable
outcomes to the Commission' requirements. The Commission believes that
the proposal provides sufficient flexibility for persons seeking
Capital Comparability Determinations in that it permits regulatory
authorities as well as non-U.S. covered SDs to submit the required
materials for the Commission's consideration.
Proposed regulation 23.106(a)(1) provided that a covered SD,
covered MSP, or a foreign regulatory authority that has direct
supervisory authority over one or more covered SDs or covered MSPs that
are eligible for substituted compliance may request a Capital
Comparability Determination. The Commission is modifying regulation
23.106(a)(1) by providing that a trade association or other similar
group also may request a Capital Comparability Determination on behalf
of its member covered SDs and covered MSPs. The purpose of this
modification is to provide greater flexibility and efficiencies in the
substituted compliance framework by allowing trade associations to
request Capital Comparability Determinations for multiple covered SDs
or covered MSPs that may be in a particular jurisdiction. This
modification potentially allows the Commission to focus its limited
resources on a smaller number of requests and will allow covered SDs
and covered MSPs to reduce costs by not having to submit individual
Capital Comparability Determination requests.
The Commission also is modifying proposed regulation 23.106(a)(3),
which provided that the Commission would consider all relevant factors
in assessing whether a foreign jurisdiction's capital
[[Page 57522]]
and financial reporting requirements are comparable to the
Commission's, including whether or how the foreign jurisdiction's
capital adequacy requirements compare to the capital standards issued
by the BCBS for banking institutions or to other standards used for
securities brokers or dealers. The Commission is removing this specific
reference to BCBS capital standards and to broker-dealer standards in
the final rule. As noted above, the Commission's approach to
substituted compliance is a principles-based, holistic approach that
focuses on whether the foreign regulations are designed with the
objective of ensuring overall safety and soundness of the non-U.S.
covered SD or MSP in a manner that is comparable with the Commission's
overall capital and financial reporting requirements. While a foreign
jurisdiction's incorporation of BCBS standards or broker-dealer
standards are approaches that the Commission would consider for
substituted compliance, it was not the Commission's intent to limit the
regulatory approaches, or to appear to limit the regulatory approaches,
that it would deem acceptable for substituted compliance. To clarify
the rule, and to avoid any potential confusion, the Commission is
removing the references to BCBS and broker-dealer standards from the
rule. This modification, however, does not represent any change in the
Commission's stated approach to substituted compliance.
Proposed regulation 23.106(a)(4) required a non-U.S. covered SD or
a non-U.S. covered MSP to file with an RFA a notice of the SD's or
MSP's intent to comply with the requirements of a foreign jurisdiction
that had received a Capital Comparability Determination. Regulation
23.106(a)(4) further provided that the RFA would determine the
information that was necessary to be included in the notice and would
provide a confirmation to the non-U.S. covered SD or non-U.S. MSP of
its ability to meet the Commission's requirements through substituted
compliance. The Commission is modifying the notice and confirmation
provisions in final regulation 23.106(a)(4) to require a non-U.S.
covered SD or non-U.S. covered MSP to file a notice of its intent to
avail itself of a Capital Comparability Determination with the
Commission. As the capital and financial reporting requirements are
entity-level requirements, it is necessary for the Commission to assess
whether each non-U.S. covered SD or non-U.S. covered MSP that files a
notice of its intent to meet the Commission's capital and reporting
requirements through substituted compliance satisfies any conditions
set forth in the applicable Capital Comparability Determination issued
to applicable foreign jurisdiction. Upon receipt of a notice,
Commission staff will engage with the non-U.S. covered SD or non-U.S.
covered MSP to determine the extent to which the foreign regulation
that it is subject to is consistent with the Commission's Capital
Comparability Determination. As part of the determination, the
Commission will review the foreign jurisdiction's regulations, process,
and/or procedures, as applicable, for assessing the ongoing financial
condition of a covered SD or a covered MSP in determining whether it is
appropriate to extend substituted compliance to the notice provisions
contained in regulation 23.105(c).
Regulation 23.106(a)(4) also provided that the failure of a non-
U.S. covered SD or non-non-U.S. covered MSP operating under substituted
compliance to comply with the capital adequacy or financial reporting
requirements of the relevant foreign jurisdiction may constitute a
violation of the Commission's capital adequacy and financial reporting
requirements. The Commission is modifying this provision in final
regulation 23.106(a)(4)(ii) to explicitly provide that the Commission
may initiate an action for a violation of the Commission's rules when a
covered SD or covered MSP subject to a capital comparability
determination has failed to comply with a foreign jurisdiction's
corresponding capital adequacy and financial reporting requirements.
This modification is intended to provide clarity to the final rule by
providing that the Commission may initiate an action against a non-U.S.
covered SD or non-U.S. covered MSP for failure to comply with the
relevant Commission capital and financial reporting requirements when
it violates the corresponding foreign jurisdiction's requirements.
F. Additional Amendments to Existing Regulations
1. Financial Reporting Requirements for FCMs or IBs That Are Also
Registered SBSDs
The Commission is amending regulation 1.10 to authorize dually-
registered FCM/SBSDs and IB/SBSDs to file SEC Financial and Operational
Combined Uniform Single Report under the Securities Exchange Act of
1934, Part II, Part IIA, or Part II C (``FOCUS Report''), as
applicable, in in lieu of CFTC Form 1-FR-FCM or Form 1-FR-IB.
Regulation 1.10 requires each FCM to file an unaudited monthly
financial report with the Commission and with the FCM's designated
self-regulatory organization (``DSRO'') within 17 business days of the
close of each month.\466\ An FCM's monthly financial reports must be
submitted on CFTC Form 1-FR-FCM. FCMs also are required to file an
audited annual financial report with the Commission and with the firm's
DSRO within 60 days of the end of the FCM's fiscal year end. An FCM's
annual financial report may be submitted on Form 1-FR-FCM or, subject
to certain conditions, presented in a manner consistent with U.S.
GAAP.\467\
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\466\ The term ``self-regulatory organization'' (``SRO'') is
defined in Commission regulation Sec. 1.3 (17 CFR 1.3) as a
contract market, a swap execution facility (all as further defined
underSec. 1.3), or an RFA under section 17 of the CEA. The term
``designated self-regulatory organization'' is also defined in
Commission regulation Sec. 1.3 and generally means the SRO that has
primary financial surveillance responsibilities over a registrant.
\467\ See Commission regulation Sec. 1.10(d)(3) (17 CFR
1.10(d)(3)).
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Regulation 1.10 requires each IB to file with NFA an unaudited
financial report on a semi-annual basis, and an audited annual
financial report.\468\ The IB unaudited reports must be submitted on
Form 1-FR-IB within 17 business days of the date of the report. IB
annual reports may be filed on Form 1-FR-IB or, subject to certain
conditions, presented in a manner consistent with U.S. GAAP. IB annual
financial reports must be filed within 90 days of the IB's fiscal year
end.\469\
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\468\ See Commission regulation Sec. 1.10(b)(2)(i) (17 CFR
1.10(b)(2)(i)). An IB is required to file its unaudited financial
report as of the middle and the end of its fiscal year end.
\469\ Commission regulation Sec. 1.10(b)(2)(ii)(A) (17 CFR
1.10(b)(2)(ii)(A)).
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Regulation 1.10(h) currently streamlines the financial reporting
requirements imposed on FCMs and IBs that are dually-registered as BDs.
Such dual-registrants are permitted to file with the Commission and
with the firms' DSRO the SEC's FOCUS Reports, in lieu of a Form 1-FR-
FCM or Form 1-FR-IB. The 2016 Capital Proposal proposed amending
regulation 1.10(h) to permit an FCM or IB that is dually-registered as
a SBSD or MSBSP to file an SEC FOCUS Report in lieu of a CFTC Form 1-
FR-FCM or CFTC Form 1-FR-IB.\470\ The proposed amendment is consistent,
as noted above, with the current provisions that authorize dually-
registered FCMs/BDs and IBs/BDs to file FOCUS Reports in lieu of the
CFTC financial forms. Furthermore, the Commission's experience with
[[Page 57523]]
regulation 1.10(h) has been that the FOCUS Reports include information
that is substantially comparable to the Forms 1-FR and provide the
information necessary for the Commission to conduct financial
surveillance of the registrants.
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\470\ See 2016 Capital Proposal, 81 FR 91252 at 91281-82.
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Regulations 1.10(f) and 1.16(f) also currently provide that a
dually-registered FCM/BD or IB/BD may automatically obtain an extension
of time to file its unaudited and audited financial reports required
under regulation 1.10 by submitting a copy of the written approval for
the extension issued by the BD's securities designated examining
authority (``DEA'').\471\ The 2016 Capital Proposal proposed amending
regulations 1.10(f) and 1.16 to provide that an FCM or IB that is also
registered with the SEC as an SBSD or an MSBSP may obtain an automatic
extension of time to file its unaudited or audited FOCUS Report with
the Commission and with the firm's DSRO, as applicable, by submitting a
copy of the SEC's or the DEA's approval of the extension request. The
proposed amendment maintains the intent of the current regulations by
retaining a consistent approach to the granting to dual registrants
extensions of time to file financial reports. The Commission also
proposed a technical amendment to regulation 1.16 to correct a cross
reference to SEC rule 17a-5 (17 CFR 240.17a-5) for extensions of time
to file audited financial statements.
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\471\ Commission regulations Sec. Sec. 1.10(f) and 1.16(f) (17
CFR 1.10(f) and 1.16(f)).
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The Commission did not receive any comments related to the proposed
amendments to the provisions of regulations 1.10 and 1.16 noted above.
After further consideration and for the reasons stated in the 2016
Capital Proposal, the Commission is adopting these amendments
substantially as proposed.
2. Amendments to the FCM and IB Notice Provisions in Regulation 1.12
Regulation 1.12 requires an FCM or IB to file a notice with the
Commission and with the registrant's DSRO when certain prescribed
events occur that trigger a notice filing requirement.\472\ Such events
include the registrant: (i) Failing to maintain compliance with the
Commission's capital requirements or the capital rules of a SRO; (ii)
failing to hold sufficient funds in segregated or secured amount
accounts to meet its regulatory requirements; (iii) failing to maintain
current books and records; and (iv) experiencing a significant
reduction in capital from the previous month-end.
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\472\ Commission regulation Sec. 1.12 (17 CFR 1.12).
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The Commission proposed amending regulation 1.12(a) to require an
FCM or IB that is a dual registrant with the SEC to file a notice if
the FCM or IB fails to meet any applicable SEC's minimum capital
requirements. The Commission stated that such notice is appropriate as
it provides Commission staff with the opportunity to assess the
potential impact of the dually-registered FCM's or IB's failure to meet
SEC minimum capital requirements on the respective firm's CFTC
regulated activities, and to initiate discussions with the SEC
regarding the capital deficiency.\473\
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\473\ See 2016 Capital Proposal, 81 FR 91252 at 91282.
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Commission regulation 1.12(b) requires an FCM or IB to file notice
with the Commission and with the firm's DSRO if a firm's adjusted net
capital falls below the applicable ``early warning level'' set forth in
the regulation.\474\ The Commission proposed amending regulation
1.12(b) to require an FCM or IB that is also registered with the SEC as
a SBSD or a MSBSP to file a notice if the SBSD's or MSBSP's capital
falls below the ``early warning level'' established in the rules of the
SEC. The proposal was intended to provide additional information to the
Commission in its efforts to monitor the financial condition of its
registrants.
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\474\ If an FCM's or IB's adjusted net capital falls below a
certain threshold, such as 120 percent of its minimum adjusted net
capital requirement, the firm is deemed to be maintaining adjusted
net capital at a level below its ``early warning level.''
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The Commission did not receive any comments related to the above
proposed amendments to regulation 1.12. For the reasons stated in the
2016 Capital Proposal, the Commission is adopting the amendments as
proposed.
3. FCM and IB Unsecured Receivables From Swap Transactions
Regulation 1.17 provides that an FCM or IB, in computing its net
capital, must exclude unsecured receivables except for certain
specified unsecured receivables, including interest receivable, floor
broker receivable, commissions receivable from other brokers or
dealers, mutual fund concessions receivable and management receivable
from registered investment companies and commodity pools. The
regulation further provides that an FCM or IB must exclude these
otherwise permitted unsecured receivables from current assets in
computing its net capital if the receivable is outstanding longer than
30 days from the payable date.\475\ The operation of the regulation
effectively allowed an FCM or IB to reflect commissions due from FCMs
that carried customer accounts introduced by the FCM or IB as a current
asset in computing its net capital, as the FCMs generally paid these
commissions within 30 days from the payable date.
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\475\ Commission regulation Sec. 1.17(c)(2)(ii) (17 CFR
1.17(c)(2)(ii)).
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The Commission proposed to amend regulation 1.17(c)(2)(ii)(B) to
codify several staff no-action letters that provided that staff would
not recommend an enforcement action against an IB that reflect certain
commissions receivable balances from swap transactions that are
outstanding no more than 60 days from the month-end accrual date as
current assets in computing its net capital, provided that the
commissions are promptly billed.\476\ The staff no-action letters were
issued to accommodate the long-standing commission billing practices in
the swaps market that differed from the futures markets. Commissions
for swaps transactions are often billed and paid in a process that
exceeds 30 days. The final rule adopted by the Commission would allow
both FCMs and IBs to recognize unsecured commissions receivable
resulting from swap transactions in computing their net capital,
provided that the unsecured receivables are not outstanding more than
60 days from the month end accrual date and the commissions are billed
promptly after the close of the month.
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\476\ See 2016 Capital Proposal, 81 FR 91252 at 91282.
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The Commission also proposed amending regulation 1.17(c)(2)(ii)(B)
by adding a new provision that allows FCMs and IBs to recognize
dividends receivable that are not outstanding more than 30 days. This
proposed amendment was to further align the Commission's capital rules
with the SEC's capital, which specifically addressed the capital
treatment of dividends.
The Commission received no comments on the proposed amendments to
regulation 1.17(c)(2)(ii)(B). After considering the issue, and for the
reasons stated in the 2016 Capital Proposal, the Commission has
determined to adopt the amendments to regulation 1.17(c)(2)(ii)(B) as
proposed.
4. Amendments to FCM and IB Notice and Disclosure Requirements for Bulk
Transfers
Regulation 1.65 provides that an FCM or IB must obtain a customer's
specific consent prior to transferring the customer's account to
another FCM or
[[Page 57524]]
IB, except if the account is transferred at the customer's
request.\477\ Regulation 1.65 further provides that an FCM or IB may
transfer a customer's account without the customer's specific consent
if the FCM's or IB's account agreement with the customer contains a
valid consent by the customer to a prospective transfer of the account;
the customer is provided with written notice of, and a reasonable
opportunity to object to, the transfer; and, the customer has not
objected to the transfer or given other instructions as to the
disposition of the account. The written notice provided to the
customers is required to contain certain prescribed information
including, the reason for the transfer, a statement that the customer
is not required to accept the proposed transfer and may direct that the
account be liquidated or transferred to an FCM or IB of the customer's
choosing, and a clear statement of how the customer is to provide
notice that it does not consent to the proposed transfer.\478\
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\477\ Commission regulation Sec. 1.65(a)(1) (17 CFR
1.65(a)(1)).
\478\ Commission regulation Sec. 1.65(a)(2) (17 CFR
1.65(a)(2)).
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An FCM or IB is also required to file with the Commission notice of
a transfer of customer accounts at least five business days prior to
the transfer if the transfer involves more than 25 percent of the FCM's
or IB's total accounts (or 50 percent if the FCM or IB has less than
100 accounts).\479\ The notice must be submitted to the Commission by
mail, addressed to the Deputy Director, Compliance and Registration
Section, Division of Swap Dealer and Intermediary Oversight.\480\
Finally, the notice must be filed with the Commission as soon as
practicable and no later than the day of the transfer if the FCM or IB
cannot file the notice at least five business days prior to the
transfer.\481\ The FCM or IB is required to file a brief statement
explaining the circumstances necessitating the delay in filing.
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\479\ Commission regulation Sec. 1.65(b) (17 CFR 1.65(b)).
\480\ Commission regulation Sec. 1.65(d) (17 CFR 1.65(d)).
\481\ Commission regulation Sec. 1.65(e) (17 CFR 1.65(e)).
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The Commission proposed to amend regulation 1.65 noting that it had
found that five days' notice, when given, often is not a sufficient
amount of time to allow the Commission to effectively monitor the bulk
transfer of customer accounts.\482\ Specifically, the Commission
proposed to amend regulation 1.65(b) to require that the notice of a
bulk transfer of customer accounts must be filed with the Commission at
least ten business days in advance of a transfer. The Commission noted
that the bulk transfers of customer accounts are generally planned well
in advance such that the FCM or IB should be able to provide the
Commission ten days advance notice of such a transfer. The Commission
also proposed to amend regulation 1.65(d) to require the notice to be
filed by the FCM or IB electronically, which is consistent with the
filing requirements of other notices and financial forms filed by FCMs
or IBs with the Commission. The Commission noted that the electronic
system to file such notices already exists and has been used by FCMs
and IBs for many years. Accordingly, the Commission believed that the
proposed electronic filing of notices of bulk transfers would not
result in any additional costs either to the Commission or to FCMs and
IBs.
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\482\ See 2016 Capital Proposal, 81 FR 91252 at 91282.
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The Commission also proposed to amend regulation 1.65(d) to provide
that the notices shall be considered filed with the Commission when
submitted to the Director of the Division of Swap Dealer and
Intermediary Oversight. The Commission proposed to require the notices
of bulk transfer to be addressed to the Director of the Division of
Swap Dealer and Intermediary Oversight to reflect organizational
changes since the rule was last revised, and to ensure that such
notices are reviewed promptly upon receipt.
The Commission further proposed to amend regulation 1.65(e) to
delegate to the Director of the Division of Swap Dealer and
Intermediary Oversight the authority to accept a lesser time period for
the notification provided for in regulation 1.65(b). However, the
notice must be filed as soon as practicable and in no event later than
the day of the transfer. This provision is deemed necessary as certain
transfers may be performed under exigent circumstances where 10 days
advance notice is not possible, such as situations where the FCM or IB
becomes insolvent and is required to terminate its business.
The Commission did not receive any comments regarding the proposed
amendments to the bulk transfer provisions of regulation 1.65. The
Commission has considered the proposed amendments and, for the reasons
stated in the 2016 Capital Proposal, has determined to adopt the
amendments as proposed.
5. Conforming Amendments to Delegated Authority Provisions in
Regulation 140.91
Commission regulations 1.10, 1.12, and 1.17 reserve certain
functions to the Commission, the greater part of which the Commission
has delegated to the Director of the Division of Swap Dealer and
Intermediary Oversight through the provisions of regulation
140.91.\483\ The Commission proposed to amend regulation 140.91 to
provide similar delegations with respect to functions reserved to the
Commission in part 23.
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\483\ Commission regulation Sec. 140.91 (17 CFR 140.91).
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Regulation 23.101(c), as adopted, requires a covered SD or covered
MSP to be in compliance with the minimum regulatory capital
requirements at all times and to be able to demonstrate such compliance
to the Commission at any time. Regulation 23.103(d), as adopted,
requires a covered SD or covered MSP, upon request, to provide the
Commission with additional information regarding its internal models
used to compute its market risk exposure requirement and OTC
derivatives credit risk requirement. Regulation 23.105(a)(2), as
adopted, requires a covered SD or covered MSP to provide the Commission
with immediate notification if the SD or MSP fails to maintain
compliance with the minimum regulatory capital requirements, and
further authorizes the Commission to request financial condition
reporting and other financial information from the covered SD or
covered MSP. Regulation 23.105(d), as adopted, authorizes the
Commission to direct a bank SD or bank MSP that is subject to capital
rules established by a prudential regulator, or has been designated a
systemically important financial institution by the Financial Stability
Oversight Council and is subject to capital requirements imposed by the
Board of Governors of the Federal Reserve System, to file with the
Commission copies of its capital computations for any periods of time
specified by the Commission.
The Commission proposed to amend regulation 140.91 to delegate to
the Director of the Division of Swap Dealer and Intermediary Oversight,
or the Director's designee, the authority reserved to the Commission
under regulations 23.101(c), 23.103(d), and 23.105(a)(2) and (d).\484\
The Commission did not receive any comments regarding the proposed
amendments to regulation 140.91 to delegate the functions noted above
to DSIO staff and has determined
[[Page 57525]]
to adopt the amendments substantially as proposed. The delegation of
such functions to staff of the Division of Swap Dealer and Intermediary
Oversight is necessary for the effective oversight of SDs and MSPs
compliance with minimum financial and related reporting requirements.
The delegation of authority is also comparable to the authorities
currently delegated to staff under regulation 140.91 regarding the
supervision of FCMs compliance with minimum financial requirements.
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\484\ See 2016 Capital Proposal, 81 FR 91252 at 91282-83.
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G. Effective Date and Compliance Date
The proposed amendments and new regulations adopted by the
Commission shall be effective 60 days after publication in the Federal
Register. Several commenters requested that timeline for implementation
be extended to allow for approval of capital models.\485\ Specific
concerns included comments that the implementation timeline should not
create competitive disparities between SDs utilizing models approved by
other regulators and SDs seeking model approval for the first time from
the Commission and NFA.\486\ Another commenter stated SDs that did not
have model approval at the compliance date would be at a significant
competitive disadvantage relative to covered SDs and FCM-SDs that had
the approval to use models at the compliance date because such SDs
would be required to use the proposed standardized capital charges
while awaiting model approval at the compliance date.\487\ Several
commenters further stated that the Commission should automatically
approve market risk models and credit risk models of covered SDs or
FCM-SDs that have already been approved by a prudential regulator, the
SEC, or certain foreign regulators.\488\ In view of these concerns, the
Commission is extending the compliance date for the amended regulations
and the new regulations until October 6, 2021. Additionally, the
Commission has provided for the ability of SDs to use capital models
pending Commission/NFA approval, provided the SD files the
certification required under Commission regulation 23.102(f) and the
model has been approved by the SEC, prudential regulators, or qualified
foreign regulators. Further, the Commission has provided for a
substituted compliance program. By setting the compliance date as
October 6, 2021, the Commission has addressed commenters' concerns by
allowing SDs a sufficient period of time to develop policies,
procedures, and systems, to implement new financial reporting regimes
and to develop capital models, as applicable, to meet the new
regulatory requirements while also maintaining consistency with the
SEC's compliance date for rules imposing capital, margin, segregation,
and financial reporting obligations for SBSDs, and amending existing
rules for BDs. The coordination of the compliance date will assist
dually-registered entities with meeting their CFTC and SEC regulatory
requirements.
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\485\ See Citadel 5/15/2017 Letter; SIFMA 5/15/2017 Letter; FIA
5/15/2017 Letter; FIA-PTG 5/24/2017 Letter.
\486\ See Citadel 5/15/2017 Letter.
\487\ See ISDA 5/15/17 Letter.
\488\ See, e.g., FIA 5/15/17 Letter; SIFMA 5/15/17 Letter. See
also, ABN/ING/Mizuho/Nomura 1/29/2018 Letter.
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III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RF Act'') requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities.\489\ This
rulemaking would affect the obligations of SDs, MSPs, FCMs, and IBs.
The Commission has previously determined that SDs, MSPs, and FCMs are
not small entities for purposes of the RF Act.\490\ Therefore, the
requirements of the RF Act do not apply to those entities. The
Commission has found it appropriate to consider whether IBs should be
deemed small entities for purposes of the RF Act on a case-by-case
basis, in the context of the particular Commission regulation at
issue.\491\ As certain IBs may be small entities for purposes of the RF
Act, the Commission considered whether this rulemaking would have a
significant economic impact on such registrants.
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\489\ 5 U.S.C. 601 et seq.
\490\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982) (FCMs) and Registration of Swap Dealers
and Major Swap Participants, 77 FR 2613, 2620 (Jan. 19, 2012) (SDs
and MSPs).
\491\ See Introducing Brokers and Associated Persons of
Introducing Brokers, Commodity Trading Advisors and Commodity Pool
Operators; Registration and Other Regulatory Requirements, 48 FR
35248, 35276 (Aug. 3, 1983).
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Only a few of the regulations included in this rulemaking, the
amendment of Commission regulations 1.10, 1.12, 1.16 and 1.17, will
impact the obligations of IBs. These amendments will permit the filing
and harmonization of financial reporting and notification rules as
adopted by the SEC for dual registered SBSD and MSBSPs and accommodate
common billing practices in the swap industry surrounding the
collection of commission receivables. The Commission believes that
these amendments will have a minimal effect on IBs, and are not
expected to impose any new burdens or costs on them. The Commission
does not, therefore, expect small entities to incur any additional
costs as a result of this proposed rulemaking.
Accordingly, for the reasons stated above, the Commission believes
that this rulemaking will not have a significant economic impact on a
substantial number of small entities. Therefore, the Chairman, on
behalf of the Commission, hereby certifies, pursuant to 5 U.S.C.
605(b), that the regulations being published today by this Federal
Register release 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'') \492\ imposes certain
requirements on Federal agencies (including the Commission) in
connection with their conducting or sponsoring any collection of
information as defined by the PRA. The rule amendments adopted herein
results in an amendment to existing collection of information
``Regulations and Forms Pertaining to Financial Integrity of the Market
Place; Margin Requirements for SDs/MSPs'' \493\ as discussed below. The
responses to this collection of information are mandatory. An agency
may not conduct or sponsor, and 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'').
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\492\ 44 U.S.C. 3501 et seq.
\493\ See OMB Control No. 3038-0024, http://www.reginfo.gov/public/do/PRAOMBHistory?ombControlNumber=3038-0024.
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The Commission did not receive any comments regarding its PRA
burden analysis in the preamble to the Proposal. The Commission is
revising collection number 3038-0024 to reflect the adoption of
amendments to Parts 1 and 23 of its regulations, as discussed below,
with changes to reflect adjustments that were made to the final rules
in response to comments on the Proposal. 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.
[[Page 57526]]
2. New Information Collection Requirements and Related Burden Estimates
\494\
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\494\ This discussion does not include information collection
requirements that are included under other Commission regulations
and related OMB control numbers.
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Currently, there are approximately 108 SDs and no MSPs
provisionally registered with the Commission that may be impacted by
this rulemaking and, in particular, the collection of information
contained herein and discussed below.
i. FOCUS Report
The amendments to Commission regulation 1.10(h) allow an FCM or IB
that is also an SEC-registered securities BD to file, subject to
certain conditions, its FOCUS Form X-17a-5-Part II in lieu of its Form
1-FR. Because these amendments provide an alternative to filing Form 1-
FR, the Commission believes that the amendments would not cause FCMs or
IBs to incur any additional burden. Rather, to the extent that the rule
provides an alternative to filing a Form 1-FR and is elected by FCMs or
IBs, it is reasonable for the Commission to infer that the alternative
is less burdensome to such FCMs and IBs.
The amendments to Commission regulation 1.10(f) allow an FCM or IB
that is dually-registered with the SEC as either a SBSD or MSBSP to
request an extension of time to file its uncertified FOCUS Report. The
Commission is unable to estimate with precision how many requests it
would receive from registrants under Sec. 1.10(f) in relation to FOCUS
Report annually. The Commission anticipates that it will receive one
such request in the aggregate annually, and that preparing such a
request will consume five burden hours, resulting in an annual increase
in burden of five hours in the aggregate.
ii. Notice of Failure To Maintain Minimum Financial Requirements
Commission regulations 1.12(a) and (b) currently require FCMs and
IBs, to file notices if they know or should have known that certain
specified minimum financial thresholds have been exceeded. The
amendments to Commission regulation 1.12(a) and (b) add as an
additional threshold for such notices certain financial requirements of
the SEC if the applicant or registrant is registered with the SEC as an
SBSD or MSBSD. The Commission is unable to estimate with precision how
many additional notices it would receive from such entities as a result
of the additional minimum threshold. In an attempt to provide
conservative estimates, the Commission anticipates receiving 10 such
notices in the aggregate annually, and that preparing such a notice
will consume five burden hours, resulting in an annual increase in
burden of 50 hours in the aggregate.
iii. Requests for Extensions of Time To File Financial Statements
The amendments to Commission regulation 1.16(f) allow an FCM or IB
that is registered with the SEC as an SBSD or MSBSP to request an
extension of time to file its audited annual financial statements.\495\
The Commission is unable to estimate with precision how many of such
requests it would receive from such entities. The Commission
anticipates receiving one such request in the aggregate annually, and
that preparing the request will consume five burden hours, resulting in
an annual increase in burden of five hours in the aggregate.
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\495\ The registrant would also be required to promptly file
with the DSRO and the Commission copies of any notice it receives
from its designated examining authority to approve or deny the
requested extension of time.
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iv. Capital Requirement Elections
Amended Commission regulation 23.101(a)(7) requires that certain
SDs that wish to change their capital election submit a written request
to the Commission and provide any additional information and
documentation requested by the Commission. The Commission is unable to
estimate with precision how many of such requests it would receive from
such entities. The Commission anticipates that it would receive one
such request in the aggregate annually, and that preparing such a
request would consume five burden hours, resulting in an annual
increase in burden of five hours in the aggregate.
v. Application for Use of Models
Commission regulation 23.102(a) allow an SD to apply to the
Commission or a RFA of which it is a member for approval to use
internal models when calculating its market risk exposure and credit
risk exposure under Commission regulations 23.101(a)(1)(i)(B),
23.101(a)(1)(ii)(A), or 23.101(a)(2)(ii)(A), by sending to the
Commission and such RFA an application, including the information set
forth in Appendix A to Commission regulation 23.102 and meeting certain
other requirements. Amended Commission regulation 1.17(c)(6)(v)
relatedly allows an FCM that is also an SD to apply in writing to the
Commission or an RFA of which it is a member for approval to compute
deductions for market risk and credit risk using internal models in
lieu of the standardized deductions otherwise required under Commission
regulation 1.17.\496\
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\496\ Note that the changes to Commission regulation Sec.
1.17(c)(6)(i) (17 CFR 1.17(c)(6)(i)), which permit any dual
registered FCM Broker-Dealer who has received approval by the SEC
under Sec. 240.15c3-1(a)(7) (17 CFR 240.15c3-1(a)(7)) to use models
to calculate its market and credit risk charges, do not add an
additional collection of information and therefore are not
considered in this analysis.
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Appendices A and B to Commission regulation 23.102 contain further
related information collection requirements, including that the SD: (i)
Provide notice to the Commission and RFA and/or update its application
and related materials for certain inaccuracies and amendments; (ii)
notify the Commission or RFA before it ceases to use such internal
models to compute deductions; (iii) if a VaR model is used, have an
annual review of such model conducted by a qualified third party
service, (iv) conduct stress-testing, retain and make available to the
Commission and the RFA records of the results and all assumptions and
parameters thereof, and notify the Commission and RFA promptly of
instances where such tests indicate any material deficiencies in the
comprehensive risk model; (v) demonstrate to the Commission or the RFA
that certain additional conditions have been satisfied and retain and
make available to the Commission or the RFA records related thereto;
and (vi) comply with additional conditions that may be imposed on the
SD by the Commission or the RFA.
As discussed above, there are currently 108 SDs and 0 MSPs
provisionally registered with the Commission. Of these, the Commission
estimates that approximately 56 SDs and no MSPs would be subject to the
Commission's capital rules as they are not subject to the capital rules
of a prudential regulator. The Commission further estimates
conservatively that 32 of these SDs would seek to obtain Commission
approval to use models for computing their market and credit risk
capital charges.
The Commission staff estimates that an SD approved to use internal
models would spend approximately 5,600 hours per year to review and
update the models and approximately 640 hours per year to back-test the
models for the aggregate of 6,240 annual burden hours for each SD.
Consequently, Commission staff estimates that reviewing and backtesting
the models for the 32 SDs will result in an aggregate annual hour
burden of approximately 199,680 hours.
[[Page 57527]]
vi. Equity Withdrawal Requirements.
Commission regulation 23.104 adds equity withdrawal restrictions on
certain SDs. Commission regulation 23.104(a) allows an SD to apply in
writing for relief from restrictions on certain equity withdrawals.
Commission staff estimates that 28 of the 107 currently provisionally
registered SDs would be subject to this regulation. Commission staff
estimates that each of these 28 SDs would file approximately two
notices annually with the Commission and that it would take
approximately 30 minutes to file each of these notices. This results in
an aggregate annual hour burden estimate of approximately 28 hours.
vii. Financial Recordkeeping, Reporting and Notification Requirements
for SDs and MSPs
Commission regulation 23.105 requires that each SD and MSP maintain
certain specified records, report certain financial information and
notify or request permission from the Commission under certain
specified circumstances, in each case, as provided in the proposed
regulation. For example, the regulation requires generally that SDs and
MSPs maintain current books and records, provide notice to the
Commission of regulatory capital deficiencies and related
documentation, provide notice of certain other events specified in the
rule, and file financial reports and related materials with the
Commission (including the information in Appendix A and B to the
regulation, as applicable). Regulation 23.105 also requires the SD or
MSP to furnish information about its custodians that hold margin for
uncleared swap transactions and the amounts of margin so held, and for
SDs approved to use models (as discussed above), provide additional
information regarding such models, as further described in regulation
23.105(k).
The Commission estimates that there are 28 SD firms which will be
required to fulfill their financial reporting, recordkeeping and
notification obligations under regulation 23.105(a)-23.105(n) because
they are not subject to a prudential regulator, not already registered
as an FCM, and not dually registered as a SBSD. The Commission expects
these 28 firms will apply to use models. Commission staff estimates
that the preparation of monthly and annual financial reports for these
SDs, including the recordkeeping, related notification and preparation
of the specific information required in Appendix A to 23.105, would
impose an on-going burden of 250 hour per firm annually. The Commission
further estimates it will cost each SD $300,000 to retain an
independent public accountant to audit its financial statements each
year. Thus, the total burden hours estimated for compliance with
23.105(a)-23.105(n) for these 28 SD firms would be 7,000 hours
annually.
Regulation 23.105(p) and its accompanying Appendix B impose a
quarterly financial reporting and notification obligations on SDs which
are subject to a prudential regulator. The Commission expects that
approximately 52 of the 108 currently provisionally registered SDs are
subject to a prudential regulator. The Commission estimates that these
reporting and notification requirements will impose a burden of 33
hours on-going annually. This results in a total aggregate burden of
1,716 hours annually.
viii. Capital Comparability Determinations
Commission regulation 23.106 allows certain SDs, MSPs, and foreign
regulatory authorities to request a Capital Comparability Determination
with respect to capital adequacy and financial reporting requirements
for SDs or MSPs, as discussed above. As part of this request, persons
are required to submit to the Commission certain specified supporting
information and further information, as requested by the Commission.
Further, if such a determination was made by the Commission, an SD or
MSP would be required to file a notice with the RFA of which it is a
member of its intent to comply with the capital adequacy and financial
reporting requirements of the foreign jurisdiction. Moreover, in
issuing a Capital Comparability Determination, the Commission would be
able to impose any terms and conditions it deems appropriate, including
additional capital and financial reporting requirements.
The Commission expects that 43 firms out of the 108 currently
provisionally registered SDs would seek Capital Comparability
Determinations. These 24 firms are located in five different
jurisdictions, all of which appear to have adopted some level of Basel
compliant capital rule or another capital rule that would apply to SDs.
