2020-18303
Federal Register, Volume 85 Issue 185 (Wednesday, September 23, 2020)
[Federal Register Volume 85, Number 185 (Wednesday, September 23, 2020)]
[Proposed Rules]
[Pages 59702-59718]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-18303]
=======================================================================
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AF05
Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing to amend the margin requirements for uncleared
swaps for swap dealers (``SDs'') and major swap participants (``MSPs'')
for which there is no prudential regulator (``CFTC Margin Rule''). In
particular, the Commission is proposing to revise the calculation
method for determining whether certain entities come within the scope
of the initial margin (``IM'') requirements under the CFTC Margin Rule
beginning on September 1, 2021, and the timing for compliance with the
IM requirements after the end of the phased compliance schedule. The
proposed amendment would align certain aspects of the CFTC Margin Rule
with the Basel Committee on Banking Supervision and Board of the
International Organization of Securities Commissions' (``BSBS/IOSCO'')
Framework for margin requirements for non-centrally cleared derivatives
(``BCBS/IOSCO Framework''). The Commission is also proposing to allow
SDs and MSPs subject to the CFTC Margin Rule to use the risk-based
model calculation of IM of a counterparty that is a CFTC-registered SD
or MSP to determine the amount of IM to be collected from the
counterparty and to determine whether the IM threshold amount for the
exchange of IM has been exceeded such that documentation concerning the
collection, posting, and custody of IM would be required.
DATES: With respect to the proposed amendments, comments must be
received on or before October 23, 2020.
ADDRESSES: You may submit comments, identified by RIN 3038-AF05, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Center, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods.
Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (``FOIA''), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Sec. 145.9 of the Commission's
regulations.\1\
---------------------------------------------------------------------------
\1\ 17 CFR 145.9. Commission regulations referred to herein are
found at 17 CFR Chapter I.
---------------------------------------------------------------------------
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other
[[Page 59703]]
---------------------------------------------------------------------------
applicable laws, and may be accessible under the FOIA.
FOR FURTHER INFORMATION CONTACT: Joshua B. Sterling, Director, 202-418-
6056, [email protected]; Thomas J. Smith, Deputy Director, 202-418-
5495, [email protected]; Warren Gorlick, Associate Director, 202-418-
5195, [email protected]; or Carmen Moncada-Terry, Special Counsel, 202-
418-5795, [email protected], Division of Swap Dealer and
Intermediary Oversight, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
Section 4s(e) of the Commodity Exchange Act (``CEA'' or ``Act'')
\2\ requires the Commission to adopt rules establishing minimum initial
and variation margin requirements for all swaps \3\ that are (i)
entered into by an SD or MSP for which there is no prudential regulator
\4\ (collectively, ``covered swap entities'' or ``CSEs'') \5\ and (ii)
not cleared by a registered derivatives clearing organization
(``uncleared swaps'').\6\ To offset the greater risk to the SD \7\ or
MSP \8\ and the financial system arising from the use of uncleared
swaps, these requirements must (i) help ensure the safety and soundness
of the SD or MSP and (ii) be appropriate for the risk associated with
the uncleared swaps held by the SD or MSP.\9\
---------------------------------------------------------------------------
\2\ 7 U.S.C. 6s(e) (capital and margin requirements).
\3\ CEA section 1a(47), 7 U.S.C. 1a(47) (swap definition);
Commission regulation 1.3, 17 CFR 1.3 (further definition of a
swap). A swap includes, among other things, an interest rate swap,
commodity swap, credit default swap, and currency swap.
\4\ CEA section 1a(39), 7 U.S.C. 1a(39) (defining the term
``prudential regulator'' to include the Board of Governors of the
Federal Reserve System; the Office of the Comptroller of the
Currency; the Federal Deposit Insurance Corporation; the Farm Credit
Administration; and the Federal Housing Finance Agency). The
definition of prudential regulator further specifies the entities
for which these agencies act as prudential regulators. The
prudential regulators published final margin requirements in
November 2015. See generally Margin and Capital Requirements for
Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015) (``Prudential
Margin Rule''). The Prudential Margin Rule is substantially similar
to the CFTC Margin Rule, including with respect to the CFTC's
phasing-in of margin requirements, as discussed below.
\5\ CEA section 4s(e)(1)(B), 7 U.S.C. 6s(e)(1)(B). SDs and MSPs
for which there is a prudential regulator must meet the margin
requirements for uncleared swaps established by the applicable
prudential regulator. CEA section 4s(e)(1)(A), 7 U.S.C. 6s(e)(1)(A).
\6\ CEA section 4s(e)(2)(B)(ii), 7 U.S.C. 6s(e)(2)(B)(ii). In
Commission regulation 23.151, the Commission further defined this
statutory language to mean all swaps that are not cleared by a
registered derivatives clearing organization or a derivatives
clearing organization that the Commission has exempted from
registration as provided under the CEA. 17 CFR 23.151.
\7\ CEA section 1a(49), 7 U.S.C. 1a(49) (swap dealer
definition); Commission regulation 1.3 (further definition of swap
dealer).
\8\ CEA section 1a(32), 7 U.S.C. 1a(32) (major swap participant
definition); Commission regulation 1.3 (further definition of major
swap participant).
\9\ CEA section 4s(e)(3)(A), 7 U.S.C. 6s(e)(3)(A).
---------------------------------------------------------------------------
Following the mandate under Section 4s(e), the Commission in 2016
promulgated Commission regulations 23.150 through 23.161, namely the
CFTC Margin Rule, which requires CSEs to collect and post initial
margin (``IM'') \10\ and variation margin (``VM'') \11\ for uncleared
swaps.\12\ In implementing the CFTC Margin Rule, the Commission has
identified certain issues that it understands would likely impede a
smooth transition to compliance for entities required to comply with
the IM requirements beginning on September 1, 2021.
---------------------------------------------------------------------------
\10\ Initial margin is the collateral (calculated as provided by
Commission regulation 23.154) that is collected or posted in
connection with one or more uncleared swaps pursuant to regulation
23.152. Initial margin is intended to secure potential future
exposure following default of a counterparty (i.e., adverse changes
in the value of an uncleared swap that may arise during the period
of time when it is being closed out). See CFTC Margin Rule, 81 FR at
683.
\11\ Variation margin, as defined in Commission regulation
23.151, is the collateral provided by a party to its counterparty to
meet the performance of its obligations under one or more uncleared
swaps between the parties as a result of a change in the value of
such obligations since the trade was executed or the last time such
collateral was provided. 17 CFR 23.151.
\12\ See generally Margin Requirements for Uncleared Swaps for
Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
The CFTC Margin Rule, which became effective April 1, 2016, is
codified in part 23 of the Commission's regulations. 17 CFR 23.150-
23.159, 23.161. In May 2016, the Commission amended the CFTC Margin
Rule to add Commission regulation 23.160, 17 CFR 23.160, providing
rules on its cross-border application. See generally 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).
---------------------------------------------------------------------------
A. Calculation Method for Determining Whether Certain Entities Are
Subject to the IM Requirements and the Timing for Compliance With the
IM Requirements After the End of the Phased Compliance Schedule
Commission regulation 23.161 sets forth a schedule for compliance
with the CFTC Margin Rule, spanning from September 1, 2016, to
September 1, 2021.\13\ Under the schedule, entities are required to
comply with the IM requirements in staggered phases,\14\ starting with
entities with the largest average aggregate notional amounts
(``AANA''), calculated on a daily basis, of uncleared swaps and certain
other financial products, and then successively with lesser AANA.
---------------------------------------------------------------------------
\13\ 17 CFR 23.161(a). On July 10, 2020, the Commission
published a notice of proposed rulemaking proposing to amend
Commission regulation 23.161(a)(7) by deferring the compliance date
for entities with an average aggregate notional amount between $8
billion and $50 billion, from September 1, 2021, to September 1,
2022. See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 85 FR 41463 (July 10, 2020) (``July
2020 Proposal''). The notice of proposed rulemaking herein describes
current Commission requirements under the CFTC Margin Rule. If the
July 2020 Proposal becomes final prior to this notice of proposed
rulemaking, all references to September 1, 2021, referring to the
beginning of the last phase of compliance under the phased
compliance schedule, should be deemed automatically superseded and
replaced with September 1, 2022.
\14\ The schedule also addresses the variation margin
requirements under the CFTC Margin Rule, providing a compliance
period of September 1, 2016, through March 1, 2017. See 17 CFR
23.161(a). The compliance period (including a six-month extension to
September 1, 2017 through no-action relief) has long expired and all
eligible entities are required to comply with the VM requirements.