As such, Commission staff estimates that it will take approximately ten
hours per firm annually to prepare and submit requests for Capital
Comparability Determinations and otherwise comply with the requirements
of proposed regulation 23.106, resulting in aggregate annual burden of
240 hours.
IV. Cost Benefit Considerations
A. Background
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its discretionary actions before promulgating a
regulation under the CEA or issuing certain orders.\497\ 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. In this cost benefit section, the Commission discusses
the costs and benefits resulting from its discretionary determinations
with respect to the section 15(a) factors.\498\ In addition, in
Attachment A to this section, the Commission, using available data,
estimates the cost of the final rule to each type of SD or MSP.
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\497\ 7 U.S.C. 19(a).
\498\ The Commission notes that the costs and benefits in this
rulemaking, and highlighted below, have informed the policy choices
described throughout this release.
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This rulemaking implements the new statutory framework of Section
4s(e) of the CEA, added by Section 731 of the Dodd-Frank Act, which
requires the Commission to adopt capital requirements for SDs and MSPs
that do not have a prudential regulator (i.e., ``covered swap
entities'' or ``CSEs'') and amends Commission regulation 1.17 to impose
specific market risk and credit risk capital charges for uncleared swap
and security-based swap positions held by an FCM.\499\ Section 4s(e) of
the CEA requires the Commission to adopt minimum capital requirements
for CSEs that are designed to help ensure the CSE's safety and
soundness and be appropriate for the risk associated with the uncleared
swaps held by a CSE. In addition, section 4s(e)(2)(C) of the CEA,
requires the Commission to set capital requirements for CSEs that
account for the risks associated with the CSE's entire swaps portfolio
and all other activities conducted by the CSE. Lastly, section
4s(e)(3)(D) of the CEA provides that the Commission, the prudential
regulators, and the SEC, must ``to the maximum extent practicable''
establish and maintain comparable capital rules. The rulemaking also
includes certain financial reporting requirements related to an SDs and
MSPs financial condition and capital requirements.
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\499\ See section 4s(e)(2)(B).
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In the following cost-benefit considerations, the Commission has
[[Page 57528]]
evaluated the costs and benefits of this rulemaking. In this section
the Commission will: (i) Discuss the general benefits and costs of
regulatory capital; (ii) summarize the rulemaking; (iii) describe the
baseline for which the cost and benefits of this rulemaking were
considered; (iv) provide an overview of the different capital
approaches set out in this rulemaking and the rationale for each
approach; (v) describe the costs and benefits to each type of SD and
MSP under their corresponding capital approaches; (vi) discuss the
reporting requirements; and (vii) an analyze the rulemaking as it
relates to each of the 15(a) factors.
Where reasonably feasible, the Commission has endeavored to
estimate quantifiable costs and benefits. Where quantification is not
feasible, the Commission identifies and describes costs and benefits
qualitatively. The Commission acknowledges that it is limited in
estimating the actual cost of its final capital rule. First, the
initial and recurring costs for any particular registrant will depend
on, among other things, its size, organizational structure, swap
dealing activity, other business activities, modelling capacities,
practices, and cost structure. In the 2016's proposal's cost-benefit
considerations, the Commission estimated the cost of its capital
proposal using SDR data on interest rate swaps for the purposes of
extrapolating certain possible ranges regarding the possible cost of
capital at Commission registered SDs. Interest rate swaps served as a
proxy for all covered swap positions held by all covered SDs and then
estimated the initial margin based on that portfolio. Interest rate
swaps were selected because they represented a majority of the swaps
notional reported to swap data repositories. The Commission did not
receive any data or comments specifically addressing this analysis.
Upon further review, the Commission has concluded that because this
approach considered only one type of swap, the Commission does not
believe that this estimate was helpful in understanding the range of
possible cost outcomes that could have flowed from the proposal.
In order for the Commission to be able to develop a credible
estimate, it would need access to proprietary information for each swap
dealer. Among some of the information that the Commission currently
lacks and would be relevant are: (i) Position level data, sufficient to
estimate risk margins; (ii) for the Bank-Based Capital Approach, data
about the registrant's Risk-Weighted Assets (RWAs); and (iii) for the
Net Liquid Assets Capital Approach and the tangible net worth approach,
data about market risk and credit risk charges. For these reasons, the
Commission has not quantified the costs of the rule in terms of the
level of capital charges the rule may require. Instead, the Commission
has attempted to quantify costs in terms of how implementation of the
rule may affect registrants' capital requirements in comparison to
their existing capital levels and other circumstances. As detailed in
Attachment A, the Commission has compiled available capital data and
considered whether additional capital would be required to meet the
Commission's capital requirements.
In considering the effects of the final rule and the resulting
costs and benefits, the Commission acknowledges that the swaps markets
have many types of market participants including SDs and their clients
(who could be professional investors, public and non-public operating
firms) and function internationally with: (i) Transactions that involve
U.S. firms occurring across different international jurisdictions; (ii)
some entities organized outside of the United States that are
prospective Commission registrants; and (iii) some entities that
typically operate both within and outside the United States. Where the
Commission does not specifically refer to matters of location, the
discussion of costs and benefits below refers to the effects of the
amendments on all relevant swaps activities, whether based on their
actual occurrence in the United States or on their connection with, or
effect on U.S. commerce pursuant to, section 2(i) of the CEA.\500\
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\500\ Pursuant to section 2(i) of the CEA, activities outside of
the United States are not subject to the swap provisions of the CEA,
including any rules prescribed or regulations promulgated
thereunder, unless those activities either have a direct and
significant connection with activities in, or effect on, commerce of
the United States; or contravene any rule or regulation established
to prevent evasion of a CEA provision enacted under the Dodd-Frank
Act, Public Law 111-203, 124 Stat. 1376. 7 U.S.C. 2(i).
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B. Regulatory Capital
Regulatory capital is designed to ensure that a firm will have
enough capital, in times of financial stress, to cover the risk
inherent of the activities in the firm. Regulatory capital's framework
can be designed differently, but its primary purpose remains the same--
to meet this objective. Although a firm may mitigate its risks through
other methods, including risk management techniques (e.g., netting,
credit limits, margin), capital is viewed as the last line of defense
of an entity, ensuring its viability in times of financial stress. In
adopting this rulemaking, the Commission was cognizant of the purpose
of capital and the potential trade-off between the costs of requiring
additional capital and the Commission's statutory mandate of helping to
ensure the safety and soundness of SDs and MSPs thereby promoting the
stability of the U.S. financial system.
C. General Summary of Rulemaking
The Commission designed this rulemaking on well-established
existing capital regimes. The framework, which draws upon the
principles and structures of bank-based capital, broker-dealer capital,
and FCM capital, provides CSEs, operating under a current capital
regime, with the ability to continue to comply with that regime, with
minor adjustments to account for the inherent risk of swap dealing and
to mitigate regulatory arbitrage. The Commission, in developing its
capital framework, provides CSEs with the flexibility to continue
operating under a similar capital framework, which should mitigate
disruptions to the markets and mitigate the possibility of duplicative
or even conflicting rules, while helping to ensure the safety and
soundness of the CSE and the stability of the U.S. financial system.
The final rule detail minimum capital requirements for different
``types'' or ``categories'' of CSEs and further define the capital
computations, including various market risk and credit risk charges,
whether using models or a standardized rules-based or table-based
approach, to determine whether a CSE satisfies the minimum capital
requirements. The Commission's final rules permit SDs that are neither
registered as FCMs nor subject to the capital rules of a prudential
regulator to elect a capital requirement that is based on existing bank
holding company (``BHC'') capital rules adopted by the Federal Reserve
Board or a capital requirement that is based on the existing FCM/BD net
capital rules. The Commission's final rule also permits certain SDs
that meet defined conditions designed to ensure that they are
``predominantly engaged in non-financial activities'' to compute their
minimum regulatory capital based upon the firms' tangible net worth.
Further, the Commission is allowing SDs to obtain approval from the
Commission, or from an RFA of which the SDs are members, to use
internal models to compute certain market risk and credit
[[Page 57529]]
risk capital charges when calculating their capital.\501\
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\501\ Section 17 of the CEA sets forth the registration
requirements for RFAs. RFAs are defined as self-regulatory
organizations under Commission regulation Sec. 1.3 (17 CFR 1.3).
The Commission recognizes that SDs that seek model approval from the
Commission or from an RFA will be required to submit documentation
addressing several capital models including value at risk, stressed
value at risk, specific risk, comprehensive risk and incremental
risk. To the extent that models are reviewed and approved by an RFA,
additional costs may be incurred by the RFA which may be passed on
to the SDs.
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The Commission is also imposing certain restrictions on the
withdrawal of capital from SDs if certain defined triggers are
breached.
The final rules also establish a program of ``substituted
compliance'' that will allow a CSE that is organized and domiciled in a
non-U.S. jurisdiction (``non-U.S. CSE'') (or an appropriate regulatory
authority in the non-U.S. CSE's home country jurisdiction) to petition
the Commission for a determination that the home country jurisdiction's
capital and financial reporting requirements are comparable to the
CFTC's capital and financial reporting requirements for such CSE, such
that the CSE may satisfy its home country jurisdiction's capital and
financial reporting requirements (subject to any conditions imposed by
the Commission) in lieu of the Commission's capital and financial
reporting requirements (i.e., ``Comparability Determination'').
Consistent with section 4s(f), the Commission is requiring SDs and
MSPs to satisfy current books and records requirements, ``early
warning'' and other notification filing requirements, and periodic and
annual financial report filing requirements with the Commission and
with any RFA of which the SDs and MSPs are members.
D. Baseline
In determining the costs and benefits of this rulemaking, the
Commission's benchmark from which this rulemaking was evaluated was the
market's status quo, i.e., the swap market as it exists today. As this
final rule will implement capital and financial reporting on CSEs and
recordkeeping requirements on SDs and MSPs, the Commission will discuss
the incremental costs and benefits to each type or category of SD and
MSP, as to their current capital and financial reporting and
recordkeeping requirements. As each CSE or its parent holding company
may be complying with current capital requirements, based on capital
requirements that are a result of the entity or its parent entity
registering with a financial agency, as a result of it being a
financial intermediary (e.g., as an BD, FCM or BHC), the Commission has
set different baselines for each type or category of entity. In the
case that a CSE does not have current capital requirements, the
Commission considered the full cost and benefit of its amendments on
the entity. The following is a list of types or categories of
registered entities and their corresponding capital regimes that the
CSE currently complies with, if there is any, and their corresponding
financial reporting and capital requirements. \502\ Therefore, the
Commission is using the status quo or baseline to evaluate the costs
and benefits of these final rules for the following types or categories
of CSEs:
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\502\ The baseline of this CBC doesn't include those SDs that
are also registered with the SEC as Security-based Swap Dealers (SD-
SBSDs), as the SEC's rule will become effective at the same time as
the Commission's Final rule. Therefore, unless SD-SBSDs are
registered as another category of registered entities that impose
capital requirements, this CBC will treat these entities as
currently having no current capital requirements. However, the
Commission recognizes that to the extent that the SEC's capital
requirements for these dual registered SD-SBSDs require greater
minimum capital than the Commission's Final Rule, the costs
discussed below with be mitigated.
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SDs That Are Bank Subsidiaries
Capital. Currently U.S. CSEs that are bank subsidiaries
and are not a BD or an FCM are not subject to capital requirements;
however, as part of a BHC or a subsidiary of a bank, the CSE's parent
entity must comply with the prudential regulators' capital
requirements. In addition, certain non-U.S. CSEs that are subsidiaries
within a bank holding company and are not BDs or FCMs are currently
complying with a foreign jurisdiction's capital, liquidity and
financial reporting requirements and these CSEs are covered below, in
the Substituted Compliance section.
Reporting. These SDs do have reporting requirements, but
not for the information that is requested in this rulemaking; however,
a BHC must report the requested information to the Federal Reserve
Board, which includes certain swap and security-based swap positions
held at its SD subsidiary.
SDs That Are BDs (Including, OTC Derivatives Dealers) (With and Without
Models)
Capital. If a CSE is also registered as a BD with the SEC,
the CSE is already meeting the SEC's BD capital requirements.
The SEC currently imposes the Net Liquid Assets Capital
Approach on BDs. However, the SEC has modified certain parts of this
approach to address certain types of BDs (i.e., ANC Firms and OTC
derivatives dealers). As discussed below, an ANC Firm is currently
approved by the SEC to use capital models to calculate certain market
and credit risk charges. In addition, OTC derivatives dealers may be
approved by the SEC to use capital models provided that they maintain a
minimum of $100 million in tentative net capital and at least $20
million in net capital. Certain non-U.S. SDs are already complying with
capital, liquidity and reporting requirements in other jurisdictions.
Therefore, the Commission will cover these SDs in the Substituted
Compliance section.
Reporting. As a BD, these SDs must comply with the SEC's
BD reporting requirements (the Commission's amended reporting
requirements are based on the SEC reporting requirements).
SDs That are FCMs and not BDs (With and Without Models)
Capital. For CSEs that are also registered with the
Commission as FCMs, the Commission's Net Liquid Assets Capital Approach
that is similar to the capital requirements of a registered BD.
Reporting. As an FCM, these SDs must comply with the
Commission's FCM reporting requirements (the Commission's amended
reporting requirements are based on these).
SDs That Are BDs and/or FCMs (ANC Firms With Models and One Other SD)
Capital. For CSEs that are also registered as BDs/FCMs
(using approved models), a significant percentage of these SDs are
currently using the ANC capital approach, as discussed below. There is
currently one other SD that is not an ANC Firm, but meets the
requirements set out above for SD/BDs and FCM-SDs.
Reporting. As an ANC firm, these SDs must comply with the
SEC's and the CFTC's ANC firm reporting requirements.
Stand-Alone SDs and Commercial SDs (With and Without Models)
Capital. Currently a CSE that is a stand-alone SD has no
capital requirements; however, certain non-US Stand-alone SDs are
complying with a foreign jurisdiction's capital, liquidity and
reporting requirements and, therefore, will be included in the
Substituted Compliance benchmark below.
Reporting. As CSEs, these entities have reporting
requirements, but not for the information required requested in this
rulemaking.
[[Page 57530]]
MSPs
Capital. Although there are no MSPs at this time, it is
possible that an MSP in the future may have existing capital
requirements. For example, if a bank is determined to be an MSP or an
insurance company, these entities may have existing capital
requirements.
Reporting. As MSPs, these entities have reporting
requirements, but not for the information required in this rulemaking.
Substituted Compliance \503\
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\503\ The Commission estimates that there are 24 SDs that may be
eligible for substituted compliance under this rulemaking.
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Capital. As discussed above, there are certain non-U.S.
CSEs that comply with a foreign jurisdiction's capital and financial
reporting requirements. Commission staff understands that generally
these foreign capital requirements are either a bank-based capital
regime or a dealer-based regime, which, as the Commission has been
informed by these foreign regulators, are similar to the Net Liquid
Assets Capital Approach.
Reporting. The Commission understands that some of these
non-U.S. CSEs are currently complying with a foreign jurisdiction's
financial reporting requirements; however, these financial reporting
requirements may not be the same as the Commission is requiring in this
rulemaking.
Prudentially Regulated SDs \504\
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\504\ The Commission notes that under section 4s(e) of the CEA,
these SDs must comply with the prudential regulators' capital
requirements, but must also comply with the Commission's reporting
and recordkeeping requirements.
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Reporting. These SDs comply with their applicable
prudential regulator's reporting requirements.
E. Overview of Approaches
In developing the capital approaches required herein, the
Commission selected from well-established frameworks. As a result of
the financial crisis and over the years after the crisis, each of the
approaches has undergone significant analysis and changes.
The Commission is providing certain CSEs with an option to choose
between a Bank-Based Capital Approach (similar to the prudential
regulators' capital approach) and a net Liquid Assets Capital Approach
(similar to the SEC's and CFTC's capital approach). As detailed below,
the Bank-Based Capital Approach is designed to require an SD to have
enough equity, including common equity tier 1 capital (as defined
above), to absorb losses in a time of stress, while the net liquid
assets method is designed to require an SD to hold at all times more
than one dollar of highly liquid assets for each dollar of
unsubordinated liabilities.
The following table summarizes the Commission's capital rules
followed by a summary of each approach:
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\505\ Under the final rule, 6.5% of RWA must be met using CET1,
the remaining amount is permitted to be met with capital in the form
of Tier 1 or Tier 2, provided that subordinated debt meets the
conditions in Commission regulation 18a-1d (17 CFR 240.18a-1d). In
addition, $20 million must be comprised of CET1, and 8% of total
amount of swap dealer's initial margin on uncleared swaps must be
comprised of CET1, Tier 1 or Tier 2 capital as defined under banking
rules.
----------------------------------------------------------------------------------------------------------------
The greatest of the
Approaches SD entities Equity type following:
----------------------------------------------------------------------------------------------------------------
Net Liquid Assets Capital, Regulation SD-FCM................. Net Liquid Assets $20 million or $100
1.17, FCM Approach. (Assets- Liabilities- million if approved to
Market Risk- Credit use capital models.
Risk). 8% of the total
customer and
noncustomer cleared
margin, plus an
additional 2% of the
total amount of a swap
dealer's initial
margin on uncleared
swaps.
RFA.
ANC, Regulation 1.17 and SEC Rule SD-FCM-ANC Approved Net Liquid Assets $5 billion tentative
15c3-1. Firm. (Assets- Liabilities- net capital (not
Market Risk- Credit discounted).
Risk). $6 billion early
warning net capital
(not discounted).
$1 billion Net
Discounted Assets.
8% of the total
customer and
noncustomer cleared
margin, plus an
additional 2% of the
total amount of a swap
dealer's initial
margin on uncleared
swaps.
RFA.
Net Liquid Assets Capital, SEC Rule SD-BDs, SD-BDs (OTC Net Liquid Assets $20 million.
15c3-1 or 18a-1. Derivatives Dealers), (Assets- Liabilities- 2% of the total amount
SD-Non-Bank Market Risk- Credit of a swap dealer's
Subsidiaries of BHC, Risk). initial margin on
SD. uncleared swaps.
RFA.
Bank-Based Capital................... SD-Non-Bank Common Tier 1 Equity, $20 million.
Subsidiaries of BHC, Tier 1 or Tier 2, 8% of RWA.
SD. subject to limits 8% of the total amount
\505\. of a swap dealer's
initial margin on
uncleared swaps.
RFA.
Tangible Net Worth Capital Approach.. SDs-Non-financial Basic Equity (Assets- $20 million plus market
Entities (15% test). Liabilities- Goodwill). and credit risk
charges.
8% of the total amount
of a swap dealer's
initial margin on
uncleared swaps.
RFA.
MSPs................................. MSP.................... Equity................. >=$0.
RFA.
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[[Page 57531]]
1. Bank-Based Capital Approach
Under the Bank-Based Capital Approach a CSE would need to maintain
regulatory capital that meets the following:
$20 million of common equity tier 1;
Six point five percent (6.5%) of common equity tier 1
capital equal to the sum of the following: (i) The amount of its risk-
weighted assets (``RWA''), which is the market risk capital charge
under a VaR computation or a standardized formula table (Reg. 1.17);
(ii) the amount of current counterparty credit risk (``CCR''), which is
the sum of the default risk capital charge and a credit value
adjustment (``CVA'') risk capital charge, which is under either a
standardized formula table or a VaR method, provided that an additional
one point five percent (1.5%) of capital may be met with common equity
tier 1 capital, additional tier 1 capital, or tier 2 capital (including
subordinated debt subject to the conditions in SEC rule 18a-1d;
Eight percent (8%) of the total amount of a swap dealer's
uncleared swap initial margin comprised of common equity tier 1,
additional tier 1, or tier 2 capital; and
The amount required by its RFA.
As noted above, the Commission is requiring a $20 million fixed-
dollar floor, as this is the minimum amount of required capital under
all approaches. The Commission is requiring this minimum level as it
believes that this is the minimum amount of capital that should be
required for a CSE, without regard to the volume of swaps the CSE
engages in, to conduct its dealing activity. As noted above, this
amount is based on the Commission's experience with other registered
entities that are currently subject to capital requirements. The
Commission is also adopting, an eight percent (8%) of uncleared swap
initial margin requirement, as through its experience in supervising
FCMs, it recognizes that this capital computation is a determinative
condition in computing their required capital and requires an SD to
maintain a higher level of capital as the operational and other risks
associated with its dealing activity base increases, as measured by the
initial margin requirements on the swaps positions. As discussed above,
under the Bank-Based Capital Approach, the Commission is maintaining
the 8% level of initial margin requirement. The Commission believes
that the 8% level is properly calibrated for the Bank-Based Capital
Approach method in determining capital. Unlike the Net Liquid Assets
Capital Approach, which leaves higher quality assets in determining the
required level of capital, the Bank-Based Capital Approach uses its
entire balance sheet in determining the amount of required capital. As
a result of including all of its assets (e.g., property, plant and
equipment (``PP&E'')) in determining the capital requirement under the
Bank-Based Capital Approach, the Commission believes that the 8%
requirement is properly set, ensuring that the Commission meets its
statutory requirements for harmonization. In addition, the Commission
has determined to include only a SD's initial margin amount on its
uncleared swaps in calculating its capital requirement under this prong
of the Bank-Based Capital Approach. As discussed above in section
II.C.3., the Commission did not include other instruments that require
initial margin because it believes that these other instruments either
do not contain the same level of risk to the SD as uncleared swaps
(e.g., cleared swaps) or are not within the products or markets for
which the Commission typically regulates. The Commission recognizes
that by not including these margined instruments in the minimum
calculation, it may be decreasing the amount of required capital;
however, these instruments are not removed from the required amount of
capital component, which includes these positions net of applied market
and credit risk charges. The Commission believes this approach better
harmonizes the minimum calculation across the different elective
approaches under the Commission's framework and in comparison to other
regulators (namely, the SEC and the Federal Reserve Board and OCC).
In addition, the Commission has included a standardized table for
market risk that is currently not part of the BCBS or prudential
regulator capital framework. The Commission included the standardized
table in calculating an SD's market risk charges to address SDs that do
not use approved models in computing market risk charges. The
Commission included the regulation 1.17 standardized market risk
charges, as it believes these charges result in adequate capital
computations for the level of market risk inherent in these financial
instruments. In addition, the Commission is currently using these
standardized charges in computing an FCM's market risk charges on the
same financial instruments for an FCM's required capital.
2. Net Liquid Assets Capital Approach
Under this approach, an SD is required to maintain minimum net
capital equal to or exceeding the greatest of:
$20 million; or
Two percent (2%) of the total amount of a swap dealer's
uncleared swap initial margin.
Net capital is generally defined as an SD's current and liquid
assets minus its liabilities (excluding certain qualifying subordinated
debt), with the remainder discounted according to either a CFTC or RFA
approved VaR-based model or a standardized rules-based approach set out
in regulation 1.17.
As noted and discussed above, under this approach, the Commission
requires a $20 million fixed-dollar floor. In addition, the Commission
is adopting, under this approach, a net liquid assets test that is
designed to allow an SD to engage in activities that are part of its
swaps business (e.g., holding risk inherent in swaps into its dealing
inventory), but in a manner that places the SD in the position of
holding at all times more than one dollar of highly liquid assets for
each dollar of unsubordinated liabilities (e.g., money owed to
customers, counterparties, and creditors). The Commission believes that
the Net Liquid Assets Capital Approach, although structurally different
than the Bank-Based Capital Approach, ensures the safety and soundness
of the SD, while providing the same protections to the financial
system.
As discussed above, under the Net Liquid Assets Capital Approach,
the Commission is changing the proposed 8% level of initial margin
requirement to 2%. The Commission believes that, under this approach,
the 2% level is properly calibrated in determining an SD's capital
requirement. As discussed above in section II.C.1., as a concept an 8%
risk margin amount capital minimum component was originally proposed by
the Commission in 2003, and subsequently adopted in 2004, to apply to
FCMs. At the time, the Commission justified this minimum amount
component based on an analysis and comparison of the amount to then
existing FCM capital regime, which used a percentage of the customer
funds held by an FCM as the minimum.\506\
[[Page 57532]]
The Commission originally proposed to use this same concept and
percentage for use in determining SD minimum capital as means to
harmonize the SD approach with Commission's experience and familiarity
with its use in the existing FCM approach. Yet, the Commission
recognizes that the Commission's margin requirements for uncleared swap
positions generally impose a higher initial margin requirement relative
to cleared futures positions, which justify using a different
multiplied in the Net Liquid Assets Capital Approach.
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\506\ See Minimum Financial and Related Reporting Requirements
for Futures Commission Merchants and Introducing Brokers, 68 FR
40835 (July 9, 2003) and 69 FR 49784 (Aug. 12, 2004). See also, CFTC
Division of Trading and Markets, Review of Standard Portfolio
Analysis of Risk Margining System Implemented by the Chicago
Mercantile Exchange, Board of Trade Clearing Corporation, and the
Chicago Board of Trade (Apr. 2001) (``T&M 2001 Report''). See, IIB/
ISDA/SIFMA 3/3/2020 Letter.
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Minimum initial margin requirements for cleared futures
transactions are generally set by clearing organizations and typically
have a different margin period of risk. In this regard, the FCM minimum
capital requirement of 8% of the risk margin amount on futures is based
upon margin calculations using clearing organization models that
require a 99% one-tailed confidence interval over a minimum liquidation
period of one day for futures.\507\ In contrast, initial margin for
uncleared swaps is required to be calculated at a 99% one-tailed
confidence interval over minimum liquidation period of 10 business days
(or the maturity of the swap if shorter).\508\ The greater margin
period of risk for uncleared swaps generally requires a higher level of
initial margin, which when used in determining minimum capital results
in a higher level of required capital relative to if cleared futures
margin was alternative used. The modification of the final rule to set
the risk margin amount multiplier at 2% for uncleared swap positions is
therefore appropriate given the generally higher initial margin
requirements imposed on such positions under the Commission's
regulations relative to cleared positions.
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\507\ See Commission regulation Sec. 39.13(g) (17 CFR
39.13(g)).
\508\ See Commission regulation Sec. 23.154 (b)(2) (17 CFR
23.154(b)(2)).
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As noted above, a 2% multiplier using uncleared swap margin is also
justified under the Net Liquid Assets Capital Approach as compared to a
8% multiplier in Bank-Based Capital Approach and Tangible Net Worth
Approach because of differences in the composition of capital under the
approaches. Bank-Based Capital Approach and Tangible Net Worth Capital
Approach do not account for illiquid assets when determining the amount
of capital, thereby including a much greater composition of assets as
compared to that under the Net Liquid Assets Capital Approach. Applying
a higher more comparable multiplier percentage under Net Liquid Assets
Capital Approach would result in much more stringent capital
requirement and could make competition among SDs utilizing this
approach exponentially more difficult, especially for SDs which may be
required to use this approach as a result of dual-registration with the
SEC as either a BD or SBSD.
3. Alternative Net Capital (``ANC'')
Under the ANC approach, an SD/BD or FCM would need to maintain its
net capital in accordance with the following requirements:
$1 billion net capital; \509\
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\509\ See SEC rule 15c3-1(a)(7) (17 CFR 240.15c3-1(a)(7)).
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$5 billion tentative net capital; \510\ and
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\510\ See Id.
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$6 billion early warning net capital.\511\
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\511\ See Id.
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An SD that is registered with the SEC as a BD and is approved by
the SEC to use internal models to compute certain market risk and
credit risk capital charges (an ``ANC Firm'') will be able to continue
to use the ANC approach in calculating its SD capital; however, with
enhancements to the minimum capital requirements as adopted by the SEC.
An ANC Firm must maintain, at all times, tentative net capital,
which is the net capital of an ANC Firm before deductions for market
and credit risk, of $5 billion. In addition, an ANC Firm must maintain,
at all times, early warning tentative net capital, which is the net
capital of an ANC Firm before deductions for market and credit risk, of
$6 billion. Lastly, an ANC Firm must maintain, at all times, $1 billion
of net capital, which is net discounted assets (discounted by VaR
models for market and credit risk).
In adopting this approach, the Commission recognizes that ANC Firms
are dual registrants with the Commission and SEC that offer a wide-
range of financial services and act as different types of
intermediaries (e.g., BD, FCM, SD). As a result of the additional
complexity and risk inherent in these entities, and the Commission's
experience with these ANC Firms, the Commission is increasing their
minimum capital requirements consistent with the SEC.
The Commission expects that SDs that are ANC Firms will elect to
use this capital approach for their swaps transactions. The Commission
believes that since this approach has been in effect for more than 10
years and it properly accounts for the inherent risk and complexity of
these firms, including their swap dealing activities, that it is
appropriate to permit ANC Firms to continue using this approach, but
with some enhancements based on the Commission's experience. As
discussed above, the Commission is increasing the minimum capital
requirements for ANC Firms in a manner consistent with the SEC's
increases for ANC Firms. The Commission believes that the increases are
appropriate to reflect the potential increase in swaps activities that
ANC Firms may engage in, particularly if affiliates move their swaps
activities into the ANC Firms to more efficiently use the capital held
by the ANC Firms.
4. Tangible Net Worth
The Commission is adopting a Tangible Net Worth Capital Approach
for both SDs and MSPs. With respect to SDs, the Commission is requiring
an SD to maintain minimum net capital equal to or in excess of the
greater of:
$20 million plus market and credit risk charges;
Eight percent (8%) of the total amount of a swap dealer's
uncleared swap initial margin; or
The amount required by its RFA.
The term tangible net worth is defined to mean an SD's net worth as
determined in accordance with generally accepted accounting principles
in the United States, excluding goodwill and other intangible assets.
As noted above, the Commission is adopting this approach as it
recognizes that certain SD's that are primarily engaged in non-
financial activities may engage in a diverse range of business
activities different from, and broader than, the dealing activities
conducted by a financial entity. An SD, availing itself of this
approach, must meet the Commission's 15% revenue test and 15% asset
test as discussed in section II.C.4. to demonstrate that entity or its
parent/consolidated entity is primarily engaged in non-financial
activities.
As discussed below, the Commission believes that the Tangible Net
Worth Capital Approach meets statutory mandate, as it is designed to
help ensure the safety and soundness of the SD, while calibrated to the
inherent risk of the uncleared swaps held by the SD and the overall
activity of the SD. As the Tangible Net Worth Capital Approach would
only be available to SDs that are primarily engaged in non-financial
activities, the Commission believes that this approach has proper
controls to ensure that it is only able to be utilized by SDs which
could not likely meet the other tests due to their unique position
[[Page 57533]]
in commercial markets as well as the swap dealing markets.
With respect to MSPs, the Commission is requiring an MSP to
maintain net tangible net worth in the amount equal to or in excess of
the greater of the MSP's positive net worth or the amount of capital
required by an RFA of which the MSP is a member. There are currently no
MSPs and the only previously registered MSP were required to register
as a result of their legacy swaps and not any current swap activity.
The Commission believes that the capital requirements for MSPs are
appropriate given that no entities are currently registered and the
Commission is uncertain of the types of entities that may register in
the future. As noted above, the Commission has taken this uncertainty
into consideration by proposing to allow an RFA to establish an MSP's
minimum capital requirements. Such RFA's are required under section 17
of the CEA to establish capital requirements for all members that are
subject to a Commission minimum capital requirement. Accordingly, RFAs
may adjust their rules going forward depending on the nature of any
entities that may seek to register as MSPs, and adopt minimum capital
requirements as appropriate. Such RFA rules must be submitted to the
Commission for review prior to the rules becoming effective.
As discussed above, the Commission is maintaining the 8% level of
initial margin requirement under the Tangible Net Worth Capital
Approach. Similar to the discussion above in the Bank-Based Capital
Approach, the Commission believes that the 8% level is properly
calibrated. Unlike the Net Liquid Assets Capital Approach, which leaves
higher quality assets in determining the required level of capital, the
Tangible Net Worth Capital Approach uses a SD's entire balance sheet in
determining the amount of required capital. As a result of including
all assets, including illiquid assets (e.g., PP&E) in determining the
capital requirements, the Commission believes that the 8% requirement
is properly set, ensuring that the Commission meets its statutory
requirements. For the same reasons discussed above with the other
approaches, the Commission also decided to include only a SD's initial
margin amount on its uncleared swaps in calculating its capital
requirement under this prong.
5. Substituted Compliance
As described above, the Commission is providing certain non-U.S.
CSEs with the ability to petition the Commission for approval to comply
with comparable foreign capital and financial reporting requirements in
lieu of some or all of the Commission's requirements. The Commission
recognizes that this may provide these CSEs with cost advantages by
avoiding the costs of potentially duplicative or conflicting
regulation.
In limiting the scope of substituted compliance, the Commission
does not believe it should make available substituted compliance to all
CSEs. The Commission is adopting substituted compliance only to non-
U.S. CSEs, as it believes that it is necessary that its capital
requirements apply to U.S. CSEs, as they are integral to the U.S. swaps
market and critical in ensuring the stability of the U.S. financial
system.
Additionally, the Commission recognizes that substituted
compliance, to the extent that it puts conditions on its comparability
determination, may result in additional costs to these CSEs; however,
the Commission believes that providing a substituted compliance regime
that allows for conditions instead of an all-or-nothing approach will
benefit these CSEs and provide for a more competitive swaps market.
Moreover, to the extent that a non-U.S. CSE must comply with a foreign
regime and the Commission does not find that regime comparable, the
Commission recognizes that these non-U.S. CSE may be burdened with
additional costs and subject to conflicting and/or duplicative costs.
F. Entities
The following section discusses the related incremental costs and
benefits of the rulemaking's capital approaches and reporting
requirements on each type or category of SDs and MSPs. The Commission
understands that certain SDs and MSPs organized and domiciled outside
of the U.S. would be included in these types or categories of entities.
These non-U.S. SDs and MSPs are discussed in the Substituted Compliance
section below.
1. Bank Subsidiaries
Currently, all U.S. CSEs that are subsidiaries in a BHC and are not
a BD or FCM currently are not subject to capital requirements; \512\
however, their parent BHC complies with the Federal Reserve's capital
requirements. Under the Federal Reserve Board's capital requirements,
which are based on Basel III requirements, a BHC must maintain adequate
capital for the entire consolidated entity.\513\ That is, all the
assets and liabilities of the BHC's consolidated subsidiaries are
consolidated into the holding company. The Federal Reserve Board's
capital requirements are then imposed on the BHC, requiring the BHC to
maintain capital levels according to those requirements.
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\512\ The Commission acknowledges that some subsidiaries in a
BHC may be an insurance company and, therefore, may have capital
requirements set by its insurance regulator. Such entities are
outside the scope of the Commission's rulemaking as these entities
are currently not registered with the CFTC as an SD or MSP. The
Commission further acknowledges that there are some non-U.S.
subsidiaries that are part of a bank and those subsidiaries and/or
their parent may be subject to the capital regime of a foreign
regulator. The Commission believes that in such a case, the capital
regime that is likely to be applicable would be either the Basel
III-based approach or a version of the net liquid assets approach.
\513\ See Regulatory Capital Rules: Regulatory Capital,
Implementation of Basel III, Capital Adequacy, Transition
Provisions, Prompt Corrective Action, Standardized Approach for
Risk-weighted Assets, Market Discipline and Disclosure Requirements,
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital
Rule; Final Rule, 78 FR 62018 (Oct. 11, 2013).