---------------------------------------------------------------------------
The last phase of compliance, which begins on September 1, 2021,
encompasses two sets of entities: (i) CSEs and covered counterparties
with an AANA between $750 billion and $50 billion (``Phase 5
entities''); \15\ and (ii) all other remaining CSEs and covered
counterparties,\16\ including financial end users (``FEUs'') with
material swaps exposure (``MSE'') of more than $8 billion in AANA,\17\
(``Phase 6 entities'').\18\ These entities had been scheduled to begin
compliance in separate phase-in dates, with Phase 5 entities to begin
compliance on September 1, 2020, and Phase 6 entities on September 1,
2021. On May 28, 2020, the Commission adopted an interim final rule
delaying the compliance date for Phase 5 entities until September 1,
2021, to address the operational challenges faced by these entities as
a result of the COVID-19 pandemic.
[[Page 59704]]
Because it was unclear what the impact of the pandemic would be on
Phase 6 entities, the Commission did not deem appropriate to postpone
these entities' September 1, 2021 compliance date through the interim
final rule process. As a result, Phase 5 and Phase 6 entities are now
required to begin compliance on September 1, 2021.
---------------------------------------------------------------------------
\15\ 17 CFR 23.161(a)(6).
\16\ The term ``covered counterparty'' is defined in Commission
regulation 23.151 as a financial end user with MSE or a swap entity,
including an SD or MSP, that enters into swaps with a CSE. See 17
CFR 23.151.
\17\ Commission regulation 23.151 provides that MSE for an
entity means that the entity and its margin affiliates have an
average daily aggregate notional amount of uncleared swaps,
uncleared security-based swaps, foreign exchange forwards, and
foreign exchange swaps with all counterparties for June, July, or
August of the previous calendar year that exceeds $8 billion, where
such amount is calculated only for business days. A company is a
``margin affiliate'' of another company if: (i) Either company
consolidates the other on a financial statement prepared in
accordance with U.S. Generally Accepted Accounting Principles, the
International Financial Reporting Standards, or other similar
standards; (ii) both companies are consolidated with a third company
on a financial statement prepared in accordance with such principles
or standards; or (iii) for a company that is not subject to such
principles or standards, if consolidation as described in paragraph
(i) or (ii) of this definition would have occurred if such
principles or standards had applied. 17 CFR 23.151.
\18\ 17 CFR 23.161(a)(7).
---------------------------------------------------------------------------
Under the Commission's margin requirements, the method for
determining when Phase 6 entities are required to comply with the
CFTC's IM requirements beginning with the last phase of compliance
differs from the method set out in the BCBS/IOSCO Framework.\19\ More
specifically, the BCBS/IOSCO Framework requires--beginning on September
1, 2022, which starts the last phase of implementation for the margin
requirements under the framework--entities with [euro]8 billion \20\ in
AANA during the period of March, April, and May of the current year,
based on an average of month-end dates, to exchange IM beginning
September 1 of each year.
---------------------------------------------------------------------------
\19\ See generally BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (July 2019), https://www.bis.org/bcbs/publ/d475.pdf (``2019 BCBS/IOSCO Framework'').
\20\ The U.S. adopted the BCBS/IOSCO threshold, but replaced the
8 billion euro figure with a dollar amount of $8 billion. As a
result, there is a small disparity in the threshold amounts given
the continuing fluctuation of the dollar-euro exchange rate. This
rule proposal does not address this issue.
---------------------------------------------------------------------------
In contrast, in the last phase of compliance under the phased
compliance schedule, under the Commission's margin requirements, Phase
6 entities (i.e., CSEs and FEUs with more than $8 billion in AANA, or
MSE) are required to begin exchanging IM on September 1, 2021. The MSE
for an FEU must be determined on September 1, 2021, based on daily AANA
(accounting only for business days) \21\ during the period of June,
July, and August of the prior year. After the last phase of compliance,
the determination of MSE for an FEU, which triggers the applicability
of the IM requirements, must be conducted on January 1 of each calendar
year based on daily AANA during the June, July, and August period of
the prior year, with application of the IM requirements, if the FEU has
MSE, required to begin on January 1 of each year.
---------------------------------------------------------------------------
\21\ The determination of MSE requires accounting for the
average daily aggregate notional amount of uncleared swaps,
uncleared security-based swaps, foreign exchange forwards, and
foreign exchange swaps for June, July and August of the previous
calendar year that exceeds $8 billion, where such amount is
calculated only for business days. See definition of MSE supra note
17. For simplicity purposes, this formulation will be referred to
hereinafter as ``daily AANA.''
---------------------------------------------------------------------------
The BCBS/IOSCO Framework was originally promulgated in September
2013,\22\ and then revised in 2015.\23\ The 2015 version of the BCBS/
IOSCO Framework changed the calculation period of June, July, and
August, with an annual implementation date of December 1, to March,
April, and May of each calendar year, with an annual implementation
date of September 1. The CFTC Margin Rule incorporated the earlier 2013
version of the BCBS/IOSCO Framework by adopting the June, July, and
August calculation period for the annual calculation of MSE. As a
result, the Commission's existing regulations do not reflect the
calculation period of March, April, and May set forth in the revised
BCBS/IOSCO Framework published in March 2015.
---------------------------------------------------------------------------
\22\ See generally BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (Sept. 2013), https://www.bis.org/publ/bcbs261.htm.
\23\ See generally BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (March 2015), available at https://www.bis.org/bcbs/publ/d317.htm.
---------------------------------------------------------------------------
The Commission also departed from BCBS/IOSCO's month-end date
calculation of AANA for determining whether an entity is subject to the
IM requirements. In the preamble to the CFTC Margin Rule, the
Commission stated that it decided to adopt a daily AANA calculation
method for determining whether an FEU has MSE, the finding of which
requires a CSE to exchange IM with the FEU, ``to gather a more
comprehensive assessment of the [FEU]'s participation in the swaps
market, and to address the possibility that a market participant might
`window dress' its exposure on an as-of date such as year-end, in order
to avoid the Commission's margin requirements.'' \24\
---------------------------------------------------------------------------
\24\ 81 FR at 645.
---------------------------------------------------------------------------
As a result, the Commission's current method for the annual
calculation of MSE, which was adopted in coordination with the U.S.
prudential regulators and is similar to the U.S. prudential regulators'
method of calculation, is not consistent with the most recent version
of the BCBS/IOSCO Framework. Nor is it consistent with requirements in
other major market jurisdictions, most of which adopted the 2015 BCBS/
IOSCO Framework's month-end date calculation of AANA using the period
of March, April, and May for the purposes of determining whether an
entity is subject to the IM requirements beginning in the last phase of
implementation.\25\
---------------------------------------------------------------------------
\25\ See, e.g., Commission Delegated Regulation (EU) 2016/2251
Supplementing Regulation (EU) No. 648/2012 of the European
Parliament and of the Council of July 4, 2012 on OTC Derivatives,
Central Counterparties and Trade Repositories with Regard to
Regulatory Technical Standards for Risk-Mitigation Techniques for
OTC Derivative Contracts Not Cleared by a Central Counterparty (Oct.
4, 2016), Article 28(1), https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R2251&from=EN. Financial Services Agency of
Japan (JFSA) Cabinet Office Ordinance on Financial Instruments
Business (Cabinet Office Ordinance No. 52 of August 6, 2007), as
amended (March 31, 2016), Article 123(11)(iv)(c); Office of the
Superintendent of Financial Institutions Canada (OSFI) Guideline No.
E-22, Margin Requirements for Non-Centrally Cleared Derivatives
(April 2020), Section 5, 71, https://www.osfi-bsif.gc.ca/Eng/Docs/e22.pdf.
---------------------------------------------------------------------------
Market participants have stated that these differences in the
methods for determining when an entity comes within the scope of the IM
requirements and the timing for compliance after the last phase of
compliance may impose an undue burden on their efforts to comply with
the CFTC's margin requirements.\26\ Entities have to account for
different compliance schedules and set up and maintain separate
processes for determining when they meet the thresholds for IM
compliance.\27\
---------------------------------------------------------------------------
\26\ See Recommendations to Improve Scoping and Implementation
of Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps, April 2020 at, 48-54,
https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download (``Margin Subcommittee Report'' or ``Report'').
\27\ See id.
---------------------------------------------------------------------------
B. No-Action Letter Concerning the Calculation of IM
The Commission's Division of Swap Dealer and Intermediary Oversight
(``DSIO'') issued CFTC No-Action Letter 19-29 in July 2019 in response
to a request for relief submitted by Cargill Incorporated
(``Cargill''), a CFTC-registered SD and CSE.\28\ DSIO stated that it
would not recommend enforcement action if Cargill used the risk-based
model calculation of IM of a counterparty that is a CFTC-registered SD
as the amount of IM that Cargill is required to collect from the SD and
to determine whether the IM threshold amount of $50 million (``IM
threshold amount'') \29\ has been exceeded, which would trigger the
requirement for
[[Page 59705]]
documentation concerning the posting, collection, and custody of IM
collateral.
---------------------------------------------------------------------------
\28\ CFTC Letter No. 19-29, Request for No-Action Relief
Concerning Calculation of Initial Margin (Dec.19, 2019) (``Letter
19-29''), http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/19-29.pdf.