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As these CSEs are not currently required to be separately
capitalized, the Commission understands that this may add incremental
cost to the consolidated entity and/or the CSE as they may have to
retain earnings or further capitalize the CSE to the required capital
levels. However, the Commission recognizes that a consolidated entity
may capitalize one of its subsidiaries in many different ways,
including retaining earnings from the CSE or from within the
consolidated group. Even with this requirement imposing capital on the
subsidiaries, as noted above, the BHC must maintain capital levels in
accordance with the Federal Reserve Board's capital requirements, which
are calculated on a consolidated basis; therefore, incremental costs
may be mitigated, as it may be possible for the consolidated entity to
keep the same level of capital within the BHC, but reallocated among
its subsidiaries.\514\ In addition, the Commission recognizes that
earnings may now have to be retained in the CSE and may no longer be
available to be reallocated to fund other more profitable activities
within the consolidated group or to be returned to shareholders;
however, the Commission believes that by providing these CSEs with the
option of differing capital approaches, these CSEs will select the
capital approach this is optimal for its operations, financial
structure and which will reduce duplicative or conflicting rules and
the administrative costs of calculating and maintaining additional sets
of books and records.
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\514\ The Commission notes that the bank or an insurance company
in a BHC must maintain certain capital and as such, may not be able
available to capitalize the CSE.
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[[Page 57534]]
The Commission believes that although the capital approaches
adopted herein may be structurally different, they each require a CSE
to maintain adequate capital levels commensurate to its regulated swap
dealing activities, which should help ensure the safety and soundness
of the CSE and the stability of the U.S. financial system.
In requiring capital for a bank subsidiary that is an SD, as
discussed above, the SD may incur additional costs. As a result of the
additional costs, some SDs may be put at a competitive disadvantage,
when compared to those dealers with lesser capital requirements or with
no capital requirements. As a result of this additional cost, some swap
dealing activity may become too costly--becoming a low margin
activity--and, therefore, some SDs may limit their dealing activity or
exit the swaps market. Additional costs may also be passed on to
customers in the form of higher prices; however, if these SDs are to
remain competitive in the swaps market, they must compete by matching
or beating prices of their competitors or provide other additional
services to their customers. In addition, as most of the largest swap
dealers are part of a BHC, these SDs are already incurring capital
charges at the consolidated level, and, therefore, the incremental cost
and the effect on competition and pricing of swaps may be mitigated.
Because these SDs have the option to select the most optimal capital
approach for them, they can control some of the burdens placed on them
by the rules and thereby, mitigate the rulemaking's effect on pricing.
2. SD/BD (Without Models)
An SD that is also a BD that does not use SEC/CFTC-approved models
to calculate its market and credit risk charges has the option to use
either the Bank-Based Capital Approach or the Net Liquid Assets Capital
Approach, but with standardized capital charges for market risk and
credit risk. The Commission recognizes that although it is giving an
option to these SDs to comply with either approach, these SDs must
still meet the SEC's BD capital requirement.
The standardized capital charges impose significant capital
requirements for uncleared swaps primarily in the form of rules-based
market risk charges and credit risk charges. The Commission does not
anticipate that many SD/BDs engaging in significant swaps activity will
do so using the standardized capital charges for market and credit
risk.
3. SD/BD/OTC Derivatives Dealers (Without Models)
An SD that is registered with the SEC as an OTC derivatives dealer
will have the option to comply with either the Bank-Based Capital
Approach or the Net Liquid Assets Capital Approach. As OTC derivatives
dealers, these SDs already comply with the SEC's net liquid assets
capital requirements. OTC derivative dealers also may be approved by
the SEC to use internal models to calculate market and credit risk
charges in lieu of standardized, rules and table-based capital charges
for swaps, security-based swaps and other financial instruments.
The Commission believes that since SDs that are registered OTC
derivatives dealers are already complying with the SEC's Net Liquid
Assets Capital Approach, they will select this approach in meeting with
the Commission SD's proposed capital requirements. The Commission
believes that allowing these entities to continue using current capital
requirements will reduce the possibility of duplicative or conflicting
rules and administrative costs of calculating and maintaining
additional sets of books and records. The Commission believes that this
will result in only a small incremental cost to OTC derivative dealers.
The Commission recognizes that OTC derivatives dealers already have
received approval from the SEC to use models in computing their current
capital requirements and, therefore, will not incur any additional
costs in developing and implementing this model-based approach in
computing capital charges.
4. FCM-SD (Without Models)
An SD that is also registered with the Commission as an FCM that
does not use models to calculate market and credit risk charges, must
compute its capital in accordance with the standardized market and
credit risk charges set forth in regulation 1.17. The Commission is
amending certain provisions of regulation 1.17 to reduce the burden on
an FCM engaging in swaps. The amendments align the FCM capital
requirements with that of the Net Liquid Assets Capital Approach for
SDs in regulation 23.101. In amending the requirements, the Commission
believes that it is reducing the burden placed on SDs/FCMs, as the
amount of capital on uncleared swaps would have been significantly
higher under the current requirements and would have placed FCM-SDs at
a competitive disadvantage. Specifically, regulation 1.17 currently
does not allow an FCM to recognize collateral held at a third-party
custodian as capital. Therefore, under regulation 1.17 an FCM-SD would
have to take a 100 percent capital charge for margin posted with third-
party custodians even though the Commission's uncleared margin rules
require initial margin to be held at a third-party custodian. This is
true even though the custodian has no ability to rehypothecate the
initial margin and the SD has the ability to retrieve the initial
margin back from the custodian with no encumbrance. Therefore, the
Commission believes that its amendments to regulation 1.17 to allow an
FCM-SD to recognize margin posted with third-party custodians in
accordance with the Commission's margin rules allows an FCM-SD to meet
its minimum level of required capital while also requiring an FCM-SD to
maintain adequate capital levels, when considering the amount of
initial margin that the SD has at its disposal in the event of a
counterparty default.
As a result of the amendments, FCM-SDs should benefit from lower
capital charges and should allow these FCM-SDs to continue to comply
with one capital rule, which should mitigate some of the administrative
costs and reduce the possibility of duplicative or conflicting rules.
The Commission is not providing these SDs with an option to use the
Bank-Based Capital Approach, as the Commission believes that this
option is unnecessary and costly, and the current FCM capital approach
reflects that the firm is not only a SD, but acts as an intermediary
for customers on futures markets. The Commission has made amendments to
account for FCM-SDs' swap activities and in allowing these FCMs to
change their current capital method, the Commission believes that this
would add an additional layer of complexity and costs to the FCMs, as
the FCMs would have to change, modify or migrate all of their current
systems to a new capital regime. In addition, the Commission believes
that requiring the same capital regime, with beneficial amendments, is
more appropriate in transitioning the Commission's capital requirements
to these entities, as it should result in fewer burdens and a simple
transition in implementing the Commission's amended capital
requirements. Further, the Commission believes that this would simplify
the Commission's ability to supervise these entities, as the Commission
will be able to seamlessly transition from its current capital regime
to these new requirements; however, the Commission recognizes that by
not providing these
[[Page 57535]]
SDs with the option to use the Bank-Based Capital Approach it may be
foreclosing the ability of these SDs to use a capital approach that may
be more cost effective.
The Commission recognizes that by amending regulation 1.17 capital
charges it is reducing the burden currently placed on FCM-SDs' swaps
activities, which may result in greater liquidity in the swaps market,
as this activity will be less costly and may incentivize these entities
to engage in more swap dealing activity.
As a result of the amendments to regulation 1.17, these FCM-SDs may
be able to realize some of the cost saving of the amendments when
competing with other dealers for counterparties. This cost savings may
also result in more efficient pricing for their counterparties.
However, the Commission notes, as stated above, that as a result of the
Commission's margin requirements for uncleared swaps these benefits may
be limited.
5. ANC Firms (SD/BDs and/or FCMs That Use Models)
An SD that is an ANC Firm (i.e., also a BD and/or FCM, with
approval by the SEC/CFTC to use models in computing market risk and
credit risk charges), will incur minimal additional capital charges, as
a result of the amendments. The Commission is retaining this approach
for these firms, but with an increase in the capital thresholds, as
noted above. The Commission is making these amendments based on market
experience in supervising ANC Firms, and in recognition that the
amendments are consistent with the SEC's capital increases for ANC
Firms. The Commission notes that the current ANC Firms are already
maintaining more than the amended thresholds; however, by increasing
these capital requirements the Commission recognizes that this may have
an additional cost, as ANC Firms will now be required to maintain these
capital levels, as under the current capital thresholds, these were
held at their discretion.
The Commission recognizes that ANC firms already have received
approval from the to use models in computing their current capital
requirements and, therefore, they will not incur any additional costs
in developing and implementing this model-based approach in computing
capital charges.
6. Stand-Alone SD (With and Without Models)
A stand-alone SD is provided with an option to comply with either
the Bank-Based Capital Approach or the Net Liquid Assets Capital
Approach. In providing this option, the Commission, as discussed above,
believes that both options provide adequate capital requirements and
account for the financial activities of an SD. Therefore, the
Commission believes that these SDs will benefit, as these SDs will have
the ability to select the most optimal approach, based on their
organizational and operational structure and the composition of their
assets. In addition, this option will also reduce the possibility of
duplicative or conflicting rules and administrative costs of
calculating and maintaining additional sets of books and records.
A stand-alone SD that does not use models must compute their market
risk and credit risk charges in accordance with rules-based
requirements and standardized tables. The Commission recognizes that
under the Bank-Based Capital Approach, market risk charges are
calculated with a prudential regulator's approved model; however, to
allow stand-alone SDs to use the Bank-Based Capital Approach without a
model, the Commission is incorporating regulation 1.17 market risk
charges into the framework. In providing this alternative, the
Commission is providing an option to those stand-alone SDs that do not
have Commission-approved models. In doing so, the Commission is
providing these SDs with a benefit, as they are still able to choose
the most efficient capital approach. The Commission incorporated
regulation 1.17 market risk charges, as amended, as it believes that
this is a well-established method that properly accounts for market
risk charges.
However, the Commission recognizes that many of these entities are
not currently subject to minimum capital requirements, and as such,
will incur additional costs on all of their financial activities,
including their swap activities, which may result in possible increases
in costs and pricing. In addition, a stand-alone SD selecting to use
models in computing its market and credit risk charges may incur
additional costs in developing and implementing these models.
The Commission recognizes that by requiring capital for SDs this
may put these SDs at a competitive disadvantage, when compared to those
dealers with a lesser capital requirement or with no additional capital
requirements as a result of these rules. As a result of this additional
cost, some swap activities may become too costly and, therefore, some
SDs may limit their activity or exit the swaps market. This additional
cost may in turn be passed on to customers in the form of higher
prices; however, if these SDs are to remain competitive in the swaps
market, they must compete by matching or beating prices of their
competitors or provide other additional services to their customers. If
an SD decides to limit its activity or withdraw from the swaps market,
this may result in a reduced level of liquidity in the swaps market.
In requiring minimum capital requirements, the Commission believes
that it is complying with its statutory mandate, as these standards are
calibrated to the level of risk in an SD and are designed to help
ensure safety and soundness of the SD and the stability of the U.S.
financial system. In addition, the Commission's proposal is modeled
after two well-established capital regimes, which should help ensure
safety and soundness of the SD and competition among all registered
SDs.
7. Non-Financial SD (With and Without Models)
An SD or an SD that has a parent that is predominantly engaged in
non-financial activities, as defined in regulation 23.100 (85% non-
financial threshold), may use the Tangible Net Worth Capital Approach.
This approach is designed after GAAP's tangible net worth computation
and excludes intangibles and goodwill.\515\ The Commission is also
requiring that the non-financial SD include in its capital requirement
its market risk and credit risk charges.
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\515\ Under GAAP, tangible net equity is determined by
subtracting a firm's liabilities from its tangible assets.
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The Commission believes that this approach, which is tailored to
non-financial entities that are SDs or have a SD in its corporate
family, provides these entities with the flexibility to meet an
appropriate capital requirement, without requiring the firms to engage
in costly restructuring of their operations and business. The
Commission recognizes that these SDs deal in swaps, but the Commission
also recognizes that these entities or their parent entity are
primarily engaged in commercial activities and these SDs primarily
transact with commercial clients. BCBS and the Commission did not fully
consider this type of business model when developing the Bank-Based
Capital Approach and the Net Liquid Assets Capital Approach. In
allowing these entities to maintain their current structure, the
Commission believes that its approach will allow for less disruption to
these SDs and in the markets, as these SDs may serve smaller clients
that would not otherwise be able to participate in the swaps market
[[Page 57536]]
without these SDs. However, the Commission, in helping to ensure the
safety and soundness of these SDs, is requiring that these entities
maintain a level of tangible net worth equal to or greater than the
greatest of (i) $20 million plus the SD's market and credit risk
charges, (ii) eight percent of its uncleared swaps initial margin
amount or (iii) the amount of capital required by an RFA, as this would
account for the SD's exposure (market and credit risk) to the swaps
markets, without penalty to the SD's or the SD's parent's commercial
activities.
In developing this approach, the Commission also recognizes that
the commercial activities of a commercial SD could affect the overall
financial health of the SD. That is, in the event of a substantial loss
emanating from its commercial activities, this loss may have a
substantial negative affect on the SD, which may find itself in
financial distress. As the Commission is not accounting for the risk in
the commercial activities, it is possible that the amount and type of
capital that a commercial SD is required to maintain may not be
adequate to prevent the failure of the SD, which then will affect all
of its swap counterparties. However, in tailoring this method to these
commercial SDs, the Commission is taking a position that is consistent
with the Commission's prior positions on commercial entities, as it
believes these commercial entities and their corresponding activities
present less default and systemic risk than a financial entity.\516\
---------------------------------------------------------------------------
\516\ See e.g., 17 CFR 39.6.
---------------------------------------------------------------------------
The Commission recognizes that these entities are not currently
subject to minimum capital requirements, and as such, will incur
additional costs due to the imposition of a capital requirement on all
of their swap dealing activities, which may result in possible
increases in pricing; however, as the Commission has developed its
capital requirements to better account for activities in these
commercial SDs, it believes that the additional cost should be
mitigated by this approach.
In addition, as the Commission expects that many of these SDs will
use models in computing its market and credit risk charges, this may
also result in additional costs in developing and implementing these
models; however, this cost should be mitigated by the savings that may
be realized by using such models.
8. MSP
An MSP must maintain capital (i.e., tangible net worth) of the
greater of positive tangible net worth or the amount of capital
required by a RFA of which the MSP is a member. This approach is
designed after GAAP's tangible net worth computation and excludes
intangible assets and goodwill. Currently there are no MSPs. The
Commission cannot determine if other entities will register in the
future as MSPs, however, the Commission is required to adopt a capital
requirement to address potential future registrants.
In adopting the Tangible Net Worth Capital Approach for MSPs, the
Commission is allowing these entities to continue their operations if
they become registered as MSPs with little to no changes to the
entities' structures. In providing for this, the Commission believes
that these entities if they become registered as MSPs will incur
minimal additional costs to comply with the proposed requirements.
The Commission believes that the adopted capital requirements will
help ensure the safety and soundness of MSPs, as these entities will
typically be posting and collecting margin on all of their new
uncleared swaps and, therefore, as these MSPs are registered only as a
result of being an end user of swaps and not a swap dealer, the margin
requirements satisfy most of the safety risk for these entities, which
is on a $1 for $1 basis, than through more burdensome capital
requirements. Therefore, the Commission is only requiring MSPs to
maintain solvency, while noting that the entity may be subject to other
capital requirements and hence required to comply with those capital
requirements.
As the Commission's capital requirements will result in minimal
additional costs to these MSPs, there should be little to no effect on
competition, as they are end users (i.e., price takers) and little to
no incremental effect on pricing.
9. Substituted Compliance
A non-U.S. CSE that is already complying with a comparable foreign
jurisdiction's capital or financial reporting regime is provided with
the ability to meet the Commission's capital requirements by meeting
the foreign jurisdiction's capital requirements. In providing these
CSEs with the ability to continue to comply with their current capital
and financial reporting regimes the Commission believes that it is
limiting the potential for conflicting and duplicate capital
requirements. In addition, as each foreign jurisdiction must be
determined to be of comparable effect, which mitigate the possible
negative impacts on the U.S. financial system.
The Commission further recognizes that non-U.S. CSEs that use
conditional substituted compliance may incur additional costs; however,
the Commission believes that conditional substituted compliance
provides an offsetting benefit to these CSEs as it allows for a
conditional substituted compliance determination instead of an all-or-
nothing approach, which may result in the Commission not recognizing a
foreign jurisdictions capital requirements, resulting in more
substantial additional cost, including possible conflicting and/or
duplicative requirements.
G. Liquidity Requirements
The Commission proposed to require FCM-SDs and covered SDs electing
the Bank-Based Capital Approach or the Net Liquid Assets Capital
Approach to satisfy specific liquidity requirements.\517\ The proposal
required covered SD electing the Bank-Based Capital Approach to meet
the liquidity coverage ratio requirements set forth in 12 CFR part
249.\518\ In addition, the proposal required covered SDs electing the
Net Liquid Assets Capital Approach and FCM-SDs to adopt a liquidity
stress test requirement that was similar to those undertaken by SEC ANC
Firms.\519\
---------------------------------------------------------------------------
\517\ See 2016 Capital Proposal, 81 FR 91252 at 91273-75.
\518\ Id.
\519\ Id.
---------------------------------------------------------------------------
The Commission proposed these requirements to address the potential
risk that a covered SD or FCM-SD may not be able to meet both expected
and unexpected current and future cash flows, including collateral
needs. As noted above, the Commission is not adopting these
requirements. Therefore, by not including these requirements, the
Commission recognizes that it may be increasing risk to the financial
system. The Commission realizes that it is possible for a firm to have
enough capital, but not enough liquidity to continue its operations as
an ongoing business. These requirements were intended to ensure that
SDs would have enough liquid assets to meet liabilities, which would
help it during a liquidity crisis--ensuring the short-term continuing
operations of the SD. However, the Commission believes this increased
risk to the financial system is mitigated by the Commission's
regulation 23.600, which imposes liquidity requirements on covered SDs.
Regulation 23.600 requires each SD to establish, document, maintain,
and enforce a system of written risk management policy and procedures
designed to monitor and manage the
[[Page 57537]]
risk associated with the covered SD's swaps activities, including
liquidity risk. In addition, for those SDs that are part of a bank
holding company, the bank holding company must comply with high quality
liquid asset requirements, which should mitigate this increased risk at
these SD. Finally, this risk is greatly reduced for firms electing the
Net Liquid Assets Capital Approach, which already incorporates a
liquidity component into its primary determination of the capital
amount.
In not adopting these requirements, the Commission believes that
SDs will be provided with greater flexibility in meeting its current
liquidity needs. This should allow SDs to allocate their funds in a
more efficient manner, which may result in a greater return on capital,
as they will no longer need to set aside funds in low-returning assets.
H. Equity Withdrawal Restrictions
In the Final Rule, the Commission is prohibiting certain
withdrawals of equity capital from covered SDs.\520\ The equity
withdrawal restriction generally provides that the capital of a covered
SD, or any subsidiary or affiliate of the covered SD that has any of
its liabilities or obligations guaranteed by the covered SD, may not be
withdrawn by action of the covered SD or by its equity holders if the
withdrawal would result in the covered SD holding less than 120 percent
of the minimum regulatory capital that the covered SD is required to
hold pursuant to proposed regulation 23.101. As discussed above in
section II. C. 9., the Commission adopted these requirements to ensure
the safety and soundness of the covered SD and the integrity of the
financial system, because the Commission believes that the withdrawal,
loan or advance may be detrimental to the financial integrity of the
covered SD. In addition, these transactions may unduly jeopardize the
covered SD's ability to meet its financial obligations to
counterparties or to pay other liabilities which may cause a
significant impact on the markets or expose the counterparties and
creditors of the covered SD to loss. However, the Commission notes that
in adopting these requirements, the Commission may be limiting the
consolidated entity's, including the covered SDs and their affiliates,
financial flexibility. That is, these requirements may limit the
ability of the consolidate entity to allocate capital, at a critical
time, to an entity that may need funding or an entity with a greater
rate of return. The Commission recognizes this, but, as stated above,
believes that if it permitted this activity, it may cause significant
impact on the financial system.
---------------------------------------------------------------------------
\520\ See 23.104(a) and (b).
---------------------------------------------------------------------------
I. Reporting and Recordkeeping Requirements
The recordkeeping, reporting and notification requirements set out
in this rulemaking are intended to facilitate effective oversight and
improve internal risk management, via requiring robust internal
procedures for creating and retaining records central to the conduct of
business as an SD or MSP. Requiring registered SDs and MSPs to comply
with recordkeeping and reporting rules should help ensure more
effective regulatory oversight. The amendments will help the Commission
determine whether an SD or MSP is operating in compliance with the
Commission's capital requirements and allow the Commission to assess
the risks and exposures that these entities are managing.
As detailed above in Section II.D., the Commission is requiring all
SDs to file certain financial information pertaining to their capital
requirements. Those SDs that are prudentially regulated are provided
with the option to submit their financial information that is reported
to their prudential regulator to the Commission. In addition, those SDs
that are also FCMs may file their financial information pertaining to
their capital requirements with the Commission, including notices, in
the same manner as they currently report. For those SDs that are also
registered with the SEC as a BD or a SBSD, these SDs may file the same
financial information to the Commission, as they file with the SEC. In
filing the required financial information with the Commission, these
entities must file through the Winjammer electronic filing system.
Alternatively, these same SDs have the option to report their financial
information like stand-alone SDs, commercial SDs and MSPs report their
financial information to the Commission. The Commission is providing
this option, as the information reported to the Commission under this
proposal and that is filed with the Commission or other financial
regulatory agencies are similar, as the information provides the
Commission with the ability to assess and monitor an SD's financial
condition and whether the SD is currently meeting the Commission's
capital requirements. In permitting these SDs to use their current
required information, the Commission believes that this should mitigate
some additional costs to prepare and report this information to the
Commission. In addition, these SDs should already have developed
policies, procedures and systems to aggregate, monitor, and track their
swap dealing activities and risks. As such, this should also mitigate
some of the costs incurred under the rulemaking.
Those SDs and MSPs that are not subject to current capital
requirements will have to develop and establish policies, procedures
and systems to monitor, track, calculate and report the required
information. In developing these policies, procedures and systems,
these SDs will incur costs; however, as these entities are registered
with the Commission as SDs, the Commission believes that they should
already have developed policies, procedures and systems to aggregate,
monitor, and track their swap activities and risks, as is required
under the Commission's swap dealer framework. This should mitigate some
of the burdens of the reporting and recordkeeping requirements. In
addition, as the information that the Commission is requiring is based
on GAAP or another accounting method, this information is already being
prepared for other purposes and therefore, should again mitigate the
costs in meeting these requirements.
The Commission also believes that as a result of the reporting and
recordkeeping requirements, SDs should be able to more effectively
track their trading and risk exposure in swaps and other financial
activities. To the extent that these SDs can better monitor and track
their risks, this should help them better manage risk.
As noted in the section F.9., the Commission is providing
substituted compliance to certain non-U.S. CSEs. As discussed above and
for the same reasons, the Commission believes that, in regards its
reporting requirements, providing substitute compliance to these non-
U.S. CSEs it should reduce the possibility of additional costs and
duplicative or conflicting requirements.
J. Section 15(a) Factors
The following is a discussion of the cost and benefit
considerations as it relates to the 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.
1. Protection of Market Participants and the Public
The rules are intended to strengthen the swaps market by requiring
all CSEs to maintain a minimum level of capital. These minimum capital
requirements should enhance the loss absorbing
[[Page 57538]]
capacity of CSEs and reduce the probability of financial contagion in
the event of a counterparty default or a financial crisis. In addition,
capital functions as a risk management tool by limiting the amount of
leverage that a CSE can incur. Financial reporting requirements for
CSEs should help the Commission and investors monitor and assess the
financial condition of these CSEs. As this rulemaking is designed to
protect financial entities from default, this should have a direct
benefit to the public, as the failure of these CSEs could result in a
financial contagion, which could negatively impact the general public.
On the other hand, the capital rules may require additional capital to
be raised and will increase the cost of swaps for all market
participants, as described above.
2. Efficiency, Competitiveness, and Financial Integrity of Swaps
Markets
The Commission seeks to promote efficiency and financial integrity
of the swaps market, and where possible, mitigate undue competitive
disparities. Most notably, the Commission aligned the regulations with
that of the prudential regulators', SEC's and the Commission's current
capital frameworks to the greatest extent possible. Doing so should
promote greater operational efficiencies for those SDs that are part of
a BHC or are also registered with the SEC as a BD or the Commission as
an FCM, as they may be able to avoid creating duplicative compliance
and operational infrastructures and instead, rely on the infrastructure
supporting the other registered entities. In addition, this approach
should also enhance efficiency and limit conflicting rules, as these
entities can continue to operate under their current regimes. Moreover,
the amendments permit CSEs to calculate credit and market risk charges
under a standardized or model-based approach, which allows them to
choose the methodology that is the most suitable for their asset
composition.
The Commission notes that the capital rule, like other requirements
under the Dodd-Frank Act, could have a substantial impact on
competition in the swaps market. As the Commission's capital rule will
result in additional costs to certain CSEs that do not have current
capital requirements, these CSEs may either limit their swap activities
or withdraw from the swaps market. In this event, it is possible that
this may result in less competition and increases in prices of swaps.
Depending on the relative cost of the Commission's capital requirements
compared with corresponding requirements under prudential regulators'
regime, SEC's regime or in other jurisdictions, certain CSEs may have a
competitive advantage or disadvantage; however, the Commission, in
developing the capital rule, harmonized it with those of the prudential
regulators and the SEC to the maximum extent practicable.
As noted above, the Commission, recognizing that SDs are critical
to the financial integrity of the financial markets, designed their
capital requirements to help ensure the safety and soundness of these
SDs. In doing so, this should protect an SD in the event of a default
by its counterparty or a financial crisis, which the Commission
determines should reduce the probability of financial contagion.
3. Price Discovery
As noted above, the capital rule may have a negative effect on
competition, as a result of increasing costs, which may result in some
SDs limiting or withdrawing from the swaps markets. In that event, this
negative effect on competition could result in a less liquid swaps
market, which will have a negative effect on price discovery. However,
as discussed above, most of the larger SDs or their parent entities are
already subject to capital requirements that impose capital charges for
their swap activities and, therefore, the rule's negative impact on
competition, liquidity and price discovery should be limited, and in
any event is outweighed by the increased benefit of the longer term
safety and soundness of the entities that provide price discovery.
4. Sound Risk Management Practices
A well-designed risk management system helps to identify, evaluate,
address, and monitor the risks associated with a firm's business. As
discussed above, capital plays an important risk management function
and limits the amount of leverage an entity can incur. In addition,
capital serves as the last line of defense in the event of a
counterparty default or severe losses at a firm. The Commission's
capital rule is developed from two well-established capital regimes.
Therefore, the Commission's capital rule should promote increase risk
management practices within a CSE. Moreover, the Commission believes
that as a result of the reporting and recordkeeping requirements, SDs
may more effectively track their trading and risk exposure in swaps and
other financial activities. To the extent that these SDs can better
monitor and track their risks, this should help them better manage risk
within the entity.
5. Other Public Interest Considerations
The Commission has not identified any additional public interest
considerations related to the costs and benefits of the proposed rule.
K. Attachment A to Cost Benefit Considerations
i. Minimum Capital Requirement
Due to data availability, the Commission's analysis is focused on
cost arising from minimum capital requirements. As discussed above,
this rulemaking would prescribe capital requirements for SDs and MSPs
that are not subject to a prudential regulator, and amendments to
existing capital rules for FCMs would prescribe capital requirement for
FCMs that are also registered as SDs and increase capital requirement
for FCMs to account for risk arising from their swaps and security-
based swaps. The Commission discusses cost at the entity level. The
analysis below makes many assumptions that assume away complex details
and the marginal cost resulting from the final rule would be much
larger and proportionally larger for smaller entities. Please note that
the true magnitude of cost is unknown.
As of June 3, 2020, there are approximately 108 SDs and no MSPs
provisionally registered with the Commission. The Commission estimates
that out of the 108 provisionally registered SDs, 15 U.S. Prudential
Regulated Registrants SDs are exempt from the Commission's capital
requirement; 38 SDs which are Non-U.S. Registrants Overseen by the FRB
are also exempt from the Commission's capital requirement. For the rest
of the 56 provisionally registered SDs, 4 SDs are also registered with
the Commission as FCMs, while the other 52 SDs are not FCMs.
The cost benefit considerations noted in the 2016 Capital Proposal
included an analysis of interest rate swap position data for the
purposes of extrapolating certain possible ranges regarding the
possible cost of capital at Commission registered SDs. The Commission
noted at the time that this was because interest rate swaps represent a
majority of the swaps notional reported to swap data repositories. The
Commission received no comments specifically addressing this analysis
and upon further review has concluded that utilizing Part 45 data for
this exercise could be problematic; drawing conclusions of estimated
capital costs from the one particular type of swap data does not
adequately reflect the variety of SDs and their respective dealing
books under the
[[Page 57539]]
Commission's jurisdiction. The Commission has updated other tables that
were included to reflect current registrations. The quantitative data
noted herein reflect data either reported on existing Commission
filings from these registrants or is readily available to the public as
part of the bank or financial holding company public disclosure
process.
Discussing Capital Requirement Cost at Entity Level
The Commission collects monthly financial and capital information
from FCMs. There are currently four SDs that are also registered as
FCMs. For the purpose of discussing cost of complying with these
minimum capital requirements, the Commission further separates these
SDs that are also FCMs into two categories: SDs that are also SEC
registered ANC firms, and FCMs that are not ANC firms registered with
the SEC.
1. SDs That Are FCMs and ANC Firms With the SEC
Table 1--Capital for SDs That Are Also FCMs and ANC Firms as of April 30, 2020
----------------------------------------------------------------------------------------------------------------
Adjusted net Net capital Excess net
Name of swap dealers Registered as capital requirement capital
----------------------------------------------------------------------------------------------------------------
CITIGROUP GLOBAL MARKETS INC... FCM BD SD $9,448,443,343 $ 4,041,143,110 $5,407,300,233
GOLDMAN SACHS & CO............. FCM BD SD 19,731,764,252 4,116,348,831 15,615,415,421
JP MORGAN SECURITIES LLC....... FCM BD SD 23,422,668,118 5,808,368,054 17,614,300,064
MORGAN STANLEY & CO LLC........ FCM BD SD 12,993,998,405 4,109,846,691 8,884,151,714
----------------------------------------------------------------------------------------------------------------
Source: FCM financial data as of April 30, 2020.
The Commission estimates that four SDs are already registered as
ANC BDs with the SEC. Under the 2019 SEC Final Capital Rule, ANC firms
registered with the SEC are required to maintain a minimum of five
billion dollars of tentative net capital and a minimum of one billion
dollars of net capital. In addition, all ANC firms use models for risk
charge computations. These minimum capital requirements for ANC firms
by the SEC are much higher than the minimum capital requirements
adopted by the Commission, thus are more likely the binding constraints
for these firms. Based on financial information reported by these SDs
in their monthly reports filed with the Commission, these four SDs
maintain a significant amount of net capital in excess of SEC's
requirement and the Commission's capital requirement. Therefore, the
Commission expects that the likelihood of these entities needing to
raise additional capital due to this rule might be low; however, there
may be other significant costs for these entities to comply with this
capital requirement. The true magnitude of these costs is hard to
predict due to the complexities of these rules.
2. SDs That Are FCMs but Currently Are Not ANC Firms Registered With
SEC
There are currently no provisionally registered swap dealers which
are registered as FCMs but not ANC firms registered with the SEC. As
noted in the 2016 Proposal, there were four previously provisionally
registered SDs in this category, but withdrew their registration. The
Commission understands that a majority of these SDs engaged in forex
dealing business exited swaps dealing as result of the adoption of
other regulatory requirements, namely the uncleared margin rules.
Accordingly, the Commission does not expect there to be any other type
of FCM registered as a SD and thus is not further considering the costs
of capital for these entities.
For SDs that are not FCMs, the Commission prescribes the following
minimum capital requirements depending on whether SDs are financial
entities or commercial entities. Standardized approach to calculate
credit and market risk may not be tailored to specific business models
of SDs. Developing risk models for capital purposes and going through
model approval process might be much more costly for SDs that currently
do not have a formal model approval process in place. For the purpose
of discussing the cost of complying with minimum capital requirement,
the Commission separated stand-alone SDs into following categories.
3. Nonbank U.S. Subsidiaries of Bank Holding Companies (BHCs) or
Financial Holding Companies Subject to Basel III Capital Regime
These SDs currently do not have any capital requirement, and the
capital requirement resulting from this final rule may increase cost to
these SDs as it may have to raise capital to the required level.
However, U.S. parents of the SDs in this category are currently subject
to the Federal Reserve's capital requirements on a consolidated basis,
including U.S. Basel III capital requirement and also are participants
of the Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank
Act Stress Test (DFAST). CCAR evaluates the capital planning process
and capital adequacy of the largest U.S.-based BHCs, including the
firms' planned capital actions. The Dodd-Frank Act stress tests are a
forward-looking component to help assess whether firms have sufficient
capital to absorb losses and have the ability to lend to households and
businesses even in times of financial and economic stress. Similarly,
other SDs in this category are subsidiaries of foreign BHCs or a
foreign financial holding company (FHC), which already comply with
Basel III risk-based capital requirements and having common equity tier
1 capital ratio at consolidated level exceeding eight percent. The
parent BHCs of these nonbank SDs, set out in the table below, are well
capitalized due to these requirements, as indicated by their common
equity tier 1 capital ratio at the consolidated level, which is much
higher than eight percent.
Therefore, assuming that these SDs would use the Bank-Based Capital
Approach, the final rule requires common equity tier 1 capital,
additional tier 1 capital, or tier 2 capital to be equal or greater
than the minimum requirement, that is, max [$20mm, 8%* RWA,\521\ 8% *
Risk Margin, RFA requirement] to be considered well-capitalized.
Assuming risk margin based requirement is not the binding constraint,
and CET1 qualified instruments are the same across jurisdictions, the
additional CET1 capital required from the Commission's capital
requirement may not be significant, as it may be possible for the
consolidated entity to keep the same
[[Page 57540]]
level of capital within the BHC, but just reallocate among its
subsidiaries.\522\ In addition, the Commission recognizes that earnings
will now have to retain in the SD and will no longer be available to be
reallocated to fund other more profitable activities within the
consolidated group or to be returned to shareholders. The Commission
understands that capital is not additive, i.e., the sum of capital at
individual subsidiary level may be more than the amount of capital
required at the parent level for all its subsidiaries, due to the loss
of netting benefits.
---------------------------------------------------------------------------
\521\ Under the final rule, 6.5% of RWA must be met using CET1,
the remaining amount is permitted to be met with capital in the form
of Tier 1 or Tier 2, provided that subordinated debt meets the
conditions in Commission regulation 1.17(h) (17 CFR 1.17(h)).
\522\ For purposes of this analysis, the Commission is only
using CET1 as a comparison since this represents the majority of
eligible capital under the approach. The Commission expects firms to
use permitted subordinated debt to comprise the remaining amount of
capital.
\523\ https://www.citigroup.com/citi/investor/data/p200423a.pdf?ieNocache=743.
\524\ https://www.credit-suisse.com/about-us-news/en/articles/media-releases/1q20-financial-report-202005.html.