\29\ Under Commission regulation 23.154(a)(3), SDs and MSPs
subject to the Commission's regulations are not required to post or
collect IM until the initial margin threshold amount has been
exceeded. See 17 CFR 23.154(a)(3). The term ``initial margin
threshold amount'' is defined in Commission regulation 23.151 to
mean an aggregate credit exposure of $50 million resulting from all
uncleared swaps between an SD and its margin affiliates (or an MSP
and its margin affiliates) on the one hand, and the SD's (or MSP's)
counterparty and its margin affiliates on the other. See 17 CFR
23.151.
---------------------------------------------------------------------------
C. Market Participant Feedback
The CFTC's Global Markets Advisory Committee (``GMAC'') established
a subcommittee in January 2020 to consider issues raised by the
implementation of margin requirements for non-cleared swaps, to
identify challenges associated with forthcoming implementation phases,
and to make recommendations through a report for the GMAC to consider
in advising the Commission. The subcommittee submitted the Margin
Subcommittee Report to the GMAC with its recommendations.\30\ The GMAC
adopted the Report and recommended to the Commission that it consider
adopting the Report's recommendations.
---------------------------------------------------------------------------
\30\ See supra note 26.
---------------------------------------------------------------------------
Among other things, the Margin Subcommittee Report recommended
alignment of the CFTC Margin Rule with the BCBS/IOSCO Framework with
respect to the method for calculating AANA for determining whether an
entity comes within the scope of the IM requirements and the timing of
compliance after the end of the phased compliance schedule.\31\ The
Report also recommended the codification of Letter 19-29.\32\
---------------------------------------------------------------------------
\31\ See Margin Subcommittee Report at 48-54.
\32\ See Margin Subcommittee Report at 34-36.
---------------------------------------------------------------------------
The Commission believes that alignment with BCBS/IOSCO, the global
standard setter for margin requirements for non-cleared derivatives,
would promote harmonization in the application of the IM requirements.
Moreover, the Commission does not believe that the disjunction between
the CFTC and BCBS/IOSCO regarding the AANA calculation method and the
timing of compliance furthers any regulatory purpose. In fact, the
Commission notes the foreseeable possibility of calculation errors
resulting from differences in the calculation methods.\33\
---------------------------------------------------------------------------
\33\ The possibility of calculation errors may be mitigated by
substituted compliance, as described in Commission regulation
23.160, if the parties are non-U.S. entities and substituted
compliance is available, as the parties would be able to avail
themselves of the rules in the foreign jurisdiction and would
therefore not face the concern about different calculation methods.
However, while the proposed changes to the method of calculation of
AANA would align the CFTC's method of calculation with BCBS/IOSCO's
approach, the Commission acknowledges that the changes would result
in a divergence from the U.S. prudential regulators' approach, which
may increase the potential for calculation errors for entities
located in the United States.
---------------------------------------------------------------------------
The Commission also believes that adopting regulations along the
lines of narrowly-tailored no-action letters, such as Letter 19-29,
could promote certainty and clarity, facilitating efforts by market
participants to take the application of the Commission's regulations
into account in their planning, without undermining the effectiveness
of the CFTC Margin Rule. Moreover, the proposed amendment would promote
efficient risk hedging by smaller CSEs that offer swaps services to
smaller entities that are neither SDs nor MSPs, with some of those
risk-taking transactions requiring the exchange of regulatory margin
and some, at the option of the parties, requiring the exchange of
contractually-agreed margin. The CSEs might then enter into offsetting
swaps with SDs and MSPs to hedge the risk associated with the risk-
taking transactions. Due to their size and limited swap business and
resources, the CSEs may find it uneconomical to develop and maintain a
margin model, and would therefore benefit from the option to rely on
their SD or MSP counterparties' IM model calculations.
II. Proposed Amendments
The Commission is proposing to revise the method for calculating
AANA for determining whether an FEU has MSE and the timing for
compliance with the IM requirements after the end of the last phase of
compliance to align these aspects of the CFTC Margin Rule with the
BCBS/IOSCO Framework. The Commission is also proposing to amend
Commission regulation 23.154(a) in a manner similar to the terms of
Letter 19-29, and thus allow CSEs to use the risk-based model
calculation of IM of counterparties that are CFTC-registered SDs or
MSPs (``swap entities'') \34\ to determine the amount of IM that must
be collected from such counterparties.
---------------------------------------------------------------------------
\34\ Commission regulation 23.151 defines the term ``swap
entity'' as a person that is registered with the Commission as an SD
or MSP under the CEA.