\525\ https://www.goldmansachs.com/investor-relations/financials/current/other-information/1q-pillar3-2020.pdf.
\526\ https://www.ing.com/web/file?uuid=e0fcbfe7-f4a7-4746-af3b-b112c5e9b302&owner=b03bc017-e0db-4b5d-abbf-003b12934429&contentid=49857&elementid=2138555.
\527\ https://mms.businesswire.com/media/20200415005331/en/785157/1/Q1_2020_Bank_of_America_Financial_Results_Press_Release.pdf?download=1.
Table 2--SD's Parent BHC's Common Equity Tier 1 Capital Ratio as of
First Quarter 2020
------------------------------------------------------------------------
Common equity tier 1
Name of swap dealers capital ratio of SEC registered
parent BHC BD
------------------------------------------------------------------------
CITIGROUP ENERGY INC........... Citigroup Inc. 11.1% N
\523\.
CREDIT SUISSE CAPITAL LLC...... Credit Suisse 12.1% Y
\524\.
GOLDMAN SACHS FINANCIAL MARKETS Goldman Sachs 12.3% Y
LP. \525\.
GOLDMAN SACHS MITSUI MARINE Goldman Sachs 12.3%... N
DERIVATIVE PRODUCTS LP.
ING CAPITAL MARKETS LLC........ ING Group 13.97% \526\ N
J ARON & COMPANY............... Goldman Sachs 12.3%... N
MERRILL LYNCH CAPITAL SERVICES Bank of America 10.8% N
INC. \527\.
MERRILL LYNCH COMMODITIES INC.. Bank of America 10.8%. N
MIZUHO CAPITAL MARKETS LLC..... Mizuho Financial Group N
11.65% \528\.
MACQUARIE ENERGY LLC........... Macquarie Bank 12.2% N
\529\.
MORGAN STANLEY CAPITAL GROUP Morgan Stanley 15.3% N
INC. \530\.
MORGAN STANLEY CAPITAL SERVICES Morgan Stanley 15.3%.. N
LLC.
MORGAN STANLEY CAPITAL PRODUCTS Morgan Stanley 15.3%.. N
LLC.
NOMURA DERIVATIVE PRODUCTS INC. Nomura Holdings 18.06% N
\531\.
NOMURA GLOBAL FINANCIAL Nomura Holdings 18.06% Y
PRODUCTS INC.
SMBC CAPITAL MARKETS INC....... SMFG 15.55% \532\..... N
------------------------------------------------------------------------
As discussed above, the Commission expects these SDs would use
models to calculate market risk and credit risk charges. Their parents
BHCs most likely are already using their risk models to calculate
capital for the positions of these wholly owned subsidiaries (including
uncleared swaps) to measure the credit and market risk exposures of
these positions.
---------------------------------------------------------------------------
\528\ https://www.mizuho-fg.com/investors/financial/basel/capital/data2003/pdf/fg_fy01.pdf.
\529\ https://www.macquarie.com/assets/macq/investor/regulatory-disclosures/2020/MBL-Basel-III-Pillar-3-capital-disclosures-032020.pdf.
\530\ https://www.morganstanley.com/about-us-ir/shareholder/1q2020.pdf.
\531\ https://www.nomuraholdings.com/company/group/holdings/pdf/basel_201912.pdf.
\532\ https://www.smfg.co.jp/english/investor/library/basel_3/2020/2020_fg_e_cc1.pdf.
---------------------------------------------------------------------------
4. U.S. SDs That Are Not Part of BHCs
The Commission estimates that there are approximately 8 U.S. SDs
not part of BHCs or financial holding companies that comply with Basel
III capital requirements. These SDs currently do not have any capital
requirement. However, these SDs are part of groups that are already
subject to the CFTC's or the SEC's net capital requirements. These SDs'
consolidated group has excess net capital ranging from $32 million to
$1.3 billion.\533\ As it is possible for the consolidated entity to
keep the same level of capital within the group, by reallocating it
among subsidiaries, the additional cost of complying with the
Commission's capital requirement may not be too burdensome. However,
for those SDs or their consolidated groups that currently have smaller
amount of excess net capital, they might need to raise additional
capital and thus might incur significant cost to comply with the
Commission's capital requirement. However, given the complexities of
the final rule, the compliance cost to some SDs might be significant,
particularly for certain business models.
---------------------------------------------------------------------------
\533\ Selected FCM Financial Data as of April 30, 2020.
\534\ At December 31, 2019, BTIG LLC's net capital was
$85,412,256 which was $85,162,256 in excess of its minimum
requirement.
\535\ GAIN GTX LLC is a wholly owned subsidiary of GAIN Capital
Holdings, Inc., a global provider of online trading services. GAIN
Capital Group LLC (a CFTC registered FCM and RFD) is also subsidiary
of GAIN Capital Holdings, Inc. and has excess net capital of
14,821,951.
\536\ Excess net capital of INTL FCSTONE FINANCIAL INC (FCM and
BD) as of Apr. 30, 2020.
\537\ Excess net capital of Jefferies LLC, parent of Jefferies
Derivative Products LLC, Jefferies Financial Products LLC, and
Jefferies Financial Services LLC.
\538\ Excess net capital at Cantor Fitzgerald & CO. (FCM and
Broker-Dealer), which is owned by Cantor Fitzgerald Securities (94%
ownership).
\539\ Excess net capital of E D & F MAN CAPITAL MARKETS INC (FCM
and BD) as of Apr. 30, 2020.
\540\ At December 31, 2018, excess net capital was $1 .09
billion for Citadel Securities LLC, a registered BD.
Table 3--Current Capital Requirement (Excess Net Capital) at the SD or
Its Parent Level
------------------------------------------------------------------------
Excess net
capital at entity SEC Registered
Name of swap dealers or its parent BD
level
------------------------------------------------------------------------
BTIG LLC............................ \534\ 85,162,256 Y
GAIN GTX LLC........................ \535\ 32,628,137 N
[[Page 57541]]
INTL FCSTONE MARKETS LLC............ \536\ 72,247,715 Y
JEFFERIES FINANCIAL PRODUCTS LLC.... \537\ N
1,334,356,732
JEFFERIES FINANCIAL SERVICES INC.... 1,334,356,732 N
CANTOR FITZGERALD SECURITIES........ \538\ 365,105,535 N
ED&F MAN DERIVATIVE PRODUCTS INC.... \539\ 95,389,978 N
CITADEL SECURITIES SWAP DEALER LLC.. \540\ N
1,090,000,000
------------------------------------------------------------------------
5. Non-Financial/Commercial SDs
The capital rule would require Non-Financial/Commercial SDs to
maintain tangible net worth in an amount equal to or in excess of the
minimum capital level that is, max ($20 million plus market risk
charges and credit risk charges, 8% of risk margin, RFA requirement).
Currently, there is no capital requirement for commercial SDs. The
Commission estimates that currently three to four SD would be in this
category, and believes that their tangible net worth greatly exceeds
the Commission's requirement. Although these SDs may not need to raise
additional capital, the cost of complying with the final rule might
still be significant, particularly if these SDs choose to develop
models for capital purposes.
6. Non-U.S. SDs Not Subject to a Prudential Regulator
The Commission is allowing a ``substituted compliance'' program for
capital requirements for SDs that are: (1) Not organized under the laws
of the U.S., and (2) not domiciled in the U.S. The Commission estimates
that there are about 24 non-U.S. provisionally registered SDs not
subject to U.S. prudential regulators that would be eligible to apply
for substituted compliance. The Commission would permit these non-U.S.
SDs (or regulatory authorities in the non-U.S. SD's home country
jurisdictions) to petition the Commission to satisfy the Commission's
capital requirements through a program of substituted compliance with
the SD's home country capital requirements. These SDs are domiciled in
U.K., Germany, France, Japan, Mexico, Singapore, and Australia; which
are members of Basel Committee on Banking Supervision and have adopted
Basel III risk-based capital.\541\ Thus, the Commission expects that
these SDs or their parents may not need to raise significant additional
capital to comply with the Commission's capital requirements. However,
these SDs may incur significant cost to obtain approval for substituted
compliance.
---------------------------------------------------------------------------
\541\ http://www.bis.org/bcbs/publ/d338.pdf.
---------------------------------------------------------------------------
ii. Margin vs. Capital
The Commission's capital rule also requires an SD to include the
initial margin for all swaps that would otherwise fall below the $50
million initial margin threshold amount or the $500,000 minimum
transfer amount, as defined in regulation 23.151, for purposes of
computing the uncleared swap initial margin amount. As such, the
uncleared swap initial margin amount would be the amount that an SD
would have to collect from a counterparty, assuming that the exclusions
and exemptions for collecting initial margin for uncleared swaps set
forth in regulations 23.150-161 would not apply, and also assuming that
the thresholds under which initial margin would not need to be
exchanged would not apply. Accordingly, swaps that are not subject to
the Commission's margin requirements such as those executed prior to
the compliance date for margin requirements (``legacy swaps''), inter-
affiliate swaps, and swaps with counterparties that would qualify for
the exception or exemption under section 2(h)(7)(A) would have to be
taken into account in determining the capital requirement.
The Commission believes that it would be appropriate to require an
SD to maintain capital for uncollateralized swap exposures to
counterparties to cover the ``residual'' risk of a counterparty's
uncleared swaps positions. The Commission's approach regarding
including uncollateralized swap exposures in the SD's capital
requirements is consistent with the approach adopted by the prudential
regulators in setting capital requirements for SDs subject to their
jurisdiction and is consistent with the approach proposed by the SEC
for SBSDs.
The Commission provides certain exemptions from initial margin
requirements for uncleared trades between affiliates. However, inter-
affiliate swaps would require capital to be held against them. The
Commission understands that SDs may have different organizational
structures due to various reasons. These reasons include, among others,
centralized risk management for consolidation of balance-sheet, asset-
liability and liquidity risk management; taxation benefits; funds
transfer pricing; merger and acquisition; trading centers; and
subsidiaries in different jurisdictions. An arms-length swap may be
offset by swap transaction with an affiliated SD because of any of the
reasons listed above and possibly others. Centralization of risk within
different entities of a firm in the same jurisdiction provides risk
reduction benefits somewhat similar to the CCP and is encouraged.
Both parties to a swap transaction may be required to hold capital
even if they both are part of the same parent institution. In that
sense, there may be double (or more) counting of capital at the parent
level for a given outward facing swap based on the legal structure of
the entity. This may lead to an uneven playing field between SDs if for
a given swap, different swap dealers are required to hold different
amount of capital based on the number of inter-affiliate trades that
they execute for the same client facing trade.
iii. Model vs. Table
The capital rule allows an SD to apply to the Commission or an RFA
of which it is a member for approval to use internal models when
calculating its market risk exposure and credit risk exposure. The
capital rule also allows an FCM that is also an SD to apply in writing
to the Commission or an RFA of which it is a member for approval to
compute deductions for market risk and credit risk using internal
models in lieu of the standardized deductions otherwise required.
As discussed above, there are approximately 108 SDs and no MSPs
provisionally registered with the Commission. Of these, the Commission
estimates that approximately 55 SDs and no MSPs would be subject to the
Commission's capital rules as they are
[[Page 57542]]
not subject to those of a prudential regulator. The Commission further
estimates conservatively that most of these SDs would seek to obtain
Commission approval to use models for computing their market and credit
risk capital charges. These entities would incur cost to develop,
maintain, document, audit models, and seek model approval. The
possibility of using models to calculate credit risk and market risk
charges may allow SDs to more efficiently deploy capital in other parts
of its operations, because models could reduce capital charges and
thereby could make additional capital available. This reduced capital
requirement due to model use could improve returns of SDs and make them
more competitive. However, if models developed for capital purposes
deviate significantly from models used for pricing and risk management,
and regulatory capital deviates significantly from economic capital,
this could reduce the discussed benefits of capital rule.
Although the Commission expects that SDs would use models for
calculating market risk and credit risk charges, it is possible that
some entities, particularly potential new entrants, may not have the
risk management capabilities of which the models are an integral part,
and, therefore, have to rely on the standardized haircut approach. The
benefit of the standardized haircut approach for measuring market risk
is its inherent simplicity. Therefore, this approach may improve
customer protections and reduce systemic risk. In addition, a
standardized haircut approach may reduce costs for the SD related to
the risk of failing to observe or correct a problem with the use of
models that could adversely impact the firm's financial conditions,
because the use of models would require the allocation by the SD of
additional firm resources and personnel. Conversely, if the
standardized haircuts are too conservative and netting benefits are
very limited, they could make conducting swap business too costly,
preventing or impairing the ability of the firms to engage in swaps,
increasing transaction costs, reducing liquidity, and reducing the
availability of swaps for risk mitigation by end users.
iv. Other Considerations
The capital rule requirements should reduce the risk of a failure
of any major market participant in the swap market, which in turn
reduces the possibility of a general market failure, and thus promotes
confidence for market participants to transact in swaps for investment
and hedging purposes. The capital requirements are designed to promote
confidence in SDs among customers, counterparties, and the entities
that provide financing to SDs, thereby, lessen the potential that these
market participants may seek to rapidly withdraw assets and financing
from SDs during a time of market stress. This heightened confidence is
expected to increase swap transactions and promote competition among
dealers. A more competitive swap market may promote a more efficient
capital allocation.
However, to the extent that costs associated with the rules are
high, they may negatively affect competition within the swap markets.
This may, for example, lead smaller dealers or entities for whom
dealing is not a core business to exit the market because compliance
with the minimum capital and reporting requirements is too costly.
These same costs may result in increased barriers of entry, as they may
prevent new dealers from entering the market. The combination of these
two events may lead to a concentration of SD in the market, which could
lead to market inefficiencies.
The capital rule could have a substantial impact on domestic and
international commerce and the relative competitive position of SDs
operating under different requirements of various jurisdictions.
Specifically, SDs subject to a particular regulatory regime may be
advantaged or disadvantaged if corresponding requirements in other
regimes are substantially more or less stringent. This could affect the
ability of U.S. SDs to compete in the domestic and global markets and,
the ability of non-U.S. SDs to compete in U.S. markets. Substantial
differences between the U.S. and foreign jurisdictions in the costs of
complying with these requirements for swaps between U.S. and foreign
jurisdictions could reduce cross-border capital flows and hinder the
ability of global firms to efficiently allocate capital among legal
entities to meet the demands of their customers/counterparties.
The willingness of end users to trade with an SD dealer will depend
on their evaluation of the counterparty credit risks of trading with
that particular SD compared to alternative SDs, and their ability to
negotiate favorable price and other terms. The capital and risk
management requirements would in general reduce the likelihood of SDs'
defaulting or failing, and therefore may increase the willingness of
end users to trade with more SDs that have strong capital reserves. End
users of covered swaps are mostly made up of sophisticated participants
such as hedge fund, asset management, other financial firms, and large
commercial corporations. Many of these entities trade substantial
volume of swaps and are relatively well-positioned to negotiate price
and other terms with competing dealers. To the extent that the capital
rule results in increased competition, participants should be able to
take advantage of this increased competition and negotiate improved
terms. On the other hand, SDs may pass on additional capital,
operational and compliance costs resulting from the final rule to end
users in the form of higher fees or wider spreads. Thus end users may
experience increased cost of using swaps for hedging and investing
purposes.
In addition, benefits may arise when SDs consolidate with other
affiliated SDs, FCMs, and/or BDs. This may yield efficiencies for
clients conducting business in swaps, including netting benefits,
reduced number of account relationships, and reduced number of
governing agreements. These potential benefits, however, may be offset
by reduced competition from a smaller number of competing SDs. Further,
the capital rule will permit conducting swap business in an entity
jointly registered as an FCM, or SBSD, or broker-dealer, which may
offer the potential for these firms to offer portfolio margining for a
variety of positions. From a holding company's perspective, aggregating
swap business in a single entity, could help simplify and streamline
risk management, allow more efficient use of capital, as well as
operational efficiencies, and avoid the need for multiple netting and
other agreements.
The rules may create the potential for regulatory arbitrage to the
extent that they differ from corresponding rules other regulators
adopt. Also, to the extent that the requirements are overly stringent,
they may prevent or discourage new entrants into swap markets and
thereby may either increase spreads and trading costs or even reduce
the availability of swaps. In these cases, end users would face higher
cost or be forced to use less effective financial instruments to meet
their business needs.
List of Subjects
17 CFR Part 1
Brokers, Commodity futures, Reporting and recordkeeping
requirements.
17 CFR Part 23
Capital and margin requirements, Major swap participants, Swap
dealers, Swaps.
[[Page 57543]]
17 CFR Part 140
Authority delegations (Government agencies).
For the reasons stated in the Preamble, the Commodity Futures
Trading Commission amends 17 CFR parts 1, 23, and 140 as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,
6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8, 9,
10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24 (2012).
0
2. Amend Sec. 1.10 by:
0
a. Revising the paragraph (f)(1) introductory text; and
0
b. Revising paragraph (h)
The revisions read as follows:
Sec. 1.10 Financial reports of futures commission merchants and
introducing brokers.
* * * * *
(f) * * * (1) In the event a registrant finds that it cannot file
its Form 1-FR, or, in accordance with paragraph (h) of this section,
its Financial and Operational Combined Uniform Single Report under the
Securities Exchange Act of 1934, Part II, Part IIA, or Part IIC (FOCUS
report), for any period within the time specified in paragraphs
(b)(1)(i) or (b)(2)(i) of this section without substantial undue
hardship, it may request approval for an extension of time, as follows:
* * * * *
(h) Filing option available to a futures commission merchant or an
introducing broker that is also a securities broker or dealer. Any
applicant or registrant which is registered with the Securities and
Exchange Commission as a securities broker or dealer, a security-based
swap dealer, or a major security-based market participant may comply
with the requirements of this section by filing (in accordance with
paragraphs (a), (b), (c), and (j) of this section) a copy, as
applicable, of its Financial and Operational Combined Uniform Single
Report under the Securities Exchange Act of 1934, Part II, Part IIA,
Part IIC, or Part II CSE (FOCUS Report), in lieu of Form 1-FR;
Provided, however, That all information which is required to be
furnished on and submitted with Form 1-FR is provided with such FOCUS
Report; and Provided, further, That a certified FOCUS Report filed by
an introducing broker or applicant for registration as an introducing
broker in lieu of a certified Form 1-FR-IB must be filed according to
National Futures Association rules, either in paper form or
electronically, in accordance with procedures established by the
National Futures Association, and if filed electronically, a paper copy
of such filing with the original manually signed certification must be
maintained by such introducing broker or applicant in accordance with
Sec. 1.31.
* * * * *
0
3. Amend Sec. 1.12 by:
0
a. Revising paragraph (a) introductory text;
0
b. Revising paragraphs (a)(1), (b)(3) and (b)(4); and
0
c. Adding paragraph (b)(5).
The revisions and additions read as follows:
Sec. 1.12 Maintenance of minimum financial requirements by futures
commission merchants and introducing brokers.
(a) Each person registered as a futures commission merchant or who
files an application for registration as a futures commission merchant,
and each person registered as an introducing broker or who files an
application for registration as an introducing broker (except for an
introducing broker or applicant for registration as an introducing
broker operating pursuant to, or who has filed concurrently with its
application for registration, a guarantee agreement and who is not also
a securities broker or dealer), who knows or should have known that its
adjusted net capital at any time is less than the minimum required by
Sec. 1.17 or by the capital rule of any self-regulatory organization
to which such person is subject, or the minimum net capital
requirements of the Securities and Exchange Commission if the applicant
or registrant is registered with the Securities and Exchange
Commission, must:
(1) Give notice, as set forth in paragraph (n) of this section that
the applicant's or registrant's capital is below the applicable minimum
requirement. Such notice must be given immediately after the applicant
or registrant knows or should have known that its adjusted net capital
or net capital, as applicable, is less than minimum required amount;
and
* * * * *
(b) * * *
(3) 150 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member, unless such
amount has been determined by a margin-based capital computation set
forth in the rules of the registered futures association, and such
amount meets or exceeds the amount of adjusted net capital required
under the margin-based capital computation set forth in Sec.
1.17(a)(1)(i)(B), in which case the required percentage is 110 percent;
(4) For securities brokers or dealers, the amount of net capital
specified in Rule 17a-11(b) of the Securities and Exchange Commission
(17 CFR 240.17a-11(b)); or
(5) For security-based swap dealers or major security-based swap
participants, the amount of net capital specified in Rule 18a-8(b) of
the Securities and Exchange Commission (17 CFR 240.18a-8(b)), must file
notice to that effect, as soon as possible and no later than twenty-
four (24) hours of such event.
* * * * *
0
4. Amend Sec. 1.16 by revising paragraphs (f)(1)(i)(B) and
(f)(1)(ii)(B) to read as follows:
Sec. 1.16 Qualifications and reports of accountants.
* * * * *
(f)(1) * * *
(i) * * *
(B) A futures commission merchant that is registered with the
Securities and Exchange Commission as a securities broker or dealer may
file with its designated self-regulatory organization a copy of any
application that the registrant has filed with its designated examining
authority, pursuant to Sec. 240.17a-5(m) of this title, for an
extension of time to file annual reports. The registrant must also
promptly file with the designated self-regulatory organization and the
Commission copies of any notice it receives from its designated
examining authority to approve or deny the requested extension of time.
Upon receipt by the designated self-regulatory organization and the
Commission of copies of any such notice of approval, the requested
extension of time referenced in the notice shall be deemed approved
under this paragraph (f)(1)(i).
* * * * *
(ii) * * *
(B) An introducing broker that is registered with the Securities
and Exchange Commission as a securities broker or dealer may file with
the National Futures Association copies of any application that the
registrant has filed with its designated examining authority, pursuant
to Sec. 240.17a-5(m) of this title, for an extension of time to file
annual reports. The registrant must also file promptly with the
National Futures Association copies of any notice it receives from its
designated examining
[[Page 57544]]
authority to approve or deny the requested extension of time. Upon the
receipt by the National Futures Association of a copy of any such
notice of approval, the requested extension of time referenced in the
notice shall be deemed approved under this paragraph (f)(1)(ii).
* * * * *
0
5. Amend Sec. 1.17 by:
0
a. Revising paragraphs (a)(1)(i)(A) and (B);
0
b. Adding paragraph (a)(1)(ii);
0
c. Revising paragraphs (b)(9) and (10) and adding paragraph (b)(11) ;
0
d. Revising paragraph (c)(1)(i);
0
e. Revising paragraph (c)(2)(i);
0
f. Revising paragraphs (c)(2)(ii)(B) and (D) and adding paragraph
(c)(2)(ii)(G);
0
g. Adding paragraphs (c)(5)(iii), (iv), (xv), and (xvi);
0
h. Revising paragraphs (c)(5)(viii), (x), (ix) and (xiv);
0
i. Revising paragraph (c)(6)(i) and (iv)(A), and adding paragraph
(c)(6)(v); and
0
j. Revising paragraph (g)(1).
The revisions and additions read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
(a)(1)(i) * * *
(A) $1,000,000, Provided, however, that if the futures commission
merchant also is a swap dealer, the minimum amount shall be
$20,000,000;
(B) The futures commission merchant's risk-based capital
requirement, computed as the sum of:
(1) Eight percent of the total risk margin requirement (as defined
in Sec. 1.17(b)(8) of this section) for positions carried by the
futures commission merchant in customer accounts and noncustomer
accounts; and
(2) For a futures commission merchant that is also a registered
swap dealer, two percent of the total uncleared swap margin, as that
term is defined in paragraph (b)(11) of this section.
* * * * *
(ii) A futures commission merchant that is registered as a swap
dealer and has received approval to use internal models to compute
market risk and credit risk charges for uncleared swaps must maintain
net capital equal to or in excess of $100 million and adjusted net
capital equal to or in excess of $20 million.
* * * * *
(b) * * *
(9) Cleared over the counter derivative positions means a swap
cleared by a derivatives clearing organization or a clearing
organization exempted by the Commission from registering as a
derivatives clearing organization, and further includes positions
cleared by any organization permitted to clear such positions under the
laws of the relevant jurisdiction.
(10) Cleared over the counter customer means any person for whom
the futures commission merchant carries on its books one or more
accounts for the cleared over the counter derivative positions of such
person, and such account or accounts are not proprietary accounts as
defined in Sec. 1.3 of this part.
(11) Uncleared swap margin: This term means the amount of initial
margin, computed in accordance with Sec. 23.154 of this chapter, that
a dually-registered futures commission merchant and swap dealer would
be required to collect from each counterparty for each outstanding swap
position of the dually-registered futures commission merchant and swap
dealer. A dually-registered futures commission merchant and swap dealer
must include all swap positions in the calculation of the uncleared
swap margin amount, including swaps that are exempt or excluded from
the scope of the Commission's margin regulations for uncleared swaps
pursuant to Sec. 23.150 of this chapter, exempt foreign exchange swaps
or foreign exchange forwards, or netting set of swaps or foreign
exchange swaps, for each counterparty, as if the counterparty was an
unaffiliated swap dealer. Furthermore, in computing the uncleared swap
margin amount, a dually-registered futures commission merchant and swap
dealer may not exclude the initial margin threshold amount or the
minimum transfer amount as such terms are defined in Sec. 23.151 of
this chapter.
(c) * * *
(1) * * *
(i) Unrealized profits shall be added and unrealized losses shall
be deducted in the accounts of the applicant or registrant, including
unrealized profits and losses on fixed price commitments, uncleared
swaps, uncleared security-based swaps, and forward contracts;
* * * * *
(2) * * *
(i) Exclude any unsecured commodity futures, options, cleared
swaps, or other Commission regulated account containing a ledger
balance and open trades, the combination of which liquidates to a
deficit or containing a debit ledger balance only: Provided, however,
deficits or debit ledger balances in unsecured customers',
noncustomers', and proprietary accounts, which are the subject of calls
for margin or other required deposits may be included in current assets
until the close of business on the business day following the date on
which such deficit or debit ledger balance originated providing that
the account had timely satisfied, through the deposit of new funds, the
previous day's debit or deficits, if any, in its entirety.
(ii) * * *
(B)(1) Interest receivable, floor brokerage receivable, commissions
receivable from other brokers or dealers (other than syndicate
profits), mutual fund concessions receivable and management fees
receivable from registered investment companies and commodity pools
that are not outstanding more than thirty (30) days from the date they
are due;
(2) Dividends receivable that are not outstanding more than thirty
(30) days from the payable date; and
(3) Commissions or fees receivable, including from other brokers or
dealers, resulting from swap transactions that are not outstanding more
than sixty (60) days from the month end accrual date provided they are
billed promptly after the close of the month of their inception;
* * * * *
(D) Receivables from registered futures commission merchants or
brokers, resulting from commodity futures, options, cleared swaps,
foreign futures or foreign options transactions, except those
specifically excluded under paragraph (c)(2)(i) of this section;
* * * * *
(G) Receivables from third-party custodians that maintain the
futures commission merchant's initial margin deposits associated with
uncleared swap and security-based swap transactions pursuant to the
margin rules of the Commission, the Securities and Exchange Commission,
a prudential regulator, as defined in section 1a(39) of the Act, or a
foreign jurisdiction that has received a Comparability Determination
under Sec. 23.160 of this chapter.
* * * * *
(5) * * *
(iii) Swaps:
(A) Uncleared swaps that are credit-default swaps referencing
broad-based securities indices.(1) Short positions (selling
protection). In the case of an uncleared short credit default swap that
references a broad-based securities index, deducting the percentage of
the notional amount based upon the current basis point spread of the
credit default swap and the maturity of the credit default swap in
accordance with the following table:
[[Page 57545]]
Table to Sec. 1.17(c)(5)(iii)(A)(1)--Market Risk Charges for Uncleared Credit Default Swaps
--------------------------------------------------------------------------------------------------------------------------------------------------------
Basis point spread (%)
Length of time to maturity of CDS contract -----------------------------------------------------------------------------------------------
100 or less 101-300 301-400 401-500 501-699 700 or more
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than 12 months..................................... 0.67 1.33 3.33 5.00 6.67 10.00
12 months but less than 24 months....................... 1.00 2.33 5.00 6.67 8.33 11.67
24 months but less than 36 months....................... 1.33 3.33 6.67 8.33 10.00 13.33
36 months but less than 48 months....................... 2.00 4.00 8.33 10.00 11.67 15.00
48 months but less than 60 months....................... 2.67 4.67 10.00 11.67 13.33 16.67
60 months but less than 72 months....................... 3.67 5.67 11.67 13.33 15.00 18.33
72 months but less than 84 months....................... 4.67 6.67 13.33 15.00 16.67 20.00
84 months but less than 120 months...................... 5.67 10.00 15.00 16.67 18.33 26.67
120 months and longer................................... 6.67 13.33 16.67 18.33 20.00 33.33
--------------------------------------------------------------------------------------------------------------------------------------------------------
(2) Long positions (purchasing protection). In the case of an
uncleared swap that is a long credit default swap referencing a broad-
based security index, deducting 50 percent of the deduction that would
be required by paragraph (c)(5)(iii)(A)(1) of this section if the swap
was a short credit default swap, each such deduction not to exceed the
current market value of the long position.
(3) Long and short positions. (i) Long and short uncleared credit
default swaps referencing the same broad-based security index. In the
case of uncleared swaps that are long and short credit default swaps
referencing the same broad-based security index, have the same credit
events which would trigger payment by the seller of protection, have
the same basket of obligations which would determine the amount of
payment by the seller of protection upon the occurrence of a credit
event, that are in the same or adjacent spread category and have a
maturity date within three months of the other maturity category,
deducting the percentage of the notional amounts specified in the
higher maturity category under paragraph (c)(5)(iii)(A)(1) or
(c)(5)(iii)(A)(2) of this section on the excess of the long or short
position.
(ii) Long basket of obligors and uncleared long credit default swap
referencing a broad-based securities index. In the case of an uncleared
swap that is a long credit default swap referencing a broad-based
security index and the futures commission merchant is long a basket of
debt securities comprising all of the components of the security index,
deducting 50 percent of the amount specified in Sec. 240.15c3-
1(c)(2)(vi) of this title for the component of securities, provided the
futures commission merchant can deliver the component securities to
satisfy the obligation of the futures commission merchant on the credit
default swap.
(iii) Short basket of obligors and uncleared short credit default
swap referencing a broad-based securities index. In the case of an
uncleared swap that is a short credit default swap referencing a broad-
based security index and the futures commission merchant is short a
basket of debt securities comprising all of the components of the
security index, deducting the amount specified in Sec. 240.15c3-
1(c)(2)(vi) of this title for the component securities.
(B) Interest rate swaps. In the case of an uncleared interest rate
swap, deducting the percentage deduction specified in Sec. 240.15c3-
1(c)(2)(vi)(A) of this title based on the maturity of the interest rate
swap, provided that the percentage deduction must be no less than one
eighth of 1 percent of the amount of a long position that is netted
against a short position in the case of an uncleared interest rate swap
with a maturity of three months or more;
(C) All other uncleared swaps. (1) In the case of any uncleared
swap that is not a credit default swap or interest rate swap, deducting
the amount calculated by multiplying the notional value of the
uncleared swap by:
(i) The percentage specified in Sec. 240.15c3-1 of this title
applicable to the reference asset if Sec. 240.15c3-1 of this title
specifies a percentage deduction for the type of asset and this section
does not specify a percentage deduction;
(ii) Six percent in the case of a currency swap that references
euros, British pounds, Canadian dollars, Japanese yen, or Swiss francs,
and twenty percent in the case of currency swaps that reference any
other foreign currencies; or
(iii) In the case of over-the-counter swap transactions involving
commodities, 20 percent of the market value of the amount of the
underlying commodities.
(D) Netting of Swap Market Risk Charges. The deductions under
paragraphs (c)(5)(iii)(B) and (C) of this section may be reduced by an
amount equal to any reduction recognized for a comparable long or short
position in the reference asset or interest rate under this section or
in Sec. 240.15c3-1 of this title.
(iv) Security-based Swaps: In the case of security-based swaps as
defined in section 3(a) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)), the percentage as specified in Sec. 240.15c3-1 of this
title.
* * * * *
(viii) In the case of a futures commission merchant, for
undermargined customer accounts, the amount of funds required in each
such account to meet maintenance margin requirements of the applicable
board of trade or if there are no such maintenance margin requirements,
clearing organization margin requirements applicable to such positions,
after application of calls for margin or other required deposits which
are outstanding no more than one business day. If there are no such
maintenance margin requirements or clearing organization margin
requirements, then the amount of funds required to provide margin equal
to the amount necessary, after application of calls for margin or other
required deposits outstanding no more than one business day, to restore
original margin when the original margin has been depleted by 50
percent or more: Provided, to the extent a deficit is excluded from
current assets in accordance with paragraph (c)(2)(i) of this section
such amount shall not also be deducted under this paragraph. In the
event that an owner of a customer account has deposited an asset other
than cash to margin, guarantee or secure his account, the value
attributable to such asset for purposes of this subparagraph shall be
the lesser of:
(A) The value attributable to the asset pursuant to the margin
rules of the applicable board of trade, or
(B) The market value of the asset after application of the
percentage deductions specified in paragraph (c)(5) of this section;
[[Page 57546]]
(ix) In the case of a futures commission merchant, for
undermargined noncustomer and omnibus accounts the amount of funds
required in each such account to meet maintenance margin requirements
of the applicable board of trade or if there are no such maintenance
margin requirements, clearing organization margin requirements
applicable to such positions, after application of calls for margin or
other required deposits which are outstanding no more than one business
day. If there are no such maintenance margin requirements or clearing
organization margin requirements, then the amount of funds required to
provide margin equal to the amount necessary after application of calls
for margin or other required deposits outstanding no more than one
business day to restore original margin when the original margin has
been depleted by 50 percent or more: Provided, to the extent a deficit
is excluded from current assets in accordance with paragraph (c)(2)(i)
of this section such amount shall not also be deducted under this
paragraph. In the event that an owner of a noncustomer or omnibus
account has deposited an asset other than cash to margin, guarantee or
secure his account the value attributable to such asset for purposes of
this paragraph shall be the lesser of the value attributable to such
asset pursuant to the margin rules of the applicable board of trade, or
the market value of such asset after application of the percentage
deductions specified in paragraph (c)(5) of this section;
(x) In the case of open futures contracts, cleared swaps, and
granted (sold) commodity options held in proprietary accounts carried
by the applicant or registrant which are not covered by a position held
by the applicant or registrant or which are not the result of a
``changer trade'' made in accordance with the rules of a contract
market:
(A) For an applicant or registrant which is a clearing member of a
clearing organization for the positions cleared by such member, the
applicable margin requirement of the applicable clearing organization;
(B) For an applicant or registrant which is a member of a self-
regulatory organization, 150 percent of the applicable maintenance
margin requirement of the applicable board of trade, or clearing
organization, whichever is greater;
(C) For all other applicants or registrants, 200 percent of the
applicable maintenance margin requirements of the applicable board of
trade or clearing organization, whichever is greater; or
(D) For open contracts or granted (sold) commodity options for
which there are no applicable maintenance margin requirements, 200
percent of the applicable initial margin requirement: Provided, the
equity in any such proprietary account shall reduce the deduction
required by this paragraph (c)(5)(x) if such equity is not otherwise
includable in adjusted net capital;
* * * * *
(xiv) For securities brokers and dealers, all other deductions
specified in Sec. 240.15c3-1 of this title;
(xv) In the case of a futures commission merchant that is also a
registered swap dealer, the amount of funds required from each swap
counterparty and security-based swap counterparty to meet initial
margin requirements of the Commission or Securities and Exchange
Commission, as applicable, after application of calls for margin or
other required deposits which are outstanding within the required time
frame to collect margin or other required deposits;
(xvi) In the case of a futures commission merchant that is also a
registered swap dealer, the amount of initial margin calculated
pursuant to Sec. 23.154 of this chapter for the account of a swap
counterparty that is subject to a margin exception or exemption under
Sec. 23.150 of this chapter, less any margin posted on such account,
and the amount of initial margin calculated pursuant to Sec. 240.18a-
3(c)(1)(i)(B) of this title for the account of a security-based swap
counterparty that is subject to a margin exception or exemption under
the rules of the Securities and Exchange Commission, less any margin
posted on such account.
(6)(i) Election of alternative capital deductions that have
received approval of Securities and Exchange Commission pursuant to
Sec. 240.15c3-1(a)(7) of this title. Any futures commission merchant
that is also registered with the Securities and Exchange Commission as
a securities broker or dealer, and who also satisfies the other
requirements of this paragraph (c)(6), may elect to compute its
adjusted net capital using the alternative capital deductions that,
under Sec. 240.15c3-1(a)(7) of this title, the Securities and Exchange
Commission has approved by written order in lieu of the deductions that
would otherwise be required under this section.
* * * * *
(iv) * * *
(A) Information that the futures commission merchant files on a
monthly basis with its designated examining authority or the Securities
and Exchange Commission, whether by way of schedules to its FOCUS
reports or by other filings, in satisfaction of Sec. 240.17a-5(a)(5)
of this title;
* * * * *
(v) Election of alternative market risk and credit risk capital
deductions for a futures commission merchant that is registered as a
swap dealer and has received approval of the Commission or a registered
futures association for which the futures commission merchant is a
member. For purposes of this paragraph (c)(6)(v) only, all references
to futures commission merchant means a futures commission merchant that
is also registered as a swap dealer.
(A) A futures commission merchant may apply in writing to the
Commission or a registered futures association of which it is a member
for approval to compute deductions for market risk and credit risk
using internal models in lieu of the standardized deductions otherwise
required under this section; Provided however, that the Commission must
issue a determination that the registered futures association's model
requirements and review process are comparable to the Commission's
requirements and review process in order for the registered futures
association's model approval to be accepted as an alternative means of
compliance with this section. The futures commission merchant must file
the application in accordance with instructions approved by the
Commission and specified on the website of the registered futures
association.
(B) A futures commission merchant's application must include the
information set forth in Appendix A to Subpart E of Part 23 and the
market risk and credit risk charges must be computed in accordance with
Sec. 23.102 of this chapter.
(C) The Commission or registered futures association upon obtaining
the Commission's determination that its requirements and model approval
process are comparable to the Commission's requirements and process,
may approve or deny the application, in whole or in part, or approve or
deny an amendment to the application, in whole or in part, subject to
any conditions or limitations the Commission or registered futures
association may require, if the Commission or registered futures
association finds the approval to be appropriate in the public
interest, after determining, among other things, whether the applicant
has met the requirements of Sec. 23.102 of this chapter.
* * * * *
[[Page 57547]]
(g)(1) The Commission may by order restrict, for a period of up to
twenty business days, any withdrawal by a futures commission merchant
of equity capital, or any unsecured advance or loan to a stockholder,
partner, limited liability company member, sole proprietor, employee or
affiliate if the Commission, based on the facts and information
available, concludes that any such withdrawal, advance or loan may be
detrimental to the financial integrity of the futures commission
merchant, or may unduly jeopardize its ability to meet customer
obligations or other liabilities that may cause a significant impact on
the markets.
* * * * *
0
6. Amend Sec. 1.65 by revising paragraph (b) introductory text,
paragraphs (d) and (e) to read as follows:
Sec. 1.65 Notice of bulk transfers and disclosure obligations to
customers.
* * * * *
(b) Notice to the Commission. Each futures commission merchant or
introducing broker shall file with the Commission, at least ten
business days in advance of the transfer, notice of any transfer of
customer accounts carried or introduced by such futures commission
merchant or introducing broker that is not initiated at the request of
the customer, where the transfer involves the lesser of:
* * * * *
(d) The notice required by paragraph (b) of this section shall be
considered filed when submitted to the Director of the Division of Swap
Dealer and Intermediary Oversight, in electronic form using a form of
user authentication assigned in accordance with procedures established
by or approved by the Commission, and otherwise in accordance with
instructions issued by or approved by the Commission.
(e) In the event that the notice required by paragraph (b) of this
section cannot be filed with the Commission at least ten days prior to
the account transfer, the Commission hereby delegates to the Director
of the Division of Swap Dealer and Intermediary Oversight, or such
other employee or employees as the Director may designate from time to
time, the authority to accept a lesser time period for such
notification at the Director's or designee's discretion. In any event,
however, the transferee futures commission merchant or introducing
broker shall file such notice as soon as practicable and no later than
the day of the transfer. Such notice shall include a brief statement
explaining the circumstances necessitating the delay in filing.
* * * * *
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
7. 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.
0
8. Add section 23.100 to subpart E to read as follows:
Sec. 23.100 Definitions applicable to capital requirements.
For purposes of Sec. Sec. 23.101 through 23.106 of subpart E, the
following terms are defined as follows:
Actual daily net trading profit and loss. This term is used in
assessing the performance of a swap dealer's VaR measure and refers to
changes in the swap dealer's portfolio value that would have occurred
were end-of-day positions to remain unchanged (therefore, excluding
fees, commissions, reserves, net interest income, and intraday
trading).
Advanced approaches Board-regulated institution. The term shall
have the meaning ascribed to it in 12 CFR part 217.
BHC equivalent risk-weighted assets. This term means the risk-
weighted assets of a swap dealer that elects to meet the capital
requirements in Sec. 23.101(a)(1)(i) calculated as follows:
(1) If the swap dealer is not approved to use internal models to
calculate credit risk exposure under Sec. 23.102, it shall calculate
its credit risk-weighted assets using the bank holding company
regulations in subpart D of 12 CFR part 217, as if the swap dealer
itself were a bank holding company, with the swap dealer permitted to
calculate its exposure amount for OTC derivative contracts using either
the current exposure method or the standardized approach for
counterparty credit risk, without regard to the status of any affiliate
of the swap dealer as an advanced approaches Board-regulated
institution;
(2) If the swap dealer is approved to use internal models to
calculate credit risk exposure under Sec. 23.102, it shall calculate
its credit risk-weighted assets using the bank holding company
regulations in subpart E of 12 CFR part 217, as if the swap dealer
itself were a bank holding company, with the swap dealer permitted to
calculate its exposure amount for OTC derivative contracts using either
the internal models methodology or the standardized approach for
counterparty credit risk, without regard to the status of any affiliate
of the swap dealer as an advanced approaches Board-regulated
institution;
(3) If the swap dealer is not approved to use internal models to
calculate market risk exposure under Sec. 23.102, it shall compute a
market risk capital charge for the positions that the swap dealer holds
in its proprietary accounts using the applicable standardized market
risk charges set forth in Sec. 240.18a-1 of this title and Sec. 1.17
of this chapter for such positions, and multiplying that amount by a
factor of 12.5;
(4) If the swap dealer is approved to use internal models to
calculate market risk exposure under Sec. 23.102, it shall calculate
its market risk-weighted assets using subpart F of 12 CFR part 217;
Provided, however, that the swap dealer may elect to apply either the
provisions of such sections that are applicable to advanced approaches
Board-regulated institutions or those that are applicable to Board-
regulated institutions that are not advanced approaches Board-regulated
institutions.
Credit risk. This term refers to the risk that the counterparty to
an uncleared swap transaction could default before the final settlement
of the transaction's cash flows.
Credit risk exposure requirement. This term refers to the amount
that the swap dealer (other than a swap dealer subject to the minimum
capital requirements of Sec. 23.101(a)(1)(i)) is required to compute
under Sec. 23.102 if approved to use internal credit risk models, or
to compute under Sec. 23.103 if not approved to use internal credit
risk models.
Exempt foreign exchange swaps and foreign exchange forwards are
those foreign exchange swaps and foreign exchange forwards that were
exempted from the definition of a swap by the U.S. Department of the
Treasury.
Market risk exposure. This term means the risk of loss in a
position or portfolio of positions resulting from movements in market
prices and other factors. Market risk exposure is the sum of:
(1) General market risks including changes in the market value of a
particular assets that result from broad market movements, such as a
changes in market interest rates, foreign exchange rates, equity
prices, and commodity prices;
(2) Specific risk, which includes risks that affect the market
value of a specific instrument, such as the credit risk of the issuer
of the particular instrument, but do not materially alter broad market
conditions;
[[Page 57548]]
(3) Incremental risk, which means the risk of loss on a position
that could result from the failure of an obligor to make timely
payments of principal and interest; and
(4) Comprehensive risk, which is the measure of all material price
risks of one or more portfolios of correlation trading positions.
Market risk exposure requirement. This term refers to the amount
that the swap dealer (other than a swap dealer subject to the minimum
capital requirements of Sec. 23.101(a)(1)(i)) is required to compute
under Sec. 23.102 if approved to use internal market risk models, or
Sec. 23.103 if not approved to use internal market risk models.
OTC derivative contract. This term shall have the meaning ascribed
to it in 12 CFR part 217.
Predominantly engaged in non-financial activities. A swap dealer is
predominantly engaged in non-financial activities if: (1) The swap
dealer's consolidated annual gross financial revenues, or if the swap
dealer is a wholly owned subsidiary, then the swap dealer's
consolidated parent's annual gross financial revenues, in either of its
two most recently completed fiscal years represents less than 15
percent of the swap dealer's consolidated gross revenue in that fiscal
year (``15% revenue test''), and (2) the consolidated total financial
assets of the swap dealer, or if the swap dealer is wholly owned
subsidiary, the consolidated total financial assets of the swap
dealer's parent, at the end of its two most recently completed fiscal
years represents less than 15 percent of the swap dealer's consolidated
total assets as of the end of the fiscal year (``15% asset test''). For
purpose of computing the 15% revenue test or the 15% asset test, a swap
dealer's activities or swap dealer's parent's activities shall be
deemed financial activities if such activities are defined as financial
activities under 12 CFR 242.3 and Appendix A to 12 CFR 242, including
lending, investing for others, safeguarding money or securities for
others, providing financial or investment advisory services,
underwriting or making markets in securities, providing securities
brokerage services, and engaging as principal in investing and trading
activities; Provided, however, a swap dealer may exclude from its
financial activities accounts receivable resulting from non-financial
activities.
Prudential regulator. This term has the same meaning as set forth
in section 1a(39) of the Act, and includes the Board of Governors of
the Federal Reserve System, the Office of the Comptroller of the
Currency, the Federal Deposit Insurance Corporation, the Farm Credit
Administration, and the Federal Housing Finance Agency, as applicable
to a swap dealer or major swap participant.
Regulatory capital. This term shall mean:
(1) With respect to the capital requirement under Sec.
23.101(a)(1)(i), the amount of common equity tier 1 capital, additional
tier 1 capital, and tier 2 capital maintained by a covered SD, computed
in accordance with Sec. 23.101(a)(1)(i);
(2) With respect to the capital requirement under Sec.
23.101(a)(1)(ii), the amount of tentative net capital and net capital
maintained by a covered SD, computed in accordance with Sec.
23.101(a)(1)(ii);
(3) With respect to the capital requirement under Sec.
23.101(a)(2)(i), the amount of tangible net worth as defined in this
section and maintained by a covered SD; and
(4) With respect to the capital requirement under 23.101(b), the
amount of tangible net worth as defined in this section and maintained
by a major swap participant.
Regulatory capital requirement. This term refers to each of the
capital requirements that Sec. 23.101 applies to a swap dealer or
major swap participant.
Tangible net worth. This term means the net worth of a swap dealer
or major swap participant as determined in accordance with generally
accepted accounting principles in the United States, excluding goodwill
and other intangible assets. In determining net worth, all long and
short positions in swaps, security-based swaps and related positions
must be marked to their market value. A swap dealer or major swap
participant must include in its computation of tangible net worth all
liabilities or obligations of a subsidiary or affiliate that the swap
dealer or major swap participant guarantees, endorses, or assumes
either directly or indirectly.
Uncleared swap margin. This term means the amount of initial
margin, computed in accordance with Sec. 23.154, that a swap dealer
would be required to collect from each counterparty for each
outstanding swap position of the swap dealer. A swap dealer must
include all swap positions in the calculation of the uncleared swap
margin amount, including swaps that are exempt or excluded from the
scope of the Commission's margin regulations for uncleared swaps
pursuant to Sec. 23.150, exempt foreign exchange swaps or foreign
exchange forwards, or netting set of swaps or foreign exchange swaps,
for each counterparty, as if that counterparty was an unaffiliated swap
dealer. Furthermore, in computing the uncleared swap margin amount, a
swap dealer may not exclude the initial margin threshold amount or
minimum transfer amount as such terms are defined in Sec. 23.151.
0
9. Add section 23.101 to subpart E to read as follows:
Sec. 23.101 Minimum financial requirements for swap dealers and
major swap participants.
(a)(1) Except as provided in paragraphs (a)(2) through (a)(5) of
this section, each swap dealer must elect to be subject to the minimum
capital requirements set forth in either paragraphs (a)(1)(i) or
(a)(1)(ii) of this section:
(i) A swap dealer that elects to meet the capital requirements in
this paragraph (a)(1)(i) must at all times maintain regulatory capital
that meets the following:
(A) $20 million of common equity tier 1 capital, as defined under
the bank holding company regulations in 12 CFR 217.20, as if the swap
dealer itself were a bank holding company subject to 12 CFR part 217;
(B) An aggregate of common equity tier 1 capital, additional tier 1
capital, and tier 2 capital, all as defined under the bank holding
company regulations in 12 CFR 217.20, equal to or greater than eight
percent of the swap dealer's BHC equivalent risk-weighted assets;
provided, however, that the swap dealer must maintain a minimum of
common equity tier 1 capital equal to six point five percent of its BHC
equivalent risk-weighted assets; provided further, that any capital
that is subordinated debt under 12 CFR 217.20 and that is included in
the swap dealer's capital for purposes of this paragraph (a)(1)(i)(B)
must qualify as subordinated debt under Sec. 240.18a-1d of this title;
(C) An aggregate of common equity tier 1 capital, additional tier 1
capital, and tier 2 capital, all as defined under the bank holding
company regulations in 12 CFR 217.20, equal to or greater than eight
percent of the amount of uncleared swap margin, as that term is defined
in Sec. 23.100 of this part, for each uncleared swap position open on
the books of the swap dealer, computed on a counterparty by
counterparty basis pursuant to Sec. 23.154 of this part; and
(D) The amount of capital required by a registered futures
association of which the swap dealer is a member.
(ii)(A) A swap dealer that elects to meet the capital requirements
in this paragraph (a)(1)(ii) must at all times maintain net capital, as
defined and computed in accordance with
[[Page 57549]]
Sec. 240.18a-1 of this title as if the swap dealer were a security-
based swap dealer registered with the Securities and Exchange
Commission and subject to Sec. 240.18a-1 of this title, that equals or
exceeds the greater of:
(1) $20 million; provided however, that if the swap dealer is
approved under Sec. 23.102 of this part to use internal models to
compute market risk capital charges or credit risk capital charges it
must maintain tentative net capital, as defined and computed in
accordance with Sec. 240.18a-1 of this title as if the swap dealer
were a security-based swap dealer registered with the Securities and
Exchange Commission and subject to Sec. 240.18a-1 of this title, of
not less than $100 million and net capital of $20 million;
(2) Two percent of the uncleared swap margin, as defined in Sec.
23.100 of this part; or
(3) The amount of capital required by a registered futures
association of which the swap dealer is a member.
(B) A swap dealer that uses internal models to compute market risk
for its proprietary positions under Sec. 240.18a-1(d) of this title
must calculate the total market risk as the sum of the VaR measure,
stressed VaR measure, specific risk measure, comprehensive risk
measure, and incremental risk measure of the portfolio of proprietary
positions in accordance with Sec. 23.102 of this part and Appendix A
to Subpart E of Part 23; and
(C) A swap dealer may recognize as a current asset, receivables
from third-party custodians that maintain the swap dealer's initial
margin deposits associated with uncleared swap and security-based swap
transactions pursuant to the margin rules of the Commission, the
Securities and Exchange Commission, a prudential regulator, as defined
in section 1a(39) of the Act, or a foreign jurisdiction that has
received a margin Comparability Determination under Sec. 23.160 of
this chapter.
(2)(i) A swap dealer that is ``predominantly engaged in non-
financial activities'' as defined in Sec. 23.100 of this part may
elect to meet the minimum capital requirements in this paragraph (a)(2)
in lieu of the capital requirements in paragraph (a)(1) of this
section.
(ii) A swap dealer that satisfies the requirements of paragraph
(a)(2)(i) of this section and elects to meet the requirements of this
paragraph (a)(2) must maintain tangible net worth, as defined in Sec.
23.100 of this part, equal to or in excess of the greatest of the
following:
(A) $20 million plus the amount of the swap dealer's market risk
exposure requirement (as defined in Sec. 23.100 of this part) and its
credit risk exposure requirement (as defined in Sec. 23.100 of this
part) associated with the swap dealer's swap and related hedge
positions that are part of the swap dealer's swap dealing activities.
The swap dealer shall compute its market risk exposure requirement and
credit risk exposure requirement for its swap positions in accordance
with Sec. 23.102 of this part if the swap dealer has obtained approval
to use internal capital models. The swap dealer shall compute its
market risk exposure requirement and credit risk exposure requirement
in accordance with the standardized approach of paragraphs (b)(1) and
(c)(1) of Sec. 23.103 of this part if it has not been approved to use
internal capital models;
(B) Eight percent of the amount of uncleared swap margin, as that
term is defined in Sec. 23.100 of this part, for each uncleared swap
positions open on the books of the swap dealer, computed on a
counterparty by counterparty basis pursuant to Sec. 23.154 of this
part; or
(C) The amount of capital required by a registered futures
association of which the swap dealer is a member.
(3) A swap dealer that is subject to minimum capital requirements
established by the rules or regulations of a prudential regulator
pursuant to section 4s(e) of the Act is not subject to the regulatory
capital requirements set forth in paragraph (a)(1) or (2) of this
section.
(4) A swap dealer that is a futures commission merchant is subject
to the minimum capital requirements of Sec. 1.17 of this title, and is
not subject to the regulatory capital requirements set forth in
paragraph (a)(1) or (2) of this section.
(5) A swap dealer that is organized and domiciled outside of the
United States, including a swap dealer that is an affiliate of a person
organized and domiciled in the United States, may satisfy its
requirements for capital adequacy under paragraphs (a)(1) or (2) of
this section by substituted compliance with the capital adequacy
requirement of its home country jurisdiction. In order to qualify for
substituted compliance, a swap dealer's home country jurisdiction must
receive from the Commission a Capital Comparability Determination under
Sec. 23.106 of this part. A swap dealer that is a registered futures
commission merchant may not apply for a Capital Comparability
Determination and must comply with the minimum capital requirements set
forth in Sec. 1.17 of this chapter.
(6) A swap dealer that elects to meet the capital requirements of
paragraph (a)(1)(i), (a)(1)(ii), or (a)(2) of this section may not
subsequently change its election without the prior written approval of
the Commission. A swap dealer that wishes to change its election must
submit a written request to the Commission and must provide any
additional information and documentation requested by the Commission.
(b)(1) Every major swap participant for which there is not a
prudential regulator must at all time have and maintain positive
tangible net worth.
(2) Notwithstanding paragraph (b)(1) of this section, each major
swap participant for which there is no prudential regulator must meet
the minimum capital requirements established by a registered futures
association of which the major swap participant is a member.
(3) Notwithstanding paragraphs (b)(1) and (2) of this section, a
major swap participant that is a futures commission merchant is subject
to the minimum capital requirements of Sec. 1.17 of this chapter, and
is not subject to the regulatory capital requirements set forth in
paragraph (b)(1) and (2) of this section.
(4) A major swap participant that is organized and domiciled
outside of the United States, including a major swap participant that
is an affiliate of a person organized and domiciled in the United
States, may satisfy its requirements for capital adequacy under
paragraphs (b)(1) and (2) of this section by substituted compliance
with the capital adequacy requirement of its home country jurisdiction.
In order to qualify for substituted compliance, a major swap
participant's home country jurisdiction must receive from the
Commission a Capital Comparability Determination under Sec. 23.106 of
this part. A major swap participant that is a registered futures
commission merchant may not apply for a Capital Comparability
Determination and must comply with the minimum capital requirements set
forth in Sec. 1.17 of this chapter.
(c)(1) Before any applicant may be registered as a swap dealer or
major swap participant, the applicant must demonstrate to the
satisfaction of a registered futures association of which it is a
member, or applying for membership, one of the following:
(i) That the applicant complies with the applicable regulatory
capital requirements in paragraphs (a)(1), (a)(2), (b)(1), or (b)(2) of
this section;
[[Page 57550]]
(ii) That the applicant is a futures commission merchant that
complies with Sec. 1.17 of this chapter;
(iii) That the applicant is subject to minimum capital requirements
established by the rules or regulations of a prudential regulator under
paragraph (a)(3) of this section;
(iv) That the applicant is organized and domiciled in a non-U.S.
jurisdiction and is regulated in a jurisdiction for which the
Commission has issued a Capital Comparability Determination under Sec.
23.106 of this part, and the non-U.S. person has obtained confirmation
from the Commission that it may rely upon the Commission's
Comparability Determination under Sec. 23.106 of this part.
(2) Each swap dealer and major swap participant subject to the
minimum capital requirements set forth in paragraphs (a) and (b) of
this section must be in compliance with such requirements at all times,
and must be able to demonstrate such compliance to the satisfaction of
the Commission and to the registered futures association of which the
swap dealer or major swap participant is a member.
0
10. Add section 23.102 to subpart E to read as follows:
Sec. 23.102 Calculation of market risk exposure requirement and
credit risk exposure requirement using internal models
(a) A swap dealer may apply to the Commission or to a registered
futures association of which the swap dealer is a member to obtain
approval to use internal models under terms and conditions required by
the Commission or the registered futures association and by these
regulations, when calculating the swap dealer's market risk exposure
and credit risk exposure under Sec. Sec. 23.101(a)(1)(i)(B),
23.101(a)(1)(ii)(A), or 23.101(a)(2)(ii)(A); Provided however, that the
Commission must issue a determination that the registered futures
association's model requirements and review process are comparable to
the Commission's requirements and review process in order for the
registered futures association's model approval to be accepted as an
alternative means of compliance with this section.
(b) The swap dealer's application to use internal models to compute
market risk exposure and credit risk exposure must be in writing and
must be filed with the Commission and with a registered futures
association of which the swap dealer is a member. The swap dealer must
file the application in accordance with instructions established by the
Commission and the registered futures association.
(c) A swap dealer's application must include the following:
(1) In the case of a swap dealer subject to the minimum capital
requirements in Sec. 23.101(a)(1)(i) applying to use internal models
to compute market risk exposure, the information required under subpart
F of 12 CFR part 217, as if the swap dealer were itself a bank holding
company subject to 12 CFR part 217.
(2) In the case of a swap dealer subject to the minimum capital
requirements in Sec. 23.101(a)(1)(i) applying to use internal models
to compute credit risk exposure, the information required under subpart
E of 12 CFR part 217 in order to calculate credit risk-weighted assets
in accordance with sections 217.131 through 217.155 of that subpart, as
if the swap dealer were itself a bank holding company subject to 12 CFR
part 217.
(3) In the case of a swap dealer subject to the minimum capital
requirements in Sec. 23.101(a)(ii) or Sec. 23.101(a)(2), the
information set forth in Appendix A to Subpart E of Part 23.
(d) The Commission, or registered futures association upon
obtaining the Commission's determination that its requirements and
model approval process are comparable to the Commission's requirements
and process, may approve or deny the application, or approve or deny an
amendment to the application, in whole or in part, subject to any
conditions or limitations the Commission or registered futures
association may require, if the Commission or registered futures
association finds the approval to be appropriate in the public
interest, after determining, among other things, whether the applicant
has met the requirements of this section. A swap dealer that has
received Commission or registered futures association approval to
compute market risk exposure requirements and credit risk exposure
requirements pursuant to internal models must compute such charges in
accordance with Appendix A to Subpart E of Part 23.
(e) A swap dealer must cease using internal models to compute its
market risk exposure requirement and credit risk exposure requirement,
upon the occurrence of any of the following:
(1) The swap dealer has materially changed a mathematical model
described in the application or materially changed its internal risk
management control system without first submitting amendments
identifying such changes and obtaining the approval of the Commission
or the registered futures association for such changes;
(2) The Commission or the registered futures association of which
the swap dealer is a member determines that the internal models are no
longer sufficient for purposes of the capital calculations of the swap
dealer as a result of changes in the operations of the swap dealer;
(3) The swap dealer fails to come into compliance with its
requirements under this section, after having received from the
Director of the Commission's Division of Swap Dealer and Intermediary
Oversight, or from the registered futures association of which the swap
dealer is a member, written notification that the swap dealer is not in
compliance with its requirements, and must come into compliance by a
date specified in the notice; or
(4) The Commission by written order finds that permitting the swap
dealer to continue to use the internal models is no longer appropriate.
(f)(1) Notwithstanding paragraphs (a) through (d) of this section,
a swap dealer may use internal market risk or credit risk models upon
the submission to the Commission and the registered futures association
of which the swap dealer is a member a certification, signed by the
Chief Executive Officer, Chief Financial Officer, or other appropriate
official with knowledge of the swap dealer's capital requirements and
the capital models, that such models are in substantial compliance with
Commission's model requirements and have been approved for use in
computing capital by the swap dealer, or an affiliate of the swap
dealer, by the Securities and Exchange Commission, a prudential
regulator (as defined in Sec. 1.3 of this chapter), a foreign
regulatory authority in a jurisdiction that the Commission has found to
be eligible for substituted compliance under Sec. 23.106, or a foreign
regulatory authority whose capital adequacy requirements are consistent
with the capital requirements issued by the Basel Committee on Banking
Supervision. A swap dealer also must file an application containing the
information required under paragraph (c) of this section with the
Commission with its certification. A swap dealer may use such models
pending the subsequent approval or denial of the swap dealer's capital
model application by the Commission or the registered futures
association of which the swap dealer is a member.
(2) A swap dealer shall revise the certification required under
paragraph (f)(1) of this section to address any material changes or
revisions to the models, or to reflect any regulatory restrictions
placed on the models since the certification was submitted.
[[Page 57551]]
(3) A swap dealer shall cease using capital models subject to the
certification under paragraph (f)(1) of this section if the regulatory
authority that previously approved the models for use by the swap
dealer, or by the swap dealer's affiliate, has withdrawn its approval
and the Commission or a registered futures association has not approved
the models.
0
11. Add section 23.103 to subpart E to read as follows:
Sec. 23.103 Calculation of market risk exposure requirement and
credit risk requirement when models are not approved.
(a) Non-model approach. A swap dealer that:
(1) Does not compute its regulatory capital requirements under
Sec. 23.101(a)(1)(i), and
(2) Either:
(A) has not received approval from the Commission or from a
registered futures association of which the swap dealer is a member to
compute its market risk exposure requirement and/or credit risk
exposure requirement pursuant to internal models under Sec. 23.102, or
(B) has had its approval to compute its market risk exposure
requirement and/or credit risk exposure requirement pursuant to
internal models under Sec. 23.102 revoked by the Commission or
registered futures association must compute its market risk exposure
requirement and/or credit risk exposure requirement pursuant to
paragraphs (b) and/or (c) of this section.
(b) Market risk exposure requirements. (1) A swap dealer that
computes its regulatory capital under Sec. 23.101(a)(1)(ii) or (a)(2)
shall compute a market risk capital charge for the positions that the
swap dealer holds in its proprietary accounts using the applicable
standardized market risk charges set forth in Sec. 240.18a-1 of this
title and Sec. 1.17 of this chapter for such positions.
(2) In computing its net capital under Sec. 23.101(a)(1)(ii), a
swap dealer shall deduct from its tentative net capital the sum of the
market risk capital charges computed under paragraph (b)(1) of this
section.
(3) In computing its minimum capital requirement under Sec.
23.101(a)(2), a swap dealer must add the amount of the market risk
capital charge computed under this section to the $20 million minimum
capital requirement.
(c) Credit risk charges. (1) A swap dealer that computes regulatory
capital under Sec. 23.101(a)(1)(ii) shall compute counterparty credit
risk charges using the applicable standardized credit risk charges set
forth in Sec. 240.18a-1 of this title and Sec. 1.17 of this chapter
for such positions.
(2) In computing its net capital under Sec. 23.101(a)(1)(ii), a
swap dealer shall reduce its tentative net capital by the sum of the
counterparty credit risk charges computed under paragraph (c)(1) of
this section.
(3) In computing its minimum capital requirement under Sec.
23.101(a)(2), a swap dealer must add the amount of the credit risk
charge computed under this section to the $20 million minimum capital
requirement.
0
12. Add section 23.104 to subpart E to read as follows:
Sec. 23.104 Equity Withdrawal Restrictions.
(a) Equity withdrawal restrictions. The capital of a swap dealer,
including the capital of any affiliate or subsidiary whose liabilities
or obligations are guaranteed, endorsed, or assumed by the swap dealer
may not be withdrawn by action of the swap dealer or its equity
holders, or by redemption of shares of stock by the swap dealer or by
such affiliates or subsidiaries, or through the payment of dividends or
any similar distribution, nor may any unsecured advance or loan be made
to an equity holder or employee if, after giving effect thereto and to
any other such withdrawals, advances, or loans which are scheduled to
occur within six months following such withdrawal, advance or loan, the
swap dealer's regulatory capital is less than 120 percent of the
minimum regulatory capital required under Sec. 23.101 of this part.
The equity withdrawal restrictions, however, do not preclude a swap
dealer from making required tax payments or from paying reasonable
compensation to equity holders. The Commission may, upon application by
the swap dealer, grant relief from this paragraph (a) if the Commission
deems such relief to be in the public interest.
(b) Temporary equity withdrawal restrictions by Commission order.
(1) The Commission may by order restrict, for a period of up to twenty
business days, any withdrawal by a swap dealer of capital or any
unsecured loan or advance to a stockholder, partner, member, employee
or affiliate under such terms and conditions as the Commission deems
appropriate in the public interest if the Commission, based on the
information available, concludes that such withdrawal, loan or advance
may be detrimental to the financial integrity of the swap dealer, or
may unduly jeopardize the swap dealer's ability to meet its financial
obligations to counterparties or to pay other liabilities which may
cause a significant impact on the markets or expose the counterparties
and creditors of the swap dealer to loss.
(2) An order temporarily prohibiting the withdrawal of capital
shall be rescinded if the Commission determines that the restriction on
capital withdrawal should not remain in effect. A hearing on an order
temporarily prohibiting withdrawal of capital will be held within two
business days from the date of the request in writing by the swap
dealer.
0
13. Add section 23.105 to subpart E to read as follows:
Sec. 23.105 Financial recordkeeping, reporting and notification
requirements for swap dealers and major swap participants.
(a) Scope. (1) Except as provided in paragraphs (a)(2) and (a)(3)
of this section, a swap dealer or major swap participant must comply
with the applicable requirements set forth in paragraphs (b) through
(p) of this section.
(2) The requirements in paragraphs (b) through (o) of this section
do not apply to any swap dealer or major swap participant that is
subject to the capital requirements of a prudential regulator.
(3) The requirements in paragraph (p) of this section do not apply
to any swap dealer or major swap participant that is subject to the
capital requirements of the Commission.
(b) Current books and records. A swap dealer or major swap
participant shall prepare and keep current ledgers or other similar
records which show or summarize, with appropriate references to
supporting documents, each transaction affecting its asset, liability,
income, expense, and capital accounts, and in which all its asset,
liability, and capital accounts are classified in accordance with U.S.
generally accepted accounting principles, and as otherwise may be
necessary for the capital calculations required under Sec. 23.101 of
this part: Provided, however, that a swap dealer or major swap
participant that is not otherwise required to prepare financial
statements in accordance with U.S. generally accepted accounting
principles, may prepare and keep records required by this section in
accordance with International Financial Reporting Standards issued by
the International Accounting Standards Board. Such records must be
maintained in accordance with Sec. 1.31 of this chapter.
(c) Notices. (1) A swap dealer or major swap participant who knows
or should have known that its regulatory capital at any time is less
than the minimum required by Sec. 23.101 of this part, must:
[[Page 57552]]
(i) Provide immediate written notice to the Commission and to the
registered futures association of which it is a member that the swap
dealer's or major swap participant's regulatory capital is less than
that required by Sec. 23.101 of this part; and
(ii) Provide together with such notice, documentation in such form
as necessary to adequately reflect the swap dealer's or major swap
participant's regulatory capital condition as of any date such person's
regulatory capital is less than the minimum required. The swap dealer
or major swap participant must provide similar documentation for other
days as the Commission or registered futures association may request.
(2) A swap dealer or major swap participant who knows or should
have known that its regulatory capital at any time is less than 120
percent of its minimum regulatory capital requirement as determined
under Sec. 23.101 of this part, must provide written notice to the
Commission and to the registered futures association of which it is a
member to that effect within 24 hours of such event.
(3) If a swap dealer or major swap participant at any time fails to
make or to keep current the books and records required by these
regulations, such swap dealer or major swap participant must, on the
same day such event occurs, provide written notice to the Commission
and to the registered futures association of which it is a member of
such fact, specifying the books and records which have not been made or
which are not current, and within 48 hours after giving such notice
file a written report stating what steps have been and are being taken
to correct the situation.
(4) A swap dealer or major swap participant must provide written
notice to the Commission and to the registered futures association of
which it is a member of a substantial reduction in capital as compared
to that last reported in a financial report filed with the Commission
pursuant to this section. The notice shall be provided if the swap
dealer or major swap participant experiences a 30 percent or more
decrease in the amount of capital that the swap dealer or major swap
participant holds in excess of its regulatory capital requirement as
computed under Sec. 23.101 of this part.
(5) A swap dealer or major swap participant must provide written
notice to the Commission and to the registered futures association of
which it is a member two business days prior to the withdrawal of
capital by action of the equity holders of the swap dealer or major
swap participant where the withdrawal exceeds 30 percent of the swap
dealer's or major swap participant's excess regulatory capital as
computed under Sec. 23.101 of this part.
(6) A swap dealer or major swap participant that is registered with
the Securities and Exchange Commission as a security-based swap dealer
or as a major security-based swap participant and files a notice with
the Securities and Exchange Commission under 17 CFR 240.18a-8 or 17 CFR
240.17a-11, as applicable, must file a copy of such notice with the
Commission and with the registered futures association of which it is a
member at the time the security-based swap dealer or major security-
based swap participant files the notice with the Securities and
Exchange Commission.