---------------------------------------------------------------------------
A. Commission Regulation 23.151--Amendments to MSE Definition
As noted above, the exchange of IM with respect to uncleared swaps
between a CSE and a counterparty that is an FEU with MSE (together,
Phase 6 entities) is required in the last phase of compliance, which is
scheduled to begin on September 1, 2021.\35\ Commission regulation
23.151 provides that an entity has MSE if it has more than $8 billion
in average daily AANA during June, July, and August of the prior
year.\36\ An FEU that has MSE based on its calculation of AANA over
June, July, and August of 2020 will come within the scope of the IM
requirements beginning on September 1, 2021. After September 1, 2021,
however, because the base year for calculating AANA is the prior year,
the annual determination of MSE, which triggers the applicability of
the IM requirements, would be on January 1 of each year,\37\ using the
AANA for June, July, and August of the prior year. If the FEU has MSE
on January 1 of a given year, the FEU would come within the scope of
the IM requirements on January 1 of such year. As such, a CSE would be
required to exchange regulatory IM beginning on such January 1 for its
uncleared swaps with such FEU.
---------------------------------------------------------------------------
\35\ See 17 CFR 23.161(a)(7), which requires that a CSE must
comply with the CFTC IM requirements with respect to their uncleared
swaps with counterparties that are FEUs with MSE beginning on
September 1, 2021.
\36\ 17 CFR 23.151.
\37\ January 1 is not explicitly set out in the Commission's
regulations as the determination date for MSE after the last phase
of compliance. However, Commission regulation 23.161(a)(7)
(addressing the last phase of compliance and the timing of
compliance going forward) and the definition of MSE in Commission
regulation 23.151 can be reasonably read together to set January 1
as the determination date. See 17 CFR 23.151; 17 CFR 23.161(a)(7).
---------------------------------------------------------------------------
The Commission proposes to amend the definition of MSE in
Commission regulation 23.151 by replacing ``June, July and August of
the previous calendar year'' with ``March, April and May of that
year.'' The period for calculating AANA for determining whether an FEU
has MSE would thus be March, April, and May of ``that year.'' ``That
year'' would be understood to mean the year the MSE is calculated for
determining whether the IM requirements apply. The calculation of MSE
is precipitated by Commission 23.161(a)(7), which requires a CSE to
exchange IM with a counterparty that is an FEU with MSE beginning on
September 1, 2021, and thereafter.
The Commission is also proposing to amend the definition of MSE to
set ``September 1 of any year'' as the determination date for MSE.
Under the current requirements, the MSE for an FEU must be determined
beginning on September 1, 2021, and subsequently, after the last phase
of compliance, on January 1 of each year. The proposed amendment would
change the date of determination of MSE, applicable after the last
phase of compliance, from January 1 to September 1. Because having MSE
triggers the applicability of the IM requirements for an FEU, requiring
the CSE to post and collect IM with its FEU counterparty, the proposed
amendment would effectively set the timing for compliance with the IM
requirements on September 1 after the last phase of compliance with
respect to
[[Page 59706]]
uncleared swaps entered into by a CSE and an FEU with MSE.
The proposed shift of the MSE determination date from January 1 to
September 1 could have the effect of deferring for nine months for 2022
\38\ the obligation to exchange IM with a firm that was not in scope on
September 1, 2021, but would be subject to the IM requirements on
January 1, 2022. As a result, in 2022, less collateral would be
collected for uncleared swaps during the nine-month period, which could
render uncleared swap positions riskier and increase the risk of
contagion and systemic risk. The Commission, however, notes that
because the deferral period would affect entities with lower AANAs than
entities brought into scope in earlier phases, the potential
uncollateralized risk would be mitigated, becoming a lesser concern,
particularly because the proposed change in the MSE determination date
would draw the Commission's rules closer to BCBS/IOSCO's approach,
promoting international harmonization.
---------------------------------------------------------------------------
\38\ If the July 2020 Proposal becomes final prior to this
notice of proposed rulemaking, all references to 2022 for the
purpose of referring to the period after the end of the last phase
of compliance under the phased compliance schedule should be deemed
automatically superseded and replaced with 2023.
---------------------------------------------------------------------------
Conversely, the change in the MSE determination date could also
result in requiring certain entities to post and collect IM that would
not otherwise be required to do so. This could occur when an FEU meets
the MSE threshold in the last phase of compliance beginning on
September 1, 2021, but falls below the threshold by January 1, 2022,
because the AANA for June, July, and August of the prior year (i.e.,
2021) has declined below $8 billion. In such case, under the current
rule, a CSE would no longer be subject to the IM requirements with
respect to such FEU beginning January 1, 2022. However, under the
proposed amendment, the CSE would continue to be subject to the IM
requirements with respect to such FEU through September 1, 2022, and,
as a result, the CSE would be required to exchange IM with the FEU for
nine months longer than the January 1, 2022 MSE determination date
would have required.
These proposed amendments to the definition of MSE would have the
effect of reducing the time frame that FEUs and their CSE
counterparties would have to prepare for compliance with the IM
requirements. Under the current rule, exchange of regulatory IM is
required with respect to Phase 6 entities beginning on September 1,
2021, which starts the last phase of the phased compliance
schedule.\39\ The MSE for the FEU must be determined using the AANA for
the June, July, and August period of the prior year (i.e., 2020). As a
result, for the last phase of compliance in 2021, a CSE and FEU will
have at least twelve months to prepare in anticipation of compliance
with the IM requirements. Under the proposed amendment, however, for
the last phase of compliance in 2021, the CSE and FEU would have only 3
months because MSE would be determined using the AANA for the March,
April, and May period of the current year (i.e., 2021).
Also, after the last phase of compliance under the phased
compliance schedule, as proposed, the date for determining MSE for an
FEU would be September 1 of each year, and the AANA calculation period
for determining whether an FEU has MSE would be March, April, and May
of such year. As a result, under the proposed amendment, an FEU with
MSE and its CSE counterparty would have three months to prepare in
advance of compliance with the IM requirements, whereas under the
current rule, such parties have four months because MSE must be
determined on January 1 based on the AANA for June, July, and August of
the prior year.
Market participants recognize the effects of the proposed changes
on the time frame for preparing for compliance with the IM
requirements, with greater impact on Phase 6 entities that are coming
into scope in the last phase of compliance, compared to those entities
subject to compliance after the end of the last compliance phase.
Nevertheless, the Margin Subcommittee Report, which the GMAC has
adopted and recommended to the Commission, supported the changes
because they would reconcile the CFTC's margin requirements with the
BCBS/IOSCO Framework.\40\ The proposed changes would eliminate the need
to maintain separate schedules and processes for the computation of
AANA and reduce the burden and cost of compliance with the IM
requirements.\41\ For the reasons set forth above, and taking account
of Section 752 of the Dodd-Frank Act that calls on the CFTC to
``consult and coordinate'' with respect to the establishment of
consistent international standards,\42\ the Commission preliminarily
believes that amending the definition of MSE by replacing ``June, July
and August of the previous calendar year'' with ``March, April and May
of that year'' and by prescribing September 1 of each year as the MSE
determination date is appropriate to harmonize its compliance schedule
with that of the BCBS/IOSCO Framework and eliminate a disjunction that
risks calculation errors and may hinder compliance with the IM
requirements.
---------------------------------------------------------------------------
\40\ See Margin Subcommittee Report at 49 (Members of the Margin
Subcommittee stated that the divergence between the U.S. and
international requirements ``creates complexity and confusion, and
leads to additional effort, cost and compliance challenges for
smaller market participants that are generally subject to margin
requirements in multiple global jurisdictions.'').
\41\ The Commission acknowledges that the burdens on market
participants would not be fully eliminated, and in fact, may
increase, for those entities that enter into uncleared swaps with
SDs and MSPs that are subject to the prudential regulators' margin
requirements for uncleared swaps and come within the scope the
prudential regulators' margin regime, as the prudential regulators
have not revised their rules consistent with the amendments proposed
herein.
\42\ See section 752 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).
---------------------------------------------------------------------------
The Commission is also proposing to amend the requirement to use
daily average AANA during the three-month calculation period for
determining MSE (``daily AANA calculation method''). The proposed
amendment would instead require the use of average month-end AANA
during the three-month calculation period (``month-end AANA calculation
method''). In adopting the CFTC Margin Rule, the Commission
acknowledged that the use of the month-end AANA calculation method
would be consistent with BCBS/IOSCO's approach. Nonetheless, the CFTC,
along with the U.S prudential regulators, adopted the daily AANA
calculation method. In the preamble to the CFTC Margin Rule, the
Commission explained that a daily average AANA calculation would
provide a more comprehensive assessment of an FEU's participation in
the swaps market in determining whether the FEU has MSE and would
address the possibility of window dressing of exposures by market
participants that might seek to avoid the CFTC's margin
requirements.\43\
---------------------------------------------------------------------------
\43\ See supra note 24.