(7) A swap dealer or major swap participant must submit a written
notice to the Commission and to the registered futures association of
which it is a member within 24 hours of the occurrence of any of the
following events:
(i) A single counterparty, or group of counterparties that are
under common ownership or control, fails to post initial margin or pay
variation margin to the swap dealer or major swap participant for swap
positions in compliance with Sec. 23.152 and Sec. 23.153 of this part
and security-based swap positions in compliance with 17 CFR 240.18a-
3(c)(1)(ii) and 17 CFR 240.18a-3(c)(2)(ii), and such initial margin and
variation margin, in the aggregate, is equal to or greater than 25
percent of the swap dealer's minimum capital requirement or 25 percent
of the major swap participant's tangible net worth;
(ii) Counterparties fail to post initial margin or pay variation
margin to the swap dealer or major swap participant for swap positions
in compliance with Sec. 23.152 and Sec. 23.153 of this part and
security-based swap positions in compliance with 17 CFR 240.18a-
3(c)(1)(ii) and 17 CFR 240.18a-3(c)(2)(ii) in an amount that, in the
aggregate, exceeds 50 percent of the swap dealer's minimum capital
requirement or 50 percent of the major swap participant's tangible net
worth;
(iii) A swap dealer or major swap participant fails to post initial
margin or pay variation margin to a single counterparty or group of
counterparties under common ownership and control for swap positions in
compliance with Sec. 23.152 and Sec. 23.153 of this part and
security-based swap positions in compliance with 17 CFR 240.18a-
3(c)(1)(ii) and 17 CFR 240.18a-3(c)(2)(ii), and such initial margin and
variation margin, in the aggregate, exceeds 25 percent of the swap
dealer's minimum capital requirement or 25 percent of the major swap
participant's tangible net worth; or
(iv) A swap dealer or major swap participant fails to post initial
margin or pay variation margin to counterparties for swap positions in
compliance with Sec. 23.152 and Sec. 23.153 of this part and
security-based swap positions in compliance with 17 CFR 240.18a-
3(c)(1)(ii) and 17 CFR 240.18a-3(c)(2)(ii) in an amount that, in the
aggregate, exceeds 50 percent of the swap dealer's s minimum capital
requirement or 50 percent of the major swap participants tangible net
worth.
(d) Unaudited financial reports. (1) A swap dealer or major swap
participant shall file with the Commission and with a registered
futures association of which it is a member monthly financial reports
meeting the requirements in paragraph (d)(2) of this section as of the
close of business each month; Provided, however, that a swap dealer or
major swap participant who is subject to the minimum capital
requirements of Sec. 23.101(a)(2) or (b), respectively, may file
quarterly financial reports meeting the requirements of paragraph
(d)(2) of this section as of the close of business each quarter end.
Such financial reports must be filed no later than 17 business days
after the date for which the report is made.
(2) The financial reports required by this section must be prepared
in the English language and be denominated in United States dollars.
The financial reports shall include a statement of financial condition,
a statement of income/loss, a statement of changes in liabilities
subordinated to the claims of general creditors, a statement of changes
in ownership equity, a statement demonstrating compliance with and
calculation of the applicable regulatory capital requirement under
Sec. 23.101, and such further material information as may be necessary
to make the required statements not misleading. The monthly report and
schedules must be prepared in accordance with generally accepted
accounting principles as established in the United States; Provided,
however, that a swap dealer or major swap participant that is not
otherwise required to prepare financial statements in accordance with
U.S. generally accepted accounting principles, may prepare the monthly
report and schedules required by this section in accordance with
International Financial Reporting Standards issued by the International
Accounting Standards Board.
(3) A swap dealer or major swap participant that is also registered
with
[[Page 57553]]
the Securities and Exchange Commission as a broker or dealer, security-
based swap dealer, or a major security-based swap participant and files
a monthly Form X-17A-5 FOCUS Report Part II with the Securities and
Exchange Commission pursuant to 17 CFR 240.18a-7 or 17 CFR 240.17a-5,
as applicable, may file such Form X-17A-5 FOCUS Report Part II with the
Commission and with the registered futures association in lieu of the
financial reports required under paragraphs (d)(1) and (2) of the
section. The swap dealer or major swap participant must file the form
with the Commission and registered futures association when it files
the Form X-17A-5 FOCUS Report Part II with the Securities and Exchange
Commission, provided, however, that the swap dealer or major swap
participant must file the Form X-17A-5 FOCUS Report Part II with the
Commission and registered futures association no later than 17 business
days after the end of each month.
(4) A swap dealer or major swap participant that is also registered
with the Commission as a futures commission merchant may file a Form 1-
FR-FCM in lieu of the monthly financial reports required under
paragraphs (d)(1) and (2) of the section.
(e) Annual audited financial report. (1) A swap dealer or major
swap participant shall file with the Commission and with a registered
futures association of which it is a member an annual financial report
as of the close of its fiscal year, certified in accordance with
paragraph (e)(2) of this section, and including the information
specified in paragraph (e)(3) of this section no later than 60 days
after the close of the swap dealer's or major swap participant's fiscal
year-end: Provided, however, that a swap dealer or major swap
participant who is subject to the minimum capital requirements of Sec.
23.101(a)(2) or (b), respectively, of this part may file an annual
financial report no later than 90 days after the close of the swap
dealer's and major swap participant's fiscal year-end.
(2) The annual financial report shall be audited and reported upon
with an opinion expressed by an independent certified public accountant
or independent licensed accountant that is in good standing in the
accountant's home jurisdiction.
(3) The annual financial reports shall be prepared in accordance
with generally accepted accounting principles as established in the
United States, be prepared in the English language, and denominated in
United States dollars: Provided, however, that a swap dealer or major
swap participant that does not otherwise prepare financial statements
in accordance with U.S. generally accepted accounting principles, may
prepare the annual financial report required by this section in
accordance with International Financial Reporting Standards issued by
the International Accounting Standards Board.
(4) The annual financial report must include the following:
(i) A statement of financial condition as of the date for which the
report is made;
(ii) Statements of income (loss), cash flows, changes in ownership
equity for the period between the date of the most recent certified
statement of financial condition filed with the Commission and
registered futures association and the date for which the report is
made, and changes in liabilities subordinated to claims of general
creditors;
(iii) Appropriate footnote disclosures;
(iv) A statement demonstrating the swap dealer's or major swap
participant's compliance with and calculation of the applicable
regulatory capital requirement under Sec. 23.101 of this part;
(v) A reconciliation of any material differences from the unaudited
financial report prepared as of the swap dealer's or major swap
participant's year-end date under paragraph (d) of this section and the
swap dealer's or major swap participant's annual financial report
prepared under this paragraph (e); and
(vi) Such further material information as may be necessary to make
the required statements not misleading.
(5) A swap dealer or major swap participant that is also registered
with the Securities and Exchange Commission as a broker or dealer,
security-based swap dealer, or a major security-based swap participant
and files an annual financial report with the Securities and Exchange
Commission pursuant to 17 CFR 240.18a-7 or 17 CFR 240.17a-5, as
applicable, may file such annual financial report with the Commission
and the registered futures association in lieu of the annual financial
report required under this paragraph (e). The swap dealer or major swap
participant must file its annual financial report with the Commission
and the registered futures association at the same time that it files
the annual financial report with the Securities and Exchange
Commission, provided that the annual financial report is filed with the
Commission and registered futures association no later than 60 days
from the swap dealer's or major swap participant's fiscal year-end
date.
(6) A swap dealer or major swap participant that is also registered
with the Commission as a futures commission merchant may file an
audited Form 1-FR-FCM in lieu of the annual financial report required
under this paragraph (e).
(f) Oath or affirmation. Attached to each unaudited and audited
financial report must be an oath or affirmation that to the best
knowledge and belief of the individual making such oath or affirmation
the information contained in the financial report is true and correct.
The individual making such oath or affirmation must be: If the swap
dealer or major swap participant is a sole proprietorship, the
proprietor; if a partnership, any general partner; if a corporation,
the duly authorized officer; and, if a limited liability company or
limited liability partnership, the chief executive officer, the chief
financial officer, the manager, the managing member, or those members
vested with the management authority for the limited liability company
or limited liability partnership.
(g) Change of fiscal year-end. A swap dealer or major swap
participant may not change the date of its fiscal year-end from that
used in its most recent annual financial report filed under paragraph
(e) of this section unless the swap dealer or major swap participant
has requested and received written approval for the change from a
registered futures association of which it is a member.
(h) Additional information requirements. From time to time the
Commission or a registered futures association, may, by written notice,
require any swap dealer or major swap participant to file financial or
operational information on a daily basis or at such other times as may
be specified by the Commission or registered futures association. Such
information must be furnished in accordance with the requirements
included in the written Commission or registered futures association
notice.
(i) Public disclosure and nonpublic treatment of reports. (1) A
swap dealer or major swap participant must no less than six months
after the date of the most recent annual audited financial report make
publicly available on its website the following unaudited information:
(i) The statement of financial condition; and
(ii) A statement disclosing the amount of the swap dealer's or
major swap participant's regulatory capital as of the end of the
quarter and the amount of its minimum regulatory capital requirement,
computed in accordance with Sec. 23.101.
[[Page 57554]]
(2) A swap dealer or major swap participant must no less than
annually make publicly available on its website the following
information:
(i) The statement of financial condition from the swap dealer or
major swap participant's audited annual financial report including
applicable footnotes; and
(ii) A statement disclosing the amount of the swap dealer's or
major swap participant's regulatory capital as of the fiscal year end
and its minimum regulatory capital requirement, computed in accordance
with Sec. 23.101.
(3) Financial information required to be made publicly available
pursuant to paragraph (i)(2) of this section must be posted within 10
business days after the firm is required to file with the Commission
the reports required under paragraph (e)(1).
(4) Financial information required to be made publicly available
pursuant to paragraph (i)(1) of this section must be posted within 30
calendar days of the date of the statements required under paragraph
(d)(1).
(5) Financial information required to be filed with the Commission
pursuant to this section, and not otherwise publicly available, will be
treated as exempt from mandatory public disclosure for purposes of the
Freedom of Information Act and the Government in the Sunshine Act and
parts 145 and 147 of this chapter; Provided, however, that all
information that is exempt from mandatory public disclosure will be
available for official use by any official or employee of the United
States or any State, by the National Futures Association and by any
other person to whom the Commission believes disclosure of such
information is in the public interest.
(j) Extension of time to file financial reports. A swap dealer or
major swap participant may file a request with the registered futures
association of which it is a member for an extension of time to file a
monthly unaudited financial report or an annual audited financial
report required under paragraphs (d) and (e) of this section. Such
request will be approved, conditionally or unconditionally, or
disapproved by the registered futures association.
(k) Additional reporting requirements for swap dealers approved to
use models to calculate market risk and credit risk for computing
capital requirements. (1) A swap dealer that has received approval or
filed an application for provisional approval under Sec. 23.102(d)
from the Commission, or from a registered futures association of which
the swap dealer is a member, to use internal models to compute its
market risk exposure requirement and credit risk exposure requirement
in computing its regulatory capital under Sec. 23.101 must file with
the Commission and with the registered futures association of which the
swap dealer is a member the following information within 17 business
days of the end of each month:
(i) For each product for which the swap dealer calculates a
deduction for market risk other than in accordance with a model
approved or for which an application of provisional approval has been
filed pursuant to Sec. 23.102(d), the product category and the amount
of the deduction for market risk;
(ii) A graph reflecting, for each business line, the daily intra-
month VaR;
(iii) The aggregate VaR for the swap dealer;
(iv) For each product for which the swap dealer uses scenario
analysis, the product category and the deduction for market risk;
(v) Credit risk information on swap, mixed swap and security-based
swap exposures including:
(A) Overall current exposure;
(B) Current exposure (including commitments) listed by counterparty
for the 15 largest exposures;
(C) The 10 largest commitments listed by counterparty;
(D) The swap dealer's maximum potential exposure listed by
counterparty for the 15 largest exposures;
(E) The swap dealer's aggregate maximum potential exposure;
(F) A summary report reflecting the swap dealer's current and
maximum potential exposures by credit rating category; and
(G) A summary report reflecting the swap dealer's current exposure
for each of the top ten countries to which the swap dealer is exposed
(by residence of the main operating group of the counterparty).
(2) A swap dealer that has received approval or filed an
application of provisional approval under Sec. 23.102(d) from the
Commission or from a registered futures association of which the swap
dealer is a member to use internal models to compute its market risk
exposure requirement and credit risk exposure requirement in computing
its regulatory capital under Sec. 23.101 must file with the Commission
and with the registered futures association of which the swap dealer is
member the following information within 17 business days of the end of
each calendar quarter:
(i) A report identifying the number of business days for which the
actual daily net trading loss exceeded the corresponding daily VaR; and
(ii) The results of back-testing of all internal models used to
compute allowable capital, including VaR, and credit risk models,
indicating the number of back-testing exceptions.
(l) Additional position and counterparty reporting requirements. A
swap dealer or major swap participant must provide on a monthly basis
to the Commission and to the registered futures association of which
the swap dealer or major swap participant is a member the specific
information required in Appendix B to Subpart E of this part.
(m) Margin reporting. A swap dealer or major swap participant must
file with the Commission and with the registered futures association of
which the swap dealer or major swap participant is a member the
following information as of the end of each month within 17 business
days of the end of each month:
(1) The name and address of each custodian holding initial margin
or variation margin collected by the swap dealer or major swap
participant for uncleared swap transactions pursuant to Sec. Sec.
23.152 and 23.153;
(2) The amount of initial margin and variation margin collected by
the swap dealer or major swap participant that is held by each
custodian listed in paragraph (m)(1) of this section;
(3) The aggregate amount of initial margin that the swap dealer or
major swap participant is required to collect from swap counterparties
pursuant to Sec. 23.152(a);
(4) The name and address of each custodian holding initial margin
or variation margin posted by the swap dealer or major swap participant
for uncleared swap transaction pursuant to Sec. Sec. 23.152 and
23.153;
(5) The amount of initial margin and variation margin posted by the
swap dealer or major swap participant that is held by each custodian
listed in paragraph (m)(4) of this section; and
(6) The aggregate amount of initial margin that the swap dealer or
majors swap participant is required to post to its swap counterparties
pursuant to Sec. 23.152(b).
(n) Electronic filing. All filings of financial reports, notices
and other information required to be submitted to the Commission or
registered futures association under paragraphs (b) through (m) of this
section must be filed in electronic form using a form of user
authentication assigned in accordance with procedures established by or
approved by the Commission or registered futures association, and
otherwise in accordance with
[[Page 57555]]
instructions issued by or approved by the Commission or registered
futures association.
A swap dealer or major swap participant must provide the Commission
or registered futures association with the means necessary to read and
to process the information contained in such report. Any such
electronic submission must clearly indicate the swap dealer or major
swap participant on whose behalf such filing is made and the use of
such user authentication in submitting such filing will constitute and
become a substitute for the manual signature of the authorized signer.
In the case of a financial report required under paragraphs (d), (e),
or (h) of this section and filed via electronic transmission in
accordance with procedures established by or approved by the Commission
or registered futures association, such transmission must be
accompanied by the user authentication assigned to the authorized
signer under such procedures, and the use of such user authentication
will constitute and become a substitute for the manual signature of the
authorized signer for the purpose of making the oath or affirmation
referred to in paragraph (f) of this section.
(o) Comparability determination for certain financial reporting. A
swap dealer or major swap participant that is subject to the monthly
financial reporting requirements of paragraph (d) of this section and
the annual financial reporting requirements of paragraph (e) of this
section may petition the Commission for a Capital Comparability
Determination under Sec. 23.106 to file monthly financial reports and/
or annual financial reports prepared in accordance with the rules a
foreign regulatory authority in lieu of the requirements contained in
this section.
(p) Quarterly financial reporting and notification provisions for
swap dealers and major swap participants that are subject to the
capital requirements of a prudential regulator. (1) Scope. A swap
dealer or major swap participant that is subject to the capital
requirements of a prudential regulator must comply with the
requirements of this paragraph.
(2) Financial report and position information. A swap dealer or
major swap participant that is subject to the capital requirements of a
prudential regulator shall file on a quarterly basis with the
Commission the financial reports and specific position information set
forth in Appendix C to subpart E of this part. The swap dealer or major
swap participant must file Appendix B to subpart E of this part with
the Commission within 30 calendar days of the date of the end of the
swap dealer's or major swap participant's fiscal quarter.
(3) Notices. A swap dealer or major swap participant that is
subject to the capital requirements of a prudential regulator must
comply with the following written notice provisions:
(i) A swap dealer or major swap participant that files a notice of
adjustment of its reported capital category with the Federal Reserve
Board, the Office of the Comptroller of the Currency, or the Federal
Deposit Insurance Corporation, or files a similar notice with its home
country supervisor(s), must give written notice of this fact that same
day by transmitting a copy of the notice of the adjustment of reported
capital category, or the similar notice provided to its home country
supervisor(s), to the Commission and with a registered futures
association of which it is a member.
(ii) A swap dealer or major swap participant must provide immediate
written notice to the Commission and with a registered futures
association of which it is a member that the swap dealer's or major
swap participant's regulatory capital is less than the applicable
minimum capital requirements set forth in 12 CFR 217.10, 12 CFR 3.10,
or 12 CFR 324.10, or the minimum capital requirements established by
its home country supervisor(s).
(iii) If a swap dealer or major swap participant at any time fails
to make or to keep current the books and records necessary to produce
reports required under paragraph (p)(2) of this section, such swap
dealer or major swap participant must, on the same day such event
occurs, provide written notice to the Commission and with a registered
futures association of which it is a member of such fact, specifying
the books and records which have not been made or which are not
current, and within 48 hours after giving such notice file a written
report stating what steps have been and are being taken to correct the
situation.
(4) Additional information. From time to time the Commission may,
by written notice, require a swap dealer or major swap participant that
is subject to the capital rules of a prudential regulator to file
financial or operational information on a daily basis or at such other
times as may be specified by the Commission. Such information must be
furnished in accordance with the requirements included in the written
Commission notice.
(5) Oath or affirmation. Attached to each financial report, must be
an oath or affirmation that to the best knowledge and belief of the
individual making such oath or affirmation the information contained in
the filing is true and correct. The individual making such oath or
affirmation must be: If the swap dealer or major swap participant is a
sole proprietorship, the proprietor; if a partnership, any general
partner; if a corporation, the duly authorized officer; and, if a
limited liability company or limited liability partnership, the chief
executive officer, the chief financial officer, the manager, the
managing member, or those members vested with the management authority
for the limited liability company or limited liability partnership.
(6) Electronic filing. All filings of financial reports, notices,
and other information made pursuant to this paragraph (p) must be
submitted to the Commission in electronic form using a form of user
authentication assigned in accordance with procedures established by or
approved by the Commission, and otherwise in accordance with
instructions issued by or approved by the Commission. Each swap dealer
and major swap participant must provide the Commission with the means
necessary to read and to process the information contained in such
report. Any such electronic submission must clearly indicate the swap
dealer or major swap participant on whose behalf such filing is made
and the use of such user authentication in submitting such filing will
constitute and become a substitute for the manual signature of the
authorized signer. In the case of a financial report required under
this paragraph (p) and filed via electronic transmission in accordance
with procedures established by or approved by the Commission, such
transmission must be accompanied by the user authentication assigned to
the authorized signer under such procedures, and the use of such user
authentication will constitute and become a substitute for the manual
signature of the authorized signer for the purpose of making the oath
or affirmation referred to in paragraph (p)(5) of this paragraph. Every
notice or report required to be transmitted to the Commission pursuant
to this paragraph (p) must also be filed with the Securities and
Exchange Commission if the swap dealer or major swap participant also
is registered with the Securities and Exchange Commission.
(7) A swap dealer or major swap participant that is subject to
rules of a prudential regulator and is also registered with the
Securities and Exchange Commission as a security-based swap dealer or a
major security-
[[Page 57556]]
based swap participant and files a quarterly Form X-17A-5 FOCUS Report
Part IIC with the Securities and Exchange Commission pursuant to 17 CFR
240.18a-7, may file such Form X-17A-5 FOCUS Report Part IIC with the
Commission in lieu of the financial reports required under paragraphs
(p)(2) of this section. The swap dealer or major swap participant must
file the form with the Commission when it files the Form X-17A-5 FOCUS
Report Part IIC with the Securities and Exchange Commission, provided,
however, that the swap dealer or major swap participant must file the
Form X-17A-5 FOCUS Report Part IIC with the Commission no later than 30
calendar days from the date the report is made.
0
14. Add section 23.106 to subpart E to read as follows:
Sec. 23.106 Substituted compliance for swap dealer's and major swap
participant's capital and financial reporting.
(a)(1) Eligibility requirements. The following persons may, either
individually or collectively, request a Capital Comparability
Determination with respect to the Commission's capital adequacy and
financial reporting requirements for swap dealers or major swap
participants:
(i) A swap dealer or major swap participant that is eligible for
substituted compliance under Sec. 23.101 or a trade association or
other similar group on behalf of its members who are swap dealers or
major swap participants; or
(ii) A foreign regulatory authority that has direct supervisory
authority over one or more swap dealers or major swap participants that
are eligible for substituted compliance under Sec. 23.101, and such
foreign regulatory authority is responsible for administering the
relevant foreign jurisdiction's capital adequacy and financial
reporting requirements over the swap dealer or major swap participant.
(2) Submission requirements. A person requesting a Capital
Comparability Determination must electronically submit to the
Commission:
(i) A description of the objectives of the relevant foreign
jurisdiction's capital adequacy and financial reporting requirements
over entities that are subject to the Commission's capital adequacy and
financial reporting requirements in this part;
(ii) A description (including specific legal and regulatory
provisions) of how the relevant foreign jurisdiction's capital adequacy
and financial reporting requirements address the elements of the
Commission's capital adequacy and financial reporting requirements for
swap dealers and major swap participants, including, at a minimum, the
methodologies for establishing and calculating capital adequacy
requirements and whether such methodologies comport with any
international standards, including Basel-based capital requirements for
banking institutions; and
(iii) A description of the ability of the relevant foreign
regulatory authority or authorities to supervise and enforce compliance
with the relevant foreign jurisdiction's capital adequacy and financial
reporting requirements. Such description should discuss the powers of
the foreign regulatory authority or authorities to supervise,
investigate, and discipline entities for compliance with capital
adequacy and financial reporting requirements, and the ongoing efforts
of the regulatory authority or authorities to detect and deter
violations, and ensure compliance with capital adequacy and financial
reporting requirements. The description should address how foreign
authorities and foreign laws and regulations address situations where a
swap dealer or major swap participant is unable to comply with the
foreign jurisdictions capital adequacy or financial reporting
requirements.
(iv) Upon request, such other information and documentation that
the Commission deems necessary to evaluate the comparability of the
capital adequacy and financial reporting requirements of the foreign
jurisdiction.
(v) All supplied documents shall be provided in English, or
provided translated to the English language, with currency amounts
stated in or converted to USD (conversions to be noted with applicable
date).
(3) Standard of Review. The Commission will issue a Capital
Comparability Determination to the extent that it determines that some
or all of the relevant foreign jurisdiction's capital adequacy and
financial reporting requirements and related financial recordkeeping
and reporting requirements for swap dealing financial intermediaries
are comparable to the Commission's corresponding capital adequacy and
financial recordkeeping and reporting requirements. In determining
whether the requirements are comparable, the Commission may consider
all relevant factors, including:
(i) The scope and objectives of the foreign jurisdiction's capital
adequacy and financial reporting requirements;
(ii) Whether the relevant foreign jurisdiction's capital adequacy
and financial reporting requirements achieve comparable outcomes to the
Commission's corresponding capital adequacy and financial reporting
requirements for swap dealers and major swap participants;
(iii) The ability of the relevant regulatory authority or
authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's capital adequacy and financial reporting
requirements; and
(iv) Any other facts or circumstances the Commission deems
relevant.
(4) Reliance. (i) A swap dealer or major swap participant that is
subject to the supervision of a foreign jurisdiction that has received
a Capital Comparability Determination from the Commission must file a
notice of its intent to comply with the capital adequacy and financial
reporting requirements of the foreign jurisdiction with the Commission.
(ii) Any swap dealer or major swap participant that has filed the
notice set forth in paragraph (a)(4)(i) of this section and has
received confirmation from the Commission that it may comply with a
foreign jurisdiction's capital adequacy and financial reporting
requirements will be deemed to be in compliance with the Commission's
corresponding capital adequacy and financial reporting requirements.
Accordingly, if a swap dealer or major swap participant has failed to
comply with the foreign jurisdiction's capital adequacy and financial
reporting requirements, the Commission may initiate an action for a
violation of the Commission's corresponding requirements. All swap
dealers and major swap participants, regardless of whether they rely on
a Capital Comparability Determination, remain subject to the
Commission's examination and enforcement authority.
(5) Conditions. In issuing a Capital Comparability Determination,
the Commission may impose any terms and conditions it deems
appropriate, including certain capital adequacy and financial reporting
requirements on swap dealers or major swap participants. The violation
of such terms and conditions may constitute a violation of the
Commission's capital adequacy or financial reporting requirements and/
or result in the modification or revocation of the Capital
Comparability Determination.
(6) Modifications. The Commission reserves the right to further
condition, modify, suspend or terminate or otherwise restrict a Capital
Comparability Determination in the Commission's discretion.
0
15. Add Appendix A to subpart E of part 23 to read as follows:
[[Page 57557]]
Appendix A to Subpart E of Part 23--Application for Internal Models To
Compute Market Risk Exposure Requirement and Credit Risk Exposure
Requirement
(a) A swap dealer that is requesting the approval of the
Commission or the approval of a registered futures association of
which the swap dealer is a member to use internal models to compute
its market risk exposure requirement and credit risk exposure
requirement under Sec. 23.102 must include the following
information as part of its application:
(1) An executive summary of the information within its
application and, if applicable, an identification of the ultimate
holding company of the swap dealer;
(2) A list of the categories of positions that the swap dealer
holds in its proprietary accounts and a brief description of the
methods that the swap dealer will use to calculate deductions for
market risk and credit risk on those categories of positions;
(3) A description of the mathematical models used by the swap
dealer under this Appendix A to compute the VaR of the swap dealer's
positions; the stressed VaR of the swap dealer's positions; the
specific risk of the swap dealer's positions subject to specific
risk; comprehensive risk of the swap dealer's positions; and the
incremental risk of the swap dealer's positions, and deductions for
credit risk exposure. The description should encompass the creation,
use, and maintenance of the mathematical models; a description of
the swap dealer's internal risk management controls over the models,
including a description of each category of persons who may input
data into the models; if a mathematical model incorporates empirical
correlations across risk categories, a description of the process
for measuring correlations; a description of the back-testing
procedures the swap dealer will use to back-test the mathematical
models; a description of how each mathematical model satisfies the
applicable qualitative and quantitative requirements set forth in
this Appendix A and a statement describing the extent to which each
mathematical model used to compute deductions for market risk
exposures and credit risk exposures will be used as part of the risk
analyses and reports presented to senior management;
(4) If the swap dealer is applying to the Commission for
approval or a registered futures association to use scenario
analysis to calculate deductions for market risk for certain
positions, a list of those types of positions, a description of how
those deductions will be calculated using scenario analysis, and an
explanation of why each scenario analysis is appropriate to
calculate deductions for market risk on those types of positions;
(5) A description of how the swap dealer will calculate current
exposure;
(6) A description of how the swap dealer will determine internal
credit ratings of counterparties and internal credit risk-weights of
counterparties, if applicable;
(7) For each instance in which a mathematical model to be used
by the swap dealer to calculate a deduction for market risk exposure
or to calculate maximum potential exposure for a particular product
or counterparty differs from the mathematical model used by the swap
dealer's ultimate holding company or the swap dealer's affiliates
(if applicable) to calculate an allowance for market risk exposure
or to calculate maximum potential exposure for that same product or
counterparty, a description of the difference(s) between the
mathematical models;
(8) A description of the swap dealer's process of re-estimating,
re-evaluating, and updating internal models to ensure continued
applicability and relevance; and
(9) Sample risk reports that are provided to management at the
swap dealer who are responsible for managing the swap dealer's risk.
(b) The application of the swap dealer shall be supplemented by
other information relating to the internal risk management control
system, mathematical models, and financial position of the swap
dealer that the Commission or a registered futures association may
request to complete its review of the application.
(c) A person who files an application with the Commission
pursuant to this appendix for which it seeks confidential treatment
may clearly mark each page or segregable portion of each page with
the words ``Confidential Treatment Requested.'' All information
submitted in connection with the application will be accorded
confidential treatment by the Commission, to the extent permitted by
law.
(d) If any of the information filed with the Commission or a
registered futures association as part of the application of the
swap dealer is found to be or becomes inaccurate before the
Commission or a registered futures association approves the
application, the swap dealer must notify the Commission or the
registered futures association promptly and provide the Commission
or the registered futures association with a description of the
circumstances in which the information was found to be or has become
inaccurate along with updated, accurate information.
(e) The Commission or the registered futures association may
approve the application or an amendment to the application, in whole
or in part, subject to any conditions or limitations the Commission
or the registered futures association may require if the Commission
or the registered futures association finds the approval to be
appropriate in the public interest, after determining, among other
things, whether the swap dealer has met all the requirements of this
Appendix A.
(f) A swap dealer shall amend its application under this
Appendix A and submit the amendment to the Commission and the
registered futures association for approval before it may materially
change a mathematical model used to calculate market risk exposure
requirements or credit risk exposure requirements or before it may
materially change its internal risk management control system with
respect to such model.
(g) As a condition for a swap dealer to use internal models to
compute deductions for market risk exposure and credit risk exposure
under this Appendix A, the swap dealer agrees that:
(1) It will notify the Commission and the registered futures
association 45 days before it ceases to use internal models to
compute deductions for market risk exposure and credit risk exposure
under this Appendix A; and
(2) The Commission or the registered futures association may
determine that the notice will become effective after a shorter or
longer period of time if the swap dealer consents or if the
Commission determines that a shorter or longer period of time is
appropriate in the public interest.
(h) The Commission or the registered futures association may by
written order revoke a swap dealer's approval to use internal models
to compute market risk exposures and credit risk exposures on
certain credit exposures arising from transactions in derivatives
instruments if the Commission or the registered futures association
finds that such approval is no longer appropriate in the public
interest. In making its finding, the Commission or the registered
futures association will consider the compliance history of the swap
dealer related to its use of models and the swap dealer's compliance
with its internal risk management controls. If the Commission or the
registered futures association withdraws all or part of a swap
dealer's approval to use internal models, the swap dealer shall
compute market risk exposure requirements and credit risk exposure
requirements in accordance with Sec. 23.103.
(i) VaR models. A value-at-risk (``VaR'') model must meet the
following minimum requirements in order to be approved:
(1) Qualitative requirements. (i) The VaR model used to
calculate market risk exposure or credit risk exposure for a
position must be integrated into the daily internal risk management
system of the swap dealer;
(ii) The VaR model must be reviewed both periodically and
annually. The periodic review may be conducted by personnel of the
swap dealer that are independent from the personnel that perform the
VaR model calculations. The annual review must be conducted by a
qualified third party service. The review must include:
(A) An evaluation of the conceptual soundness of, and empirical
support for, the internal models;
(B) An ongoing monitoring process that includes verification of
processes and the comparison of the swap dealer's model outputs with
relevant internal and external data sources or estimation
techniques; and
(C) An outcomes analysis process that includes back-testing.
This process must include a comparison of the changes in the swap
dealer's portfolio value that would have occurred were end-of-day
positions to remain unchanged (therefore, excluding fees,
commissions, reserves, net interest income, and intraday trading)
with VaR-based measures during a sample period not used in model
development.
(iii) For purposes of computing market risk, the swap dealer
must determine the appropriate multiplication factor as follows:
(A) Beginning three months after the swap dealer begins using
the VaR model to
[[Page 57558]]
calculate the market risk exposure, the swap dealer must conduct
monthly back-testing of the model by comparing its actual daily net
trading profit or loss with the corresponding VaR measure generated
by the VaR model, using a 99 percent, one-tailed confidence level
with price changes equivalent to a one business-day movement in
rates and prices, for each of the past 250 business days, or other
period as may be appropriate for the first year of its use;
(B) On the last business day of each quarter, the swap dealer
must identify the number of back-testing exceptions of the VaR model
using actual daily net trading profit and loss, as that term is
defined in Sec. Sec. 23.100. An exception has occurred when for a
business day the actual net trading loss, if any, exceeds the
corresponding VaR measure. The counting period shall be for the
prior 250 business days except that during the first year of use of
the model another appropriate period may be used; and
(C) The swap dealer must use the multiplication factor indicated
in Table 1 of this Appendix A in determining its market risk until
it obtains the next quarter's back-testing results;
Table 1--Multiplication Factor Based on the Number of Back-Testing
Exceptions of the VaR Model
------------------------------------------------------------------------
Multiplication
Number of exceptions factor
------------------------------------------------------------------------
4 or fewer.............................................. 3.00
5....................................................... 3.40
6....................................................... 3.50
7....................................................... 3.65
8....................................................... 3.75
9....................................................... 3.85
10 or more.............................................. 4.00
------------------------------------------------------------------------
(iv) For purposes of computing the credit equivalent amount of
the swap dealer's exposures to a counterparty, the swap dealer must
determine the appropriate multiplication factor as follows:
(A) Beginning three months after it begins using the VaR model
to calculate maximum potential exposure, the swap dealer must
conduct back-testing of the model by comparing, for at least 80
counterparties (or the actual number of counterparties if the swap
dealer does not have 80 counterparties) with widely varying types
and sizes of positions with the firm, the ten business day change in
its current exposure to the counterparty based on its positions held
at the beginning of the ten-business day period with the
corresponding ten-business day maximum potential exposure for the
counterparty generated by the VaR model;
(B) As of the last business day of each quarter, the swap dealer
must identify the number of back-testing exceptions of the VaR
model, that is, the number of ten-business day periods in the past
250 business days, or other period as may be appropriate for the
first year of its use, for which the change in current exposure to a
counterparty, assuming the portfolio remains static for the ten-
business day period, exceeds the corresponding maximum potential
exposure; and
(C) The swap dealer will propose, as part of its application, a
schedule of multiplication factors, which must be approved by the
Commission, or a registered futures association of which the swap
dealer is a member, based on the number of back-testing exceptions
of the VaR model. The swap dealer must use the multiplication factor
indicated in the approved schedule in determining the credit
equivalent amount of its exposures to a counterparty until it
obtains the next quarter's back-testing results, unless the
Commission or the registered futures association determines, based
on, among other relevant factors, a review of the swap dealer's
internal risk management control system, including a review of the
VaR model, that a different adjustment or other action is
appropriate.
(2) Quantitative requirements. (i) For purposes of determining
market risk exposure, the VaR model must use a 99 percent, one-
tailed confidence level with price changes equivalent to a ten
business-day movement in rates and prices;
(ii) For purposes of determining maximum potential exposure, the
VaR model must use a 99 percent, one-tailed confidence level with
price changes equivalent to a one-year movement in rates and prices;
or based on a review of the swap dealer's procedures for managing
collateral and if the collateral is marked to market daily and the
swap dealer has the ability to call for additional collateral daily,
the Commission, or the registered futures association of which the
swap dealer is a member, may approve a time horizon of not less than
ten business days;
(iii) The VaR model must use an effective historical observation
period of at least one year. The swap dealer must consider the
effects of market stress in its construction of the model.
Historical data sets must be updated at least monthly and reassessed
whenever market prices or volatilities change significantly or
portfolio composition warrant; and
(iv) The VaR model must take into account and incorporate all
significant, identifiable market risk factors applicable to
positions in the accounts of the swap dealer, including:
(A) Risks arising from the non-linear price characteristics of
derivatives and the sensitivity of the fair value of those positions
to changes in the volatility of the derivatives' underlying rates,
prices, or other material risk factors. A swap dealer with a large
or complex portfolio with non-linear derivatives (such as options or
positions with embedded optionality) must measure the volatility of
these positions at different maturities and/or strike prices, where
material;
(B) Empirical correlations within and across risk factors
provided that the swap dealer validates and demonstrates the
reasonableness of its process for measuring correlations, if the
VaR-based measure does not incorporate empirical correlations across
risk categories, the swap dealer must add the separate measures from
its internal models used to calculate the VaR-based measure for the
appropriate risk categories (interest rate risk, credit spread risk,
equity price risk, foreign exchange rate risk, and/or commodity
price risk) to determine its aggregate VaR-based measure, or,
alternatively, risk factors sufficient to cover all the market risk
inherent in the positions in the proprietary or other trading
accounts of the swap dealer, including interest rate risk, equity
price risk, foreign exchange risk, and commodity price risk; and
(C) Spread risk, where applicable, and segments of the yield
curve sufficient to capture differences in volatility and imperfect
correlation of rates along the yield curve for securities and
derivatives that are sensitive to different interest rates. For
material positions in major currencies and markets, modeling
techniques must incorporate enough segments of the yield curve--in
no case less than six--to capture differences in volatility and less
than perfect correlation of rates along the yield curve.
(j) Stressed VaR-based Measure. A stressed VaR model must meet
the following minimum requirements in order to be approved:
(1) Requirements for stressed VaR-based measure. (i) A swap
dealer must calculate a stressed VaR-based measure for its positions
using the same model(s) used to calculate the VaR-based measure
under paragraph (i) of this appendix, subject to the same confidence
level and holding period applicable to the VaR-based measure, but
with model inputs calibrated to historical data from a continuous
12-month period that reflects a period of significant financial
stress appropriate to the swap dealer's current portfolio.
(ii) The stressed VaR-based measure must be calculated at least
weekly and be no less than the swap dealer's VaR-based measure.
(iii) A swap dealer must have policies and procedures that
describe how it determines the period of significant financial
stress used to calculate the swap dealer's stressed VaR-based
measure under this appendix and must be able to provide empirical
support for the period used. The swap dealer must obtain the prior
approval of the Commission, or a registered futures association of
which the swap dealer is a member, if the swap dealer makes any
material changes to these policies and procedures. The policies and
procedures must address:
(A) How the swap dealer links the period of significant
financial stress used to calculate the stressed VaR-based measure to
the composition and directional bias of its current portfolio; and
(B) The swap dealer's process for selecting, reviewing, and
updating the period of significant financial stress used to
calculate the stressed VaR-based measure and for monitoring the
appropriateness of the period to the swap dealer's current
portfolio.
(iv) Nothing in this appendix prevents the Commission or the
registered futures association of which the swap dealer is a member
from requiring a swap dealer to use a different period of
significant financial stress in the calculation of the stressed VaR-
based measure.
(k) Specific Risk. A specific risk model must meet the following
minimum requirements in order to be approved:
(1) General requirement. A swap dealer must use one of the
methods in this
[[Page 57559]]
paragraph (k) to measure the specific risk for each of its debt,
equity, and securitization positions with specific risk.
(2) Modeled specific risk. A swap dealer may use models to
measure the specific risk of its proprietary positions. A swap
dealer must use models to measure the specific risk of correlation
trading positions that are modeled under paragraph (m) of this
appendix.
(i) Requirements for specific risk modeling. (A) If a swap
dealer uses internal models to measure the specific risk of a
portfolio, the internal models must:
(1) Explain the historical price variation in the portfolio;
(2) Be responsive to changes in market conditions;
(3) Be robust to an adverse environment, including signaling
rising risk in an adverse environment; and
(4) Capture all material components of specific risk for the
debt and equity positions in the portfolio. Specifically, the
internal models must:
(i) Capture name-related basis risk;
(ii) Capture event risk and idiosyncratic risk; and
(iii) Capture and demonstrate sensitivity to material
differences between positions that are similar but not identical and
to changes in portfolio composition and concentrations.
(B) If a swap dealer calculates an incremental risk measure for
a portfolio of debt or equity positions under paragraph (l) of this
appendix, the swap dealer is not required to capture default and
credit migration risks in its internal models used to measure the
specific risk of those portfolios.
(C) A swap dealer shall validate a specific risk model through
back-testing.
(ii) Specific risk fully modeled for one or more portfolios. If
the swap dealer's VaR-based measure captures all material aspects of
specific risk for one or more of its portfolios of debt, equity, or
correlation trading positions, the swap dealer has no specific risk
add-on for those portfolios.
(3) Specific risk not modeled. (i) If the swap dealer's VaR-
based measure does not capture all material aspects of specific risk
for a portfolio of debt, equity, or correlation trading positions,
the swap dealer must calculate a specific-risk add-on for the
portfolio under the standardized measurement method as described in
12 CFR 217.210.
(ii) A swap dealer must calculate a specific risk add-on under
the standardized measurement method as described in 12 CFR 217.200
for all of its securitization positions that are not modeled under
this paragraph (k).
(l) Incremental Risk. An incremental risk model must meet the
following minimum requirements in order to be approved:
(1) General requirement. A swap dealer that measures the
specific risk of a portfolio of debt positions under paragraph (k)
of this appendix using internal models must calculate at least
weekly an incremental risk measure for that portfolio according to
the requirements in this appendix. The incremental risk measure is
the swap dealer's measure of potential losses due to incremental
risk over a one-year time horizon at a one-tail, 99.9 percent
confidence level, either under the assumption of a constant level of
risk, or under the assumption of constant positions. With the prior
approval of the Commission or a registered futures association of
which the swap dealer is a member, a swap dealer may choose to
include portfolios of equity positions in its incremental risk
model, provided that it consistently includes such equity positions
in a manner that is consistent with how the swap dealer internally
measures and manages the incremental risk of such positions at the
portfolio level. If equity positions are included in the model, for
modeling purposes default is considered to have occurred upon the
default of any debt of the issuer of the equity position. A swap
dealer may not include correlation trading positions or
securitization positions in its incremental risk measure.
(2) Requirements for incremental risk modeling. For purposes of
calculating the incremental risk measure, the incremental risk model
must:
(i) Measure incremental risk over a one-year time horizon and at
a one-tail, 99.9 percent confidence level, either under the
assumption of a constant level of risk, or under the assumption of
constant positions.
(A) A constant level of risk assumption means that the swap
dealer rebalances, or rolls over, the swap dealer's trading
positions at the beginning of each liquidity horizon over the one-
year horizon in a manner that maintains the swap dealer's initial
risk level. The swap dealer must determine the frequency of
rebalancing in a manner consistent with the liquidity horizons of
the positions in the portfolio. The liquidity horizon of a position
or set of positions is the time required for a swap dealer to reduce
its exposure to, or hedge all of its material risks of, the
position(s) in a stressed market. The liquidity horizon for a
position or set of positions may not be less than the shorter of
three months or the contractual maturity of the position.
(B) A constant position assumption means that the swap dealer
maintains the same set of positions throughout the one-year horizon.
If a swap dealer uses this assumption, it must do so consistently
across all portfolios.
(C) A swap dealer's selection of a constant position or a
constant risk assumption must be consistent between the swap
dealer's incremental risk model and its comprehensive risk model
described in paragraph (m) of this appendix, if applicable.
(D) A swap dealer's treatment of liquidity horizons must be
consistent between the swap dealer's incremental risk model and its
comprehensive risk model described in paragraph (m) of this
appendix, if applicable.
(ii) Recognize the impact of correlations between default and
migration events among obligors.
(iii) Reflect the effect of issuer and market concentrations, as
well as concentrations that can arise within and across product
classes during stressed conditions.
(iv) Reflect netting only of long and short positions that
reference the same financial instrument.
(v) Reflect any material mismatch between a position and its
hedge.
(vi) Recognize the effect that liquidity horizons have on
dynamic hedging strategies. In such cases, a swap dealer must:
(A) Choose to model the rebalancing of the hedge consistently
over the relevant set of trading positions;
(B) Demonstrate that including rebalancing results in a more
appropriate risk measurement;
(C) Demonstrate that the market for the hedge is sufficiently
liquid to permit rebalancing during periods of stress; and
(D) Capture in the incremental risk model any residual risks
arising from such hedging strategies.
(vii) Reflect the nonlinear impact of options and other
positions with material nonlinear behavior with respect to default
and migration changes.
(viii) Maintain consistency with the swap dealer's internal risk
management methodologies for identifying, measuring, and managing
risk.
(m) Comprehensive Risk. A comprehensive risk model must meet the
following minimum requirements in order to be approved:
(1) General requirement. (i) Subject to the prior approval of
the Commission or a registered futures association of which the swap
dealer is a member, a swap dealer may use the method in this
paragraph to measure comprehensive risk, that is, all price risk,
for one or more portfolios of correlation trading positions.
(ii) A swap dealer that measures the price risk of a portfolio
of correlation trading positions using internal models must
calculate at least weekly a comprehensive risk measure that captures
all price risk according to the requirements of this paragraph (m).
The comprehensive risk measure is either:
(A) The sum of:
(1) The swap dealer's modeled measure of all price risk
determined according to the requirements in paragraph (m)(2) of this
appendix; and
(2) A surcharge for the swap dealer's modeled correlation
trading positions equal to the total specific risk add-on for such
positions as calculated under paragraph (k) of this appendix
multiplied by 8.0 percent; or
(B) With approval of the Commission, or the registered futures
association of which the swap dealer is a member, and provided the
swap dealer has met the requirements of this paragraph (m) for a
period of at least one year and can demonstrate the effectiveness of
the model through the results of ongoing model validation efforts
including robust benchmarking, the greater of:
(1) The swap dealer's modeled measure of all price risk
determined according to the requirements in paragraph (b) of this
appendix; or
(2) The total specific risk add-on that would apply to the swap
dealer's modeled correlation trading positions as calculated under
paragraph (k) of this appendix multiplied by 8.0 percent.
(2) Requirements for modeling all price risk. If a swap dealer
uses an internal model to measure the price risk of a portfolio of
correlation trading positions:
(i) The internal model must measure comprehensive risk over a
one-year time
[[Page 57560]]
horizon at a one-tail, 99.9 percent confidence level, either under
the assumption of a constant level of risk, or under the assumption
of constant positions.
(ii) The model must capture all material price risk, including
but not limited to the following:
(A) The risks associated with the contractual structure of cash
flows of the position, its issuer, and its underlying exposures;
(B) Credit spread risk, including nonlinear price risks;
(C) The volatility of implied correlations, including nonlinear
price risks such as the cross-effect between spreads and
correlations;
(D) Basis risk;
(E) Recovery rate volatility as it relates to the propensity for
recovery rates to affect tranche prices; and
(F) To the extent the comprehensive risk measure incorporates
the benefits of dynamic hedging, the static nature of the hedge over
the liquidity horizon must be recognized. In such cases, a swap
dealer must:
(1) Choose to model the rebalancing of the hedge consistently
over the relevant set of trading positions;
(2) Demonstrate that including rebalancing results in a more
appropriate risk measurement;
(3) Demonstrate that the market for the hedge is sufficiently
liquid to permit rebalancing during periods of stress; and
(4) Capture in the comprehensive risk model any residual risks
arising from such hedging strategies;
(iii) The swap dealer must use market data that are relevant in
representing the risk profile of the swap dealer's correlation
trading positions in order to ensure that the swap dealer fully
captures the material risks of the correlation trading positions in
its comprehensive risk measure in accordance with this appendix; and
(iv) The swap dealer must be able to demonstrate that its model
is an appropriate representation of comprehensive risk in light of
the historical price variation of its correlation trading positions.
(3) Requirements for stress testing. (i) A swap dealer must at
least weekly apply specific, supervisory stress scenarios to its
portfolio of correlation trading positions that capture changes in:
(A) Default rates;
(B) Recovery rates;
(C) Credit spreads;
(D) Correlations of underlying exposures; and
(E) Correlations of a correlation trading position and its
hedge.
(ii) Other requirements. (A) A swap dealer must retain and make
available to the Commission and to the registered futures
association of which the swap dealer is a member the results and all
assumptions and parameters of the supervisory stress testing,
including comparisons with the capital requirements generated by the
swap dealer's comprehensive risk model.
(B) A swap dealer must report promptly to the Commission and to
the registered futures association of which it is a member any
instances where the stress tests indicate any material deficiencies
in the comprehensive risk model.
(n) Securitization Exposures. (1) To use the simplified
supervisory formula approach (SSFA) to determine the specific risk-
weighting factor for a securitization position, a swap dealer must
have data that enables it to assign accurately the parameters
described in paragraph (n)(2) of this appendix. Data used to assign
the parameters described in paragraph (n)(2) of this appendix must
be the most currently available data; if the contracts governing the
underlying exposures of the securitization require payments on a
monthly or quarterly basis, the data used to assign the parameters
described in paragraph (n)(2) of this appendix must be no more than
91 calendar days old. A swap dealer that does not have the
appropriate data to assign the parameters described in paragraph
(n)(2) of this appendix must assign a specific risk-weighting of 100
percent to the position.
(2) SSFA parameters. To calculate the specific risk-weighting
factor for a securitization position using the SSFA, a swap dealer
must have accurate information on the five inputs to the SSFA
calculation described in paragraphs (n)(2)(i) through (n)(2)(v) of
this appendix.
(i) KG is the weighted-average (with unpaid principal
used as the weight for each exposure) total capital requirement of
the underlying exposures calculated for a swap dealer's credit risk.
KG is expressed as a decimal value between zero and one
(that is, an average risk weight of 100 percent presents a value of
KG equal to 0.08).
(ii) Parameter W is expressed as a decimal value between zero
and one. Parameter W is the ratio of the sum of the dollar amounts
of any underlying exposures of the securitization that meet any of
the criteria as set forth in paragraphs (n)(2)(ii)(A) through (F) of
this appendix to the balance, measured in dollars, of underlying
exposures:
(A) Ninety days or more past due;
(B) Subject to a bankruptcy or insolvency proceeding;
(C) In the process of foreclosure;
(D) Held as real estate owned;
(E) Has contractually deferred payments for 90 days or more,
other than principal or interest payments deferred on;
(1) Federally-guaranteed student loans, in accordance with the
terms of those guarantee programs; or
(2) Consumer loans, including non-federally guaranteed student
loans, provided that such payments are deferred pursuant to
provisions included in the contract at the time funds are disbursed
that provide for period(s) of deferral that are not initiated based
on changes in the creditworthiness of the borrower; or
(F) Is in default.
(iii) Parameter A is the attachment point for the position,
which represents the threshold at which credit losses will first be
allocated to the position. Except as provided in 12 CFR
217.210(b)(2)(vii)(D) for nth to default derivatives, parameter A
equals the ratio of the current dollar amount of underlying
exposures that are subordinated to the position of the swap dealer
to the current dollar amount of underlying exposures. Any reserve
account funded by the accumulated cash flows from the underlying
exposures that is subordinated to the position that contains the
swap dealer's securitization exposure may be included in the
calculation of parameter A to the extent that cash is present in the
account. Parameter A is expressed as a decimal value between zero
and one.
(iv) Parameter D is the detachment point for the position, which
represents the threshold at which credit losses of principal
allocated to the position would result in a total loss of principal.
Except as provided in 12 CFR 210(b)(2)(vii)(D) for nth-to-default
credit derivatives, parameter D equals parameter A plus the ratio of
the current dollar amount of the securitization positions that are
pari passu with the position (that is, have equal seniority with
respect to credit risk) to the current dollar amount of the
underlying exposures. Parameter D is expressed as a decimal value
between zero and one.
(v) A supervisory calibration parameter, p, is equal to 0.5 for
securitization positions that are not resecuritization positions and
equal to 1.5 for resecuritization positions.
(3) Mechanics of the SSFA. KG and W are used to
calculate KA, the augmented value of KG, which
reflects the observed credit quality of the underlying exposures.
KA is defined in paragraph (n)(4) of this appendix. The
values of parameters A and D, relative to KA determine
the specific risk-weighting factor assigned to a securitization
position, or portion of a position, as appropriate, is the larger of
the specific risk-weighting factor determined in accordance with
this paragraph (n)(3), paragraph (n)(4) of this appendix, and a
specific risk-weighting factor of 1.6 percent.
(i) When the detachment point, parameter D, for a securitization
position is less than or equal to KA, the position must
be assigned a specific risk-weighting factor of 100 percent.
(ii) When the attachment point, parameter A, for a
securitization position is greater than or equal to KA,
the swap dealer must calculate the specific risk-weighting factor in
accordance with paragraph (n)(4) of this appendix.
(iii) When A is less than KA and D is greater than
KA, the specific risk-weighting factor is a weighted-
average of 1.00 and KSSFA calculated under paragraphs
(n)(3)(iii)(A) and (3)(iii)(B) of this appendix. For the purpose of
this calculation:
(A) The weight assigned to 1.00 equals
[[Page 57561]]
[GRAPHIC] [TIFF OMITTED] TR15SE20.014
(iii) The specific risk-weighting factor for the position
(expressed as a percent) is equal to KSSFA x 100.
(o) Additional conditions. As a condition for the swap dealer to
use this Appendix A to calculate certain of its capital charges, the
Commission, or registered futures association of which the swap
dealer is a member, may impose additional conditions on the swap
dealer, which may include, but are not limited to restricting the
swap dealer's business on a product-specific, category-specific, or
general basis; submitting to the Commission or the registered
futures association a plan to increase the swap dealer's regulatory
capital; filing more frequent reports with the Commission or the
registered futures association; modifying the swap dealer's internal
risk management control procedures; or computing the swap dealer's
deductions for market and credit risk in accordance with Sec. Sec.
23.102 as appropriate. If the Commission or registered futures
association finds it is necessary or appropriate in the public
interest, the Commission or registered futures association may
impose additional conditions on the swap dealer, if:
(1) The swap dealer is required to provide notice to the
Commission or the registered futures association that the swap
dealer's regulatory capital is less than $100 million;
(2) The swap dealer fails to meet the reporting requirements set
forth in Sec. 23.105;
(3) Any event specified in Sec. 23.105 occurs;
(4) There is a material deficiency in the internal risk
management control system or in the mathematical models used to
price securities or to calculate deductions for market and credit
risk or allowances for market and credit risk, as applicable, of the
swap dealer;
(5) The swap dealer fails to comply with this Appendix A; or
(6) The Commission finds that imposition of other conditions is
necessary or appropriate in the public interest.
0
16. Add Appendix B to Subpart E of Part 23 to read as follows:
Appendix B to Subpart E of Part 23--Swap Dealer and Major Swap
Participant Position Information
BILLING CODE 6351-01-P
[[Page 57562]]
[GRAPHIC] [TIFF OMITTED] TR15SE20.015
[[Page 57563]]
[GRAPHIC] [TIFF OMITTED] TR15SE20.016
[[Page 57564]]
[GRAPHIC] [TIFF OMITTED] TR15SE20.017
[[Page 57565]]
[GRAPHIC] [TIFF OMITTED] TR15SE20.018
0
17. Add Appendix C to Subpart E of Part 23 to read as follows:
Appendix C to Subpart E of Part 23--Financial Reports and Specific
Position Information for Swap Dealers and Major Swap Participants
Subject to the Capital Requirements of a Prudential Regulator
[[Page 57566]]
[GRAPHIC] [TIFF OMITTED] TR15SE20.019
[[Page 57567]]
[GRAPHIC] [TIFF OMITTED] TR15SE20.020
[[Page 57568]]
[GRAPHIC] [TIFF OMITTED] TR15SE20.021
[[Page 57569]]
[GRAPHIC] [TIFF OMITTED] TR15SE20.022
BILLING CODE 6351-01-C
[[Page 57570]]
PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION
0
18. The authority citation for part 140 continues to read as follows:
Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and
16(b).
0
19. In Sec. 140.91, redesignate paragraphs (a)(11) and (12) as
paragraphs (a)(12) and (13), and add a new paragraph (a)(11) to read as
follows:
Sec. 140.91 Delegation of authority to the Director of the Division
of Clearing and Risk and to the Director of the Division of Swap Dealer
and Intermediary Oversight.
(a) * * *
(11) All functions reserved to the Commission in Sec. 23.100-106
of this chapter, except for those related to the revocation of a swap
dealer's or major swap participant's approval to use internal models to
compute capital requirements under Sec. 23.102 of this chapter, those
related to the Commission's order under Sec. 23.104 of this chapter,
and the issuance of Capital Comparability Determinations under Sec.
23.106 of this chapter.
* * * * *
Issued in Washington, DC, on July 24, 2020, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Capital Requirements of Swap Dealers and Major Swap
Participants--Commission Voting Summary, Chairman's Statement, and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz and
Stump voted in the affirmative. Commissioners Behnam and Berkovitz
voted in the negative.
Appendix 2--Supporting Statement of Chairman Heath P. Tarbert
Today marks 10 years and a day since the Dodd-Frank Wall Street
Reform and Consumer Protection Act (``Dodd-Frank Act'') was signed
into law. Much has changed during the past decade--our derivatives
markets today are faster, increasingly digital, and more deeply
connected to the global economy than they were in 2010. Yet amidst
these changes, there has been at least one constant: The absence of
capital requirements for swap dealers and major swap participants
for which the CFTC is responsible.\1\ As a response to the credit
crisis of 2008, Section 731 of the Dodd-Frank Act amended the
Commodity Exchange Act (``CEA''), providing that the CFTC ``shall
adopt'' capital and financial reporting requirements for these
entities.\2\ It is high time to fulfill this mandate and close the
book on our Dodd-Frank Act responsibilities.\3\ After all, ``late''
is always better than ``too late.''
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\1\ The CFTC does not have jurisdiction to establish capital
requirements for swap dealers subject to the jurisdiction of a
federal banking regulator as identified in Section 1a(39) of the
CEA, 7 U.S.C. 1(a)(39) (2018).
\2\ See Section 4s(e) and 4s(f)(2) of the CEA, 7 U.S.C. 6s(e),
6s(f)(2) (2018).
\3\ Section 731 of the Dodd-Frank Act also required the CFTC to
establish initial and variation margin requirements for uncleared
swaps, which are being implemented on a phased schedule that
currently extends to all but the smallest swap market participants.
See Statement of Chairman Heath P. Tarbert in Support of Extending
the Phase 5 Initial Margin Compliance Deadline (May 28, 2020),
https://www.cftc.gov/PressRoom/SpeechesTestimony/tarbertstatement052820c.
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There is another compelling reason to finalize a capital rule
that is more than a decade in the making: \4\ Certainty. One of our
strategic goals as an agency is to enhance the regulatory experience
for market participants at home and abroad.\5\ Certainty is the
bedrock of this goal. Our swap dealers cannot effectively plan for
compliance without clarity from us about what their capital
obligations will look like. Today we lift this cloud of uncertainty
by finalizing a capital rule that carefully accounts for the
differences among our swap dealers.
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\4\ The capital rule was first proposed in 2011 and re-proposed
in 2016. See Capital Requirements of Swap Dealers and Major Swap
Participants, 76 FR 27802 (May 12, 2011); see also Capital
Requirements of Swap Dealers and Major Swap Participants, 81 FR
91252 (Dec. 16, 2016). The comment period was re-opened in December
2019, allowing the Commission to glean additional insights from
market participants prior to presenting today's final rule. See
Capital Requirements of Swap Dealers and Major Swap Participants, 84
FR 69664 (Dec. 16, 2019).
\5\ See CFTC Strategic Plan 2020-2024, at 4 (discussing
Strategic Goal 3), https://www.cftc.gov/media/3871/CFTC2020_2024StrategicPlan/download.
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The final capital rule is designed to enhance customer
protection and reduce systemic risk in the financial system. Capital
requirements are the ultimate backstop, ensuring that customers are
protected and the financial system remains sound in the event that
all other measures fail. While our uncleared margin rules have
effectively absorbed the shocks of recent pandemic-driven
volatility,\6\ a capital regime will provide further assurances that
our markets and their participants can weather new storms.
---------------------------------------------------------------------------
\6\ Heath Tarbert, Volatility Ain't What it Used to Be, Wall
Street Journal (Mar. 23, 2020), https://www.wsj.com/articles/volatility-aint-what-it-used-to-be-11585004897.
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Determining Capital
The final capital rule requires swap dealers and major swap
participants to maintain a level of minimum capital based on one of
three basic approaches. Each approach incorporates minimum amounts
of capital based on various criteria, including a $20 million floor,
a level of capital required by the National Futures Association, and
the amount of margin on uncleared swap transactions. The three basic
approaches will be the focus of my remarks because they are
effectively tailored to the distinctive type of swap dealer
involved.
Regulatory Flexibility
Our derivatives markets are vibrant in large part because of the
diversity of swap dealers and other market participants. Of the 108
provisionally registered swap dealers, 56 will be subject to the
capital requirements. Of those, four are futures commission
merchants that are dually registered with the SEC as broker-dealers
and 12 are non-bank subsidiaries of bank holding companies. Others
are non-banks that deal in financial swaps involving interest rates,
foreign currency, credit, and the like; still more are primarily
engaged in agricultural and energy businesses; and several are
subject to the laws and regulations of other countries.
The final capital rule applies to entities with a variety of
business structures, asset profiles, and risk levels. For example, a
swap dealer primarily involved in the energy business is
fundamentally different from a large bank involved in financial
swaps. A ``one-size-fits-all'' approach would be incompatible with
the rich gradations in our derivatives markets. As a result, the
final capital requirements offer regulatory flexibility by
accounting for key differences among covered entities. This flexible
approach is designed to enhance the regulatory experience for our
market participants \7\ while safeguarding the markets, as more
fully discussed below.
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\7\ See CFTC Strategic Plan, supra note 5, at 4.
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1. Capital Requirements for FCM Swap Dealers
The CFTC has longstanding capital requirements for Futures
Commission Merchants (``FCMs'') to ensure customer funds are
protected in the event of an FCM failure.\8\ The final rule
preserves existing FCM capital rules for swap dealers that are also
registered as FCMs, but makes a few key adjustments to better
address risk and customer protection associated with dealing in
swaps.
---------------------------------------------------------------------------
\8\ See Regulation 1.17, 17 CFR 1.17 (2019).
---------------------------------------------------------------------------
The final rule requires FCM swap dealers to maintain minimum
capital equal to or greater than the sum of: (i) The current FCM
risk margin amount of 8% of customer and noncustomer cleared
futures, cleared foreign futures, and cleared swaps positions; and
(ii) 2% of the total margin amount associated with uncleared swaps.
Security-based swaps are excluded from both margin amounts. In
addition, the final rule increases the $1 million minimum capital
``floor'' for FCMs to $20 million for FCM swap dealers.
These changes reflect sound policy. In particular, excluding
security-based swaps comports with the CFTC's longstanding respect
for the SEC's jurisdiction over those products. Moreover, excluding
cleared swaps from the 2% risk margin amount brings our capital
requirements in line with the lower credit risk posed by cleared
products. This approach is also consistent with the CFTC's net
capital requirement for Registered
[[Page 57571]]
Foreign Exchange Dealers,\9\ as well as the SEC's capital rules for
broker dealers.\10\
---------------------------------------------------------------------------
\9\ See Section 2(c)(2)(C) of the CEA, 7 U.S.C. 2(c)(2)(C)
(2018), and Regulation 5.7(a), 17 CFR 5.7(a) (2019).
\10\ See SEC Rule 240.15c3-1, 17 CFR 240.15C3-1 (2019).
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2. Capital Requirements for Non-FCM Swap Dealers
Well-crafted rules must account for the differences among our
market participants. For swap dealers that are not FCMs, the final
rule provides three methods of determining minimum capital that
respond to their different business models, risk profiles, and
capital structures.\11\
---------------------------------------------------------------------------
\11\ See Regulation 23.101.
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a. The Net Liquid Assets Approach
Some swap dealers have responsibility for customer funds, such
as those that are dually registered with the SEC as broker dealers.
For these swap dealers, capital requirements can advance customer
protection where all else has failed, by providing a ``cushion'' for
orderly liquidation.\12\ An effective cushion requires liquidity,
which can be analogized to the readily available cash in one's
wallet. Consistent with this analogy, swap dealers may select the
Net Liquid Assets approach in the final rule--requiring them to
maintain 2% of the margin amount associated with uncleared swaps--
which we believe is sufficient to protect customer funds in the
event of a liquidation.
---------------------------------------------------------------------------
\12\ Former SEC Commissioner Dan Gallagher, ``The Philosophies
of Capital Requirements'' (speech in Washington, DC, Jan. 15, 2014)
at 1, https://www.sec.gov/news/speech/2014-spch011514dmg.
---------------------------------------------------------------------------
The Net Liquid Assets approach is not only about customer
protection: It also facilitates sensible harmonization with SEC
capital requirements for dual registrants. In doing so, the Net
Liquid Assets approach supports the CFTC's strategic goal of
improving the regulatory experience for market participants.\13\
---------------------------------------------------------------------------
\13\ See CFTC Strategic Plan, supra note 5 at 4 (discussing
Strategic Goal 3).
---------------------------------------------------------------------------
b. The Bank-Based Approach
Banks are the backbone of our financial system, and are subject
to a specific statutory regime managed by the Federal Reserve Board
and other federal banking regulators. Banks--and by extension their
non-bank swap dealer subsidiaries--naturally raise greater systemic
risk concerns than other types of swap dealers.
While the cash in one's wallet is the appropriate analogy when
thinking about capital as a measure of customer protection, the
central role banks play in our financial system requires us to
consider a much bigger picture. For banks, capital must facilitate
safety and soundness, ensuring that they act prudently.\14\ The
personal finance analogy for assessing bank capital, therefore, is
not just cash-in-wallet, but also savings accounts, checking
accounts, retirement funds, and other assets.
---------------------------------------------------------------------------
\14\ See Gallagher, supra note 12, at 1.
---------------------------------------------------------------------------
This broad view of bank capital as a window into solvency is
designed to reduce overall risk in the financial system, advancing a
strategic goal of the CFTC.\15\ As stated in the agency's 2020-2024
Strategic Plan, ``[t]aking steps to avoid systemic risk will not
only protect market participants, but increase confidence in the
soundness of U.S. derivatives markets.'' \16\ Our bank-based capital
approach is designed to meet this goal.
---------------------------------------------------------------------------
\15\ See CFTC Strategic Plan, supra note 5, at 5 (discussing
Strategic Goal 1, which is to strengthen the resilience and
integrity of our derivatives markets while fostering their
vibrancy).
\16\ Id.
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Accordingly, swap dealers selecting the Bank-Based Approach may
satisfy their capital requirements by retaining (i) 8% of risk-
weighted assets (``RWA''), composed of at least 6.5% of tier 1
common equity (``CET1''), and (ii) 8% of their uncleared swap margin
amount. Requiring at least 6.5% of a swap dealer's RWA to be
composed of CET1--the highest-quality regulatory capital--addresses
potential systemic risk by ensuring that available capital can
immediately stem losses, avoiding financial contagion. Second, the
requirement that swap dealers electing the Bank-Based Approach must
retain 8% of margin for uncleared swaps reflects the uniquely
critical role they play in the financial system.
c. The Tangible Net Worth Approach
Finally, some swap dealers are not financial entities, but
rather commercial businesses engaged in the agriculture and energy
sectors. These swap dealers help American families put food on the
table and gas in the car. Unlike financial entities, their balance
sheets often contain significant physical assets, such as oil
refineries, grain warehouses, and even railroad rolling stock. Net
worth--inclusive of physical assets--is the appropriate measure to
assess minimum capital for these commercial entities. In extending
our analogy, capital for these swap dealers must be inclusive not
just of cash or retirement account holdings, but one's house and
car--the assets that could be pledged as collateral in borrowing.
The final capital rule recognizes that commercial entities are
fundamentally different from other swap dealers. This is reflected
in the Tangible Net Worth (``TNW'') approach, which sets minimum
capital at 8% of the margin amount for uncleared swaps. Eligibility
for the TNW approach is determined at the consolidated parent level,
which allows a financial subsidiary of a commercial entity that is
registered as a swap dealer to elect the approach.
3. Market and Credit Risk Models
In addition to capital requirements, today's final rule makes
important adjustments to the requirements that swap dealers must
satisfy to rely on internal market and credit risk models rather
than the standardized models provided in Regulation 1.17. Like
minimum capital requirements, market and credit risk models will be
most effective when they reflect a swap dealer's unique business and
risk profile. In addition, internal models specific to a swap
dealer's portfolio can provide a more nuanced view of risk than
standardized models.
That said, the final rule provides a certification process for
swap dealers relying on internal market and credit risk models,
ensuring flexibility while retaining oversight through the National
Futures Association. Permitting swap dealers to rely on bespoke
models that best account for their particular situations is good
governance and enhances the regulatory experience.\17\ At the same
time, by subjecting those models to objective validation by the
National Futures Association (and potentially other domestic and
foreign regulators), there is a check on that flexibility. Further,
this approach makes the CFTC's model approval process more closely
aligned with the SEC and federal banking regulators.\18\
---------------------------------------------------------------------------
\17\ See CFTC Strategic Plan, supra note 5, at 7.
\18\ The market and credit risk model approval process in the
final rule is similar to the requirements established by the Federal
Reserve Board for bank holding companies, as well as the SEC's
requirements for security-based swap dealers.
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Allowing swap dealers to rely on internal risk models is also an
appropriate instance of principles-based regulation,\19\ as
prescriptive requirements that do not account for differences among
firms simply cannot measure risk as accurately as internal models
that account for key differences among swap dealers.
---------------------------------------------------------------------------
\19\ For a discussion of the circumstances in which to apply
principles vs. rules, see Heath P. Tarbert, Rules for Principles and
Principles for Rules: Tools for Crafting Sound Financial Regulation,
10 Harvard Business Law Review (2020).
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4. Financial Reporting
Today's final rule also adopts financial reporting,
recordkeeping, and notification requirements for swap dealers and
major swap participants. These requirements include the obligation
to provide financial statements and reports to the CFTC and the
National Futures Association. Most importantly, covered entities
must alert us when there is undercapitalization, a books and records
problem, and/or a specified triggering event, such as the failure to
post required margin. The rule also includes public reporting
requirements for those swap dealers not subject to the jurisdiction
of a banking regulator.
These reporting requirements should serve as early warning
systems for systemic risk, allowing the CFTC to react quickly to
emerging threats to financial stability. At the same time, the
reporting requirements are designed to harmonize, as appropriate,
with existing financial reporting requirements for FCMs, bank swap
dealers, and SEC-registered entities. The final rule also eliminates
weekly position reporting, which does not materially advance our
ability to monitor systemic risk. In short, balance is the
touchstone of the financial reporting rules, allowing us to achieve
greater insight into potential systemic risk without placing undue
burdens on market participants.
5. Substituted Compliance
Last, our final rule today accounts for non-U.S. domiciled swap
dealers by allowing them to petition the CFTC for substituted
compliance in satisfaction of their capital and financial reporting
requirements. These swap dealers may seek a comparability
determination based on the capital and
[[Page 57572]]
financial reporting rules of their home jurisdictions, provided
certain conditions are met. In providing this option, the final rule
supports international comity while enhancing the regulatory
experience for market participants abroad.\20\
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\20\ See CFTC Strategic Plan, supra note 5, at 4 (discussing
Strategic Goal 3).