---------------------------------------------------------------------------
In the Margin Subcommittee Report, the GMAC subcommittee stated
that the daily AANA calculation method entails more work for smaller
counterparties and that the method is only used in the United States,
noting that in the United States, daily AANA calculations over the
three-month calculation period for Phase 5 required 64 observations
while global determinations based on month-end AANA calculations
required only three observations.\44\ The Report further stated that a
month-end AANA calculation, by accounting for three periodic dates on
which AANA would
[[Page 59707]]
be calculated, would mitigate the risk that market participants would
adjust exposures to avoid the CFTC's margin requirements, and that it
would be neither practicable nor financially desirable for parties to
tear-up their positions on a recurring basis prior to each month-end
AANA calculation, as it would interfere with their hedging strategies
and cause them to incur realized profit and loss.\45\
---------------------------------------------------------------------------
\44\ Margin Subcommittee Report at 52.
\45\ Id.
---------------------------------------------------------------------------
The Commission believes that it is appropriate to propose the
month-end AANA calculation method to determine whether an FEU has MSE
because such method of calculation would align the CFTC's approach with
the BCBS/IOSCO Framework and that of other major market jurisdictions.
The Commission notes that there is the risk that market participants
that are counterparties to CSEs may ``window dress'' their exposures by
adjusting their exposures as they approach the month-end date for the
calculation of AANA. In doing so, an FEU would no longer have to post
and collect IM with all CSEs for all its uncleared swaps for at least
twelve months from the date on which compliance with the IM
requirements would have been initially required.\46\ The Commission
believes that it has sufficient tools at its disposal to address the
``window dressing'' concern. In particular, the Commission notes that
Commission regulation 23.402(a)(ii) requires CSEs to have written
policies and procedures to prevent their evasion, or participation in
or facilitation of an evasion, of any provision of the CEA or the
Commission regulations.\47\ The Commission also reminds market
participants that are counterparties to CSEs that section 4b of the CEA
prohibits any person entering into a swap with another person from
cheating or defrauding or willfully deceiving or attempting to deceive
the other person.\48\
---------------------------------------------------------------------------
\46\ As proposed, the MSE calculation would be made annually on
September 1 of each year and would be in effect for the next twelve
months after that date.
\47\ 17 CFR 23.402(a)(ii).
\48\ 7 U.S.C. 6b.
---------------------------------------------------------------------------
The Commission acknowledges that replacing the daily AANA
calculation method with the month-end AANA calculation method for
determining MSE could result in an AANA calculation that is not fully
representative of an entity's participation in the swap markets. The
current definition of MSE provides that AANA must be calculated
counting uncleared swaps, uncleared security-based swaps, foreign
exchange forwards, or foreign exchange swaps. Some of these financial
products because of their terms, such as tenure and time of execution,
may be undercounted or excluded from the AANA calculation if month-end
dates are used to determine MSE.\49\ The proposed month-end AANA
calculation method therefore may not account for products that are
required to be included in the calculation.
---------------------------------------------------------------------------
\49\ For example, the Commission observes that certain physical
commodity swaps such as electricity and natural gas swaps are
products for which a month-end AANA calculation might not provide a
comprehensive assessment of the full scope of an FEU's exposure to
those products.
---------------------------------------------------------------------------
The Commission preliminarily believes that the notional amounts
associated with products that may be excluded from the AANA calculation
may be relatively low and that their contribution to the AANA
calculation for the purpose of determining MSE may be insignificant. In
this regard, in an exercise undertaken by the Commission's Office of
the Chief Economist (``OCE'') on a sample of days, the OCE estimated
(setting aside the window dressing issue) that calculations based on
end-of-month AANA would yield fairly similar results as calculations
based on the current daily AANA approach. Based on 2020 swap data, the
OCE estimated that 492 entities of the 514 entities that would come
into scope during Phase 6 based on the current methodology would also
come into scope in the event that the Commission were to adopt the
proposed methodology. Put differently, all but 22 of the entities that
are above MSE under the current methodology would also be above MSE
under the proposed methodology. In addition, there are 20 entities that
would be in scope under the proposed methodology, but would not be in
scope under the current methodology, so that the aggregate number of
Phase 6 entities under the current and proposed methodologies differs
only by two. In aggregate, the two methodologies would capture quite
similar sets of entities. In addition, the entities that fall out of
scope applying the month-end methodology tend to be among the smallest
of the Phase 6 entities. That is, entities that are in-scope under the
current methodology but not the proposed methodology average $6.95
billion in AANA, compared to $20 billion for all Phase 6 entities.\50\
---------------------------------------------------------------------------
\50\ Note that the OCE calculation excludes commodity swaps, and
the examples of products for which end-of-month calculations may be
undercounting tend to be in commodity swaps like natural gas