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Conclusion
Today we mark a decade and a day following the enactment of the
Dodd-Frank Act by completing the CFTC's required rulemakings under
Section 731. The final capital rule is flexible and tailored, to
accommodate the wide array of swap dealers that touch every corner
of our markets. The final rule is also long on customer protection
and systemic risk mitigation, advancing the CFTC's mission of
promoting the integrity, resilience, and vibrancy of the U.S.
derivatives markets through sound regulation. After 10 years of hard
work by CFTC staff, I am pleased to support the final rule and the
long-awaited certainty it brings to our markets. Given the current
economic crisis the world faces in light of the continuing COVID-19
pandemic, we are fortunate to have a final rule that has come late,
but not too late.
Appendix 3--Supporting Statement of Commissioner Brian D. Quintenz
Ten years and one day ago, the Dodd-Frank Act Wall Street Reform
and Consumer Protection Act was enacted. I am proud to vote for
today's final rule which, in my view, is the capstone of the
Commodity Futures Trading Commission's (CFTC or Commission) work to
appropriately calibrate the post-crisis reforms. Capital ensures
that firms are able to continue to operate during times of economic
and financial stress by providing an adequate cushion to protect
them from losses. Just as important as the safety and soundness of
individual firms, capital is designed to give the marketplace
confidence that any given firm has a high probability of surviving
the next crisis.
But, capital requirements also create important incentives that
drive market behavior. The cost of capital may be the most
determinative factor in a firm's decision to remain, or become, a
swap dealer (SD), or to continue to provide clearing services to
clients, in the case of a futures commission merchant (FCM). If
capital costs are too expensive, firms will restrict certain
business activities, end unprofitable business lines, or, in some
cases, exit the swaps or futures markets altogether. As a result,
over time, the swaps and futures markets will become less liquid,
less accessible to end users, more heavily concentrated, and less
competitive. These are not the hallmarks of a healthy financial
system. This is why I have always regarded the finalization of
capital requirements for SDs and FCMs to be the most consequential
rulemaking of the post-crisis reforms.
I believe the final capital regulations for SDs and FCMs adopted
today establish minimum capital requirements that will ensure the
safety and soundness of these firms for years to come, through
periods of economic growth and stability and through periods of
market contraction and extreme volatility. They are appropriately
calibrated to the true risks posed by an SD's or FCM's business and
ensure these firms have the capital necessary to support their
active participation in the markets and servicing of clients. They
are also largely harmonized with the capital approaches of the
prudential regulators and the Securities and Exchange Commission
(SEC), which should reduce unnecessary burdens and facilitate
compliance.
No rule is perfect. I expect there will be aspects of this rule
that need to be revised or recalibrated in the future--and I
specifically discuss some areas below which I would like to see
revisited. Nevertheless, it is a common saying that you cannot build
a great house without a solid foundation. I am confident that
today's capital regulations provide that foundation and will support
vibrant, healthy derivatives markets, with future Commissions able
to build upon this progress in the years to come. I would like to
highlight a few aspects of the final rule below.
The risk margin amount. We heard from many commenters that, of
all the alternatives, the proposed eight percent risk margin amount
would act not as a capital floor as intended, but rather as the
primary driver of firms' capital requirements and as a potential
binding constraint on their businesses. The final rule appropriately
recalibrates the scope of products included in this calculation,
while also adopting a risk margin amount percentage that is
appropriately tailored to the capital approach elected by the firm.
Specifically, the final rule maintains the existing minimum capital
requirements for standalone FCMs, with those firms continuing to
maintain minimum capital equal to or greater than 8% of the risk
margin amount for customer futures and cleared swaps. For FCM-SDs,
the final rule establishes a minimum capital requirement equal to or
greater than (i) 8% of the risk margin amount for customer futures
and cleared swaps, plus (ii) 2% of the risk margin amount for the
FCM-SD's uncleared swaps. For non-FCM SDs that elect the Net Liquid
Assets Approach, the Final Rule requires the firm to maintain
minimum capital equal to or greater than 2% of the SD's uncleared
swap margin. For non-FCM SDs electing either the Bank-Based Approach
or the Tentative Net Worth Approach, the final rule establishes a
minimum capital requirement equal to or greater than 8% of the
firm's uncleared swap margin. For the reasons discussed below, I
believe each of these adjustments from the proposal represents an
improvement that more precisely tailors the capital requirements of
a firm to its particular business and its selected capital approach.
I support the removal of a firm's cleared and uncleared
security-based swaps (SBS) from the risk margin amount calculation.
It is appropriate that the Commission maintain its historical
approach and establish minimum capital requirements for registrants
that are based upon products within the CFTC's jurisdiction. I am
also very pleased that proprietary cleared futures and swaps were
removed from the risk margin amount. FCMs, FCM-SDs, and SDs electing
the Net Liquid Assets Approach are all subject to rigorous market
and credit risk capital charges on these proprietary cleared
positions. I believe these capital charges adequately account for
the risk of these positions and there is no reason to account for
them yet again in the firm's minimum capital requirement. Moreover,
for SDs that elect one of the other capital approaches, I also
believe it is appropriate to exclude proprietary cleared positions
given that the SD's credit exposure on such positions is limited to
either a clearing organization or to the FCM that carries the SD's
account.
Finally, I also support the reduced 2% risk margin multiplier
amount on uncleared swap margin for FCMs, FCM-SDs, and SDs electing
the Net Liquid Assets Approach, while maintaining the 8% multiplier
for other types of standalone SDs. Under the FCM capital rules and
the Net Liquid Assets Capital Approach for standalone SDs, the types
of capital that may be used to meet a firm's minimum capital
requirement are significantly more conservative than the types of
capital that may be used under the Bank-Based Capital Approach and
the Tangible Net Worth Capital Approach. The Net Liquid Assets
Approach is liquidity-focused and generally requires the firm to
hold at least one dollar of highly liquid assets for each dollar of
the firm's liabilities. As a result, when computing what qualifies
as eligible capital under this approach, firms must subtract all
illiquid assets, such as fixed assets and intangible assets. In
contrast, the other capital approaches focus on the solvency of the
firm and require the firms to maintain positive balance sheet
equity. Under these approaches, firms are not required to subtract
illiquid assets or fixed assets from their balance sheet equity.
Given the significantly more restrictive standard for qualifying
eligible capital under the Net Liquid Assets Approach, I think it is
appropriate to lower the risk margin multiplier to 2% in order to
minimize competitive disparities across the other two capital
approaches.
The final rule also expresses the Commission's ongoing
commitment to monitor, and if necessary, adjust, the risk margin
percentage. This should only be done, however, with a wealth of data
and a highly robust economic analysis. With the benefit of the
financial reporting the Commission will soon receive from SDs, the
Commission may be able to further refine this metric to promote
consistency across the possible SD capital approaches.
Bank-based capital approach. In response to commenters, the
final rule now permits firms to use a combination of common equity
tier 1, additional tier 1, and tier 2 capital to meet its minimum
capital requirements under both the 8% of risk-weighted assets and
8% of uncleared swap margin alternatives. In particular, with
respect to the 8% of uncleared swap margin alternative, the rule
does not limit the amounts of additional tier 1 or tier 2 capital
the firm can use to meet the requirement. Because of this additional
flexibility, the final rule requires firms electing this approach to
satisfy all of the four possible minimum capital alternatives.
[[Page 57573]]
The Commission will need to closely observe the impact of this
change to ensure it does not create any competitive disadvantages
for firms electing this approach. I anticipate that if additional
data and analysis shows this outcome creates unintended
consequences, the Commission will take action to address them.
Model approval process. I am also pleased with the model
approval process established in the final rule, which allows the
Commission to realize the benefits of the NFA's considerable
expertise and resources. Once the Commission, or the Director of the
Division of Swap Dealer and Intermediary Oversight (DSIO) pursuant
to delegated authority, makes a determination that the NFA's model
review process is comparable to the Commission's process, the NFA's
approval of a model will satisfy the Commission's model approval
requirement. In addition, for a firm utilizing a model that has
already been approved by its relevant regulator, the final rule
provides a process whereby, upon making certain representations, the
firm can continue to use the model pending approval by the
Commission or NFA. These steps help ensure that firms seeking to use
models will be able to do so by the rule's compliance date.
Areas for further improvement. As I noted above, no rule is
perfect. I would like to briefly highlight three areas not addressed
in this final rule that I hope the Commission will address in the
future.
Standardized market risk capital charges. First, this final rule
does not adjust any of the standardized market risk charges under
Regulation 1.17. I believe that many of these standardized charges
are too high given the liquidity and actual risks of the product.
For example, the final rule applies a 20% notional standardized
market risk charge on uncleared foreign exchange non-deliverable
forwards. In contrast, the Commission's uncleared margin rules apply
a 6% notional charge on these products for purposes of the
standardized initial margin calculation. I hope that in the future
the Commission can work with the SEC to recalibrate and update these
charges to better reflect the risks of the underlying products.
Alternative forms of collateral. Second, I hope that with the
benefit of experience and information received from financial
reporting, the Commission will consider modifying its rules to
recognize alternative forms of collateral, such as letters of credit
or liens, provided by commercial end users that are exempt from
clearing and margin requirements when computing credit risk charges.
Alternative collateral arrangements are frequently used by SDs in
commodity derivatives transactions with end users to create ``right
way'' risk and can be effective means of managing the credit risk of
certain derivatives transactions. I think it would be beneficial for
the Commission's capital regime to recognize, as appropriate, the
risk-reducing nature of these arrangements.
Net liquid assets approach. Third, I am also interested in
continuing to explore commenters' suggestion that firms electing the
Net Liquid Assets Approach be required to maintain tentative net
capital in excess of the risk margin amount, as opposed to the
current net capital requirement. I continue to have concerns that in
periods of high volatility, the procyclicality of increasing margin
requirements may cause unnecessary stress on these firms, as their
capital charges for positions increase at the same time as their
minimum capital requirement. I am interested in looking at possible
adjustments that could be made to address this issue.
In closing, I believe the capital regime adopted today strikes
the necessary balance between capital levels that protect firms from
losses on certain products, and levels that allow firms to earn an
economic benefit from servicing their customers' risk management
needs through those products. There is a direct tradeoff between the
amount of capital regulators require firms to hold to ensure firms'
resilience and viability, and the amount of available capital firms
have to deploy in financial markets to support the market's ongoing
liquidity and health. The capital standards adopted today protect
the safety and soundness of firms, while ensuring they can continue
to service their clients and make markets.
I would also like to thank DSIO, in particular Tom Smith, for
their thoughtfulness and tireless dedication to getting this rule
right. It has truly been a pleasure to work with and learn from you
throughout this process.
Appendix 4--Dissenting Statement of Commissioner Rostin Behnam
I respectfully dissent from the Commodity Futures Trading
Commission's (the ``Commission'' or ``CFTC'') rulemaking today
regarding Capital Requirements of Swap Dealers and Major Swap
Participants (the ``Final Capital Rule'').
Ten Years of Dodd-Frank
Yesterday marked ten years since Congress passed the Dodd-Frank
Wall Street Reform and Consumer Protection Act.\1\ Congress passed
Dodd-Frank as a targeted legislative response to the 2008 financial
crisis and the near obsolescence of the U.S. financial regulatory
framework. The Great Recession wreaked havoc on Main Street
Americans and the global economy. Undercapitalization was at the
heart of the 2008 crisis, and the swift response to require
financial institutions to hold additional capital mitigated both the
blunt economic shock we endured this past March, and the substantial
weight we continue to shoulder as a result of the Covid-19 pandemic.
---------------------------------------------------------------------------
\1\ See The Dodd-Frank Wall Street Reform and Consumer
Protection Act, Public Law 111-203 124 Stat. 1376 (2010) (the
``Dodd-Frank Act'').
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Section 731 of the Dodd-Frank Act \2\ requires the CFTC to
establish capital rules for all registered Swap Dealers (``SDs'')
and Major Swap Participants (``MSPs'') that are not banks, as well
as associated financial recordkeeping and reporting requirements.
The capital requirements in Section 731, which established Section
4s(e) of the Commodity Exchange Act (``the Act''), are clear: ``. .
. [t]o offset the greater risk to the swap dealer or major swap
participant and the financial system arising from the use of swaps
that are not cleared,'' the Commission's capital requirements shall
``help ensure the safety and soundness of the swap dealer or major
swap participant'' and ``be appropriate to the risk associated with
the non-cleared swaps held as a swap dealer or major swap
participant.'' \3\ There can be no doubt that Congress intended to
impose significant new requirements that would contribute to the
protection from another financial crisis.
---------------------------------------------------------------------------
\2\ Id.at section 731(e), 124 Stat. at 1704-6.
\3\ Section 4s(e)(3) of the Commodity Exchange Act (``the
Act''), 7 U.S.C. 6s(e)(3).
---------------------------------------------------------------------------
Congress's 2010 response largely incorporated the international
financial reform initiatives for over-the-counter derivatives laid
out at the 2009 G20 Pittsburgh Summit aimed at improving
transparency, mitigating systemic risk, and protecting against
market abuse.\4\ One of the core initiatives in the G20 statement
was the imposition of higher capital requirements. Paragraph 16 of
the statement provides the purpose the G20 leaders agreed to aim
for: ``To make sure our regulatory system for banks and other
financial firms reins in the excesses that led to the crisis.'' \5\
Paragraph 17 then lays out what the G20 leaders agreed to do to rein
in the excesses, and the first item is this: ``We committed to act
together to raise capital standards.'' \6\ The G20 leaders said
unequivocally that, for over-the-counter derivatives markets,
``[n]on-centrally cleared contracts should be subject to higher
capital requirements.'' \7\ Congress had this same goal in mind when
enacting the Dodd-Frank Act a decade ago.\8\
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\4\ G20, Leaders' Statement, The Pittsburgh Summit (Sept. 24-25,
2009), available at https://www.oecd.org/g20/summits/pittsburgh/.
\5\ Id. at 2.
\6\ Id.
\7\ Id. at 9.
\8\ See Statement of Sen. Christopher Dodd, Cong. Rec., Vol.
156, Issue 104, S5828, S5832 (July 14, 2010) (``Derivatives are
vitally important if utilized properly in terms of wealth creation
and growing an economy. But what was once a way for companies to
hedge against sudden price shocks has become a profit center in and
of itself, and it can be a dangerous one as well, when dealers and
other large market participants don't hold enough capital to back up
their risky bets and regulators don't have information about where
the risks lie.'').
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Three and a Half Years of the Capital Proposal
In 2016, the Commission issued a bipartisan proposal to
implement capital requirements as directed by Congress through
Section 731 of the Dodd-Frank Act.\9\ The Commission now jumps from
a proposal issued in 2016 to a significantly different final rule
nearly four years later, without any intervening reproposal to
provide interested market participants clear proposed capital
requirements to meaningfully comment upon. In so doing, the
Commission undermines the spirit of the Dodd-Frank Act and violates
the letter of the Administrative Procedure Act (``APA'').\10\
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\9\ Capital Requirements of Swap Dealers and Major Swap
Participants, 81 FR 91252 (proposed Dec. 16, 2016) (the ``2016
Proposal'').
\10\ 5 U.S.C. 551 et seq.
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The preamble to the Final Capital Rule asserts that all of the
actions taken today are
[[Page 57574]]
a ``logical outgrowth'' from the 2016 Proposal.\11\ The preamble
even goes a step further, arguing that ``modifications described in
the 2019 Capital Reopening, including a discussion and specific
inclusion of potential rule language, were logical outgrowths'' of
the 2016 Proposal.\12\ This simply cannot be true if the requirement
that a final rule is a logical outgrowth of an agency's proposed
rule is to have any meaning at all.\13\
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\11\ Final Capital Rule at 1.B.
\12\ Id.; Capital Requirements for Swap Dealers and Major Swap
Participants, 84 FR 69664 (Dec. 19, 2019).
\13\ See Small Refiner Lead Phase-Down Task Force v. United
States Envtl. Prot. Agency, 705 F.2d 506, 548-49 (D.C. Cir. 1983)
(``Agency notice must describe the range of alternatives being
considered with reasonable specificity. Otherwise, interested
parties will not know what to comment on, and notice will not lead
to better-informed agency decisionmaking.'').
---------------------------------------------------------------------------
The changes in the Final Capital Rule to the amount of capital
that a futures commission merchant SD (FCM-SD) must maintain are
illustrative of the point. The 2016 Proposal would have required an
FCM-SD to maintain regulatory capital equal to or greater than 8% of
the initial margin associated with the FCM-SD's proprietary cleared
and uncleared futures, foreign futures, swap, and security-based
swap positions. In 2019, the Commission reopened the comment period
on the 2016 Proposal.\14\ In the Federal Register release announcing
the 2019 reopening, the Commission sought additional public input
based on an initial review of comments received from the 2016
Proposal on myriad alternatives, seeking comment ``on all aspects of
the proposed risk margin amount, including comments regarding the
possible increase or decrease of the risk margin percentage in
coordination with the inclusion or exclusion of certain products in
order to establish the most optimal capital requirement.'' \15\
This, in many respects, is a blank check. Not only does it allow for
any conceivable percentage of risk margin, it simultaneously opens
up multiple combinations of inputs. The Commission now states that
any of the possible outcomes along this sliding scale would have
been a logical outgrowth. It is the equivalent of saying that the
Final Capital Rule is a logical outgrowth because it imposes any
capital requirements at all, and that simply cannot be the case
under the legal intent and plain reading of the principle of logical
outgrowth.
---------------------------------------------------------------------------
\14\ 84 FR 69664.
\15\ Id. at 69668.
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A Final Capital Rule (and Five Years of Review)
Where did the Commission end up? The Commission decides today to
set the multiplier for the uncleared swaps of FCM-SDs at 2%, rather
than the 8% originally proposed. The Commission also is modifying
the final rule from the proposal to remove security-based swaps,
proprietary futures, foreign futures, and cleared swaps from the
risk margin amount calculation. These are significant changes from
the 2016 proposal, and they are just one of the possible outcomes
suggested in the reopening of the comment period.
I am not sure if 2% is the appropriate landing spot to insulate
our markets from outsize risk. And based on the preamble to this
Final Capital Rule, I do not think the Commission is certain either.
The preamble states that the Commission does not have the data to
determine whether or not 2% is the optimal or even adequate
percentage.\16\ Instead, the Commission chooses 2% with the intent
that ``the Commission's decision to modify the final rule by
removing cleared and uncleared security-based swaps, as well as
proprietary futures, foreign futures, and cleared swaps positions
from the risk margin amount calculation, and to set the multiplier
at 2% should mitigate many of the commenters' concerns that the
proposed 8% risk margin amount calculation was over inclusive of the
types of positions included in the calculation and was set at a
percentage that was too high.'' \17\ Due to this lack of data, the
Commission will need to conduct a 5-year post implementation review
``to assess whether the minimum capital requirements for FCM-SDs are
adequately calibrated to ensure their safety and soundness.'' \18\
And I applaud the Commission for including this critical regulatory
component of the capital regime's implementation. However, this
information is exactly the type of data that the Commission would
have benefited from during the notice and comment process. By
failing to issue a reproposal in 2019, allowing just a few
additional months of concrete, data driven deliberation, which could
have clearly stated a specific approach, we lost the opportunity to
find out whether the minimum capital requirements that we selected
are adequately calibrated to ensure safety and soundness.
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\16\ Final Capital Rule at II.B.2.b. (``The Commission does not
have the benefit of . . . comprehensive data regarding the
multiplier for the uncleared swaps risk margin amount at this
time.'')
\17\ Id.
\18\ Id.
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Because of the lack of clarity in the reopening of the comment
period, we again received more general comments that 8% was too
high. In justifying the selection of 2%, the preamble states that
``2% should mitigate many of the commenters' concerns that the
proposed 8% risk margin amount calculation was over inclusive of the
types of positions included in the calculation and was set at a
percentage that was too high.'' \19\ Because we did not provide a
clear alternative, we again received comments on 8% rather than
comments on 2%, or on some alternative.
---------------------------------------------------------------------------
\19\ Id.
---------------------------------------------------------------------------
Ultimately, this lack of information gathering impacts the CFTC
and results in a Final Capital Rule that has not benefited from
fulsome public comment. However, the impacts on our market
participants are greater. They have been denied the ability to
comment meaningfully. This is particularly true of the cost benefit
analysis. Broadly asking stakeholders to comment on any variation
results in a situation where no one had an opportunity to comment on
anything approximating what the Commission has done in its Final
Capital Rule. As a result, this rule ultimately derived from a
process that is, in many respects, equivalent to not soliciting
comments from the public and market participants at all.\20\
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\20\ See Texas v. United States EPA, 389 F.Supp. 3d. 497, 505
(S.D. Tex. 2019) (``The APA does not envision requiring interested
parties to parse through such vague references like tea leaves to
discern an agency's regulatory intent regarding such significant
changes to a final rule'').
---------------------------------------------------------------------------
I note that, less than a month ago, the Commission voted to
withdraw the Regulation Automated Trading proposal (``Regulation
AT''),\21\ the most recent iteration of which had been issued in
November 2016, a couple of weeks before the 2016 Proposal.\22\ At
the same time that Regulation AT was withdrawn, the Commission
issued a rebranded Electronic Trading Risk Principles proposal
intended to ``accomplish a similar goal'' to the original Regulation
AT.\23\ Following the logic set forth today for the Final Capital
Rule, the Commission could have simply issued a final rule for
Electronic Trading Risk Principles last month, arguing that it was
merely a logical outgrowth of the latest iteration of Regulation AT.
While I disagreed with last month's policy decision, procedurally
the Commission did the right thing under the APA. We should have
followed the same procedure for capital, and issued a
reproposal.\24\ If we had done so last December, we could have
received meaningful comments from market participants on a clearly
stated reproposal, and we could well have been in position to
finalize a stronger, more carefully considered Final Capital Rule
today that addresses current market conditions in a manner that is
more data driven.
---------------------------------------------------------------------------
\21\ Press Release Number 8188-20, CFTC, CFTC Approves Two Final
Rules and Two Proposed Rules at June 25 Open Meeting (June 25,
2020), https://www.cftc.gov/PressRoom/PressReleases/8188-20.
\22\ Regulation Automated Trading, 81 FR 85333 (proposed Nov.
25, 2016).
\23\ Electronic Trading Risk Principles (proposed Jun. 25,
2020), at I.B.
\24\ Statement of Dissent of Commissioner Rostin Behnam, Capital
Requirements of Swap Dealers and Major Swap Participants (Dec. 10,
2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement121019.
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Conclusion
Before I conclude, I would like to thank staff from the Division
of Swap Dealer and Intermediary Oversight for their excellent work
on this highly technical and complex rulemaking, and willingness to
answer my questions and take feedback.
While I would have liked to stand with my fellow Commissioners
today, I cannot justify it under these circumstances. I truly wish
that I could support today's Commission action as we mark the tenth
anniversary of the Dodd-Frank Act this week. To reiterate sentiments
made in my first speech as a CFTC Commissioner,\25\ capital is a
[[Page 57575]]
cornerstone financial crisis reform \26\ that is critical to
protecting our financial institutions and our financial system as a
whole from systemic risk and contagion. But it is also critical to
protection from unintended consequences if capital (and margin)
levels are applied and set without due regard to the uniqueness of
our financial markets and market participants.
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\25\ See Rostin Behnam, Commissioner, CFTC, The Dodd-Frank
Inflection Point: Building on Derivatives Reform, Remarks of CFTC
Commissioner Rostin Behnam at the Georgetown Center for Financial
Markets and Policy (Nov. 14, 2017), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam.
\26\ G20, Leaders' Statement, Framework for Strong, Sustainable
and Balanced Growth, The Pittsburgh Summit (September 24-25 2009),
http://www.g20.utoronto.ca/2009/2009communique0925.html (``We
committed to act together to raise capital standards . . .'').
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I appreciate that in moving forward, we must fulfill our
directive to establish capital standards appropriately, and in
consideration of other activities engaged in by SDs and MSPs such
that we ensure that we do not penalize commercial end-users who need
choices and benefit from competition in our markets. At the same
time, we must heed Congressional intent without any compromise,
regardless of what we think is best, remaining cognizant of the
impact that capital requirements have on market stability, and
follow APA rulemaking requirements when we do so.
Shortly before the Commission voted on the reopening in
December, 2019, Chairman Tarbert gave remarks about transparency
\27\, making many very powerful and important points about the
incredible importance of being mindful--as regulators--of ``. . .
not only what we do, but how we do it.'' \28\ The Chairman ended
that particular statement with a wonderful quote from Aristotle.
Among many profound lessons from the Greek philosopher, he is also
sometimes credited with the statement that ``[p]atience is bitter,
but its fruit is sweet.'' In that vein, I simply wish the Commission
had devoted a little bit more time to how we fulfill this
foundational Dodd-Frank requirement.
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\27\ Heath P. Tarbert, Chairman, CFTC, Statement of Chairman
Heath P. Tarbert Before the December 10, 2019 Open Meeting (Dec. 10,
2019), https://www.cftc.gov/PressRoom/SpeechesTestimony/tarbertstatement121019.
\28\ Id.
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The road has been long, far too long in many respects. But,
unsure of what deadlines we are racing to meet at this point, or
targets we are aiming to hit, I feel strongly the Commission and our
markets, would have stood on sturdier ground, and perhaps even have
landed at the same conclusion voted on today, if we had practiced a
little patience.
Appendix 5--Dissenting Statement of Commissioner Dan M. Berkovitz
Today, for the first time, the Commission adopts capital
requirements for non-bank swap dealers (``Final Rule''). This is the
last major swap dealer regulation required under the Dodd-Frank Act.
The Dodd-Frank Act specified that the swap dealer capital
requirement ``shall--(i) help ensure the safety and soundness of the
swap dealer or major swap participant; and (ii) be appropriate for
the risk associated with the non-cleared swaps held as a swap dealer
or major swap participant.'' \1\
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\1\ CEA section 4s(e)(3)(A).
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Unfortunately, there is no rational basis to conclude that the
minimum capital requirements in the Final Rule meet those standards
and serve their intended purpose. The Final Rule is not based on
quantitative analysis of data or the appropriate level of capital
for the risks presented by a swap dealer. Rather, it appears to be
designed with the objective of ensuring that most dealers will not
need to raise more capital. In its consideration of costs and
benefits, the Commission concludes that, depending on the type of
swap dealer, ``the likelihood of . . . needing to raise additional
capital due to this rule might be low,'' ``may not be significant,''
or ``that their tangible net worth greatly exceeds the Commission's
requirement.'' \2\ For this reason, I dissent.
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\2\ Final Capital Rule release, Cost Benefit Considerations,
Attachment A. The analysis also notes that a few non-bank financial
swap dealers ``might need to raise additional capital and thus might
incur significant cost to comply with the Commission's capital
requirement.''
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No Rational Basis To Conclude That Minimum Capital Levels Are
Appropriate
The Final Rule permits swap dealers, depending on their
characteristics, to select one of three different approaches to
calculate their minimum capital requirements. The approaches are
identified as the: (1) ``Net Liquid Assets Capital Approach,'' (2)
``Bank-Based Capital Approach,'' and (3) ``Tangible Net Worth
Capital Approach.'' The first two approaches are based on existing
CFTC, Securities and Exchange Commission (``SEC''), and Federal
Reserve capital requirements for futures commission merchants
(``FCMs''), securities broker-dealers (``BDs''), and banks. The
third approach is designed to accommodate commercial swap dealers
whose capital is normally in the form of physical assets.
These methods are based on existing holistic, all-enterprise
capital approaches that take into account a broad spectrum of risks.
They are not necessarily suited to the swap dealers subject to the
CFTC capital requirements, which are mostly stand-alone legal
entities for swap dealing. Accordingly, it is not clear that these
methodologies will generate capital requirements that are
``appropriate for the risk associated with the non-cleared swaps
held as a swap dealer or major swap participant.'' \3\ However,
using those precedents has some advantages in that it allows the
different types of swap dealers to manage capital using known
structures. While these historical approaches were not specifically
designed to be able to meet the statutory standard, it may be
possible to achieve the intended outcome using these structures if
the specific methods, limits, and other factors had been developed
based on the swap dealer specific standard. Unfortunately, this did
not happen.
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\3\ CEA section 4s(e)(3)(A).
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In December 2016, the Commission issued a re-proposal of the
previously proposed capital regulations (``2016 Re-Proposal'') \4\
that contained minimum capital requirements in each approach that
were largely based on existing levels for FCM capital requirements.
The 2016 Re-Proposal included cleared and uncleared swaps and
uncleared security-based swaps in the calculation of the minimum
requirements.
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\4\ Proposed Rule, Capital Requirements of Swap Dealers and
Major Swap Participants, 81 FR 91252 (Dec. 16, 2016).
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Commenters objected that the 2016 Re-Proposal was too costly and
burdensome. At the end of last year the Commission, by a 3-2 vote,
issued a second re-proposal (``2019 Second Re-Proposal'') consisting
of over 140 mostly open-ended questions designed to invite comments
supporting reduced minimum capital requirements or otherwise lower
the costs for swap dealers to comply.\5\
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\5\ For a more in-depth discussion of the procedural and
substantive problems inherent in the 2019 Second Re-Proposal, see
Dissenting Statement of Commissioner Dan M. Berkovitz, ``Proposed''
Rule and ``Request for Additional Comment'' on Capital Requirements
of Swap Dealers and Major Swap Participants (Dec. 10, 2019),
available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatment121019b.
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Not surprisingly, the Final Rule adopts numerous provisions that
are weaker than the 2016 Re-Proposal. The preamble to the Final Rule
identifies ``lower capital charges,'' ``harmonization,'' and
consistency with ``historical'' precedent as rationales for these
provisions.
While the Commission makes conclusory statements that the rule
helps ``ensure the safety and soundness'' of the swap dealers, there
is little or no analysis supporting these assertions. Similarly,
there is no analysis as to how or why these capital levels are
``appropriate for the risk associated with the non-cleared swaps
held as a swap dealer or major swap participant.''
The capital requirements for dually-registered FCM/BDs that are
also swap dealers illustrate how this approach leads to arbitrary
results from a risk-based perspective. Under the 2016 Re-Proposal,
in addition to capital required to be held for non-swap activity,
the FCM/BD swap dealer would be required to hold capital equal to a
minimum of 8% of initial margin for uncleared swaps, security-based
swaps, and certain futures positions of the swap dealer. As
explained in the 2016 Re-Proposal, the 8% multiplier level is drawn
from the Commission's experience with its risk-based capital
requirements for FCMs.\6\
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\6\ See 17 CFR 1.17(a)(1)(i)(B).
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Based on comments received on the prior proposals, and on the
desire to ``harmonize'' with the SEC, the Final Rule lowers the
capital add-on multiplier level to 2%, and only applies the
multiplier to uncleared swaps initial margin.\7\ Security-based
swaps are not included in the calculation based on the rationale
that only swaps are within the CFTC's jurisdiction. If the entity is
also registered with the SEC and the SEC's capital requirements are
greater than the CFTC's, then the entity can use the SEC's
requirement with no add-on for uncleared swaps. The Commission makes
these changes not based on any analysis of the risk to the
registrant,
[[Page 57576]]
but because this approach ``maintains a consistency with the long-
standing historical approach that the Commission and SEC have
followed with respect to dually-registered FCM/BDs.'' \8\
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\7\ While the Final Capital Rule selectively picks the 2% level
purportedly to ``harmonize'' with the SEC's security-based swap
dealer capital rule, the final rule uses different formulas and
positions for the calculation. Furthermore, the SEC's rule has a
built-in increase in the multiplier from 2% to 8% over time. The
CFTC Final Capital Rule expressly choses to deviate from that SEC
approach and has no such increases.
\8\ Final Rule release, section II.C.2.
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The following example shows how this approach can result in an
arbitrary outcome from a risk perspective. Under the Final Rule, if
the amount of uncleared swap margin for an FCM that is not a BD is
$1 billion, multiplying that amount by 2% yields a minimum capital
add-on of $20 million. Similarly, under the SEC's capital rule, for
a securities-based swap dealer that is not an FCM with $1 billion of
required margin for uncleared security-based swaps, a 2% add-on
would be $20 million.\9\ Now, let's consider the add-on for a
dually-registered FCM/BD. Each of the CFTC and SEC capital rules
individually require that the minimum capital requirements include
capital based on either the uncleared swap positions or the
uncleared security-based swap positions, respectively, but not the
aggregate of both types of positions. A dually-registered firm with
the same aggregate risk margin amount of $1 billion, but split half
to swaps and half to security-based swaps, would be required to
reserve $10 million ($500 million * 2%). Thus, the dually-registered
firm with a total initial margin requirement of $1 billion held for
a portfolio split evenly between swaps and security-based swaps
would be required to reserve only half the capital required for the
same amount of initial margin held for a portfolio that was either
all swaps or all security-based swaps. For such dually-registered
firms, the amount of capital required to be held may ultimately be
based on irrelevant and arbitrary considerations of ``historical
precedent'' and agency jurisdiction rather than swap risk-based
calculations.
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\9\ While it is acknowledged that this example is somewhat
simplified from the calculations and absolute minimum amounts
specified in both the CFTC and SEC capital rules, the example
illustrates a possible outcome of the rules.
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Financial Data and Monitoring Capital Sufficiency
The capital requirements for swap dealers are one of the most
complex and highly technical areas in our regulations. The swap
dealers subject to the CFTC capital requirements vary significantly
and include (i) very large FCMs and/or BDs registered with the CFTC
and the SEC; (ii) U.S. and foreign affiliates of banking
organizations; (iii) large commercial enterprises and affiliates
thereof; and (iv) other financial companies that are not affiliated
with banks. Each grouping has unique capital structures.
Furthermore, there was little available quantitative financial
accounting data for the swap activities of these entities to
calibrate the appropriate levels of capital. Given this complex and
technical backdrop, the Final Rule notes in several places that the
Commission will gather and analyze the new financial reporting data
now required under the rule and may reassess components of the rule
to determine whether it needs to be amended to be better fit for
purpose. I strongly support that effort and will follow this
monitoring and analysis closely.
Substituted Compliance for Capital Requirements
Under the Final Rule, swap dealers organized and domiciled
outside of the United States, including many subsidiaries of U.S.
firms, can satisfy the capital requirements by complying with the
capital requirements of the country of their domicile if the
Commission grants substituted compliance. The methods and standards
for such a determination are similar to those to be established in
the final cross-border swap regulations scheduled for consideration
by the Commission tomorrow. Unfortunately, those methods and
standards are substantively weaker than the standards currently used
by the Commission and may result in outsourcing swap dealer capital
oversight to other jurisdictions where not appropriate.
Conclusion
Notwithstanding my dissent, I want to once again acknowledge the
complexity and highly technical nature of the capital requirements.
Given these difficulties, I would like to recognize the hard-working
staff of the CFTC for their efforts in fashioning the Final Rule.
Some of you spent many a late night addressing comments and
questions and revising the rule release. While I cannot support the
outcome, I nonetheless appreciate and thank you for the dedication
you bring to your work here at the CFTC.
Unfortunately, the rule the Commission will be adopting today is
simply an affirmation of the status quo. This is not what Congress
intended when it directed the CFTC to adopt capital requirements
``appropriate for the risk'' presented by uncleared swap activities
of swap dealers. For this reason, I dissent.
[FR Doc. 2020-16492 Filed 9-14-20; 8:45 am]
BILLING CODE 6351-01-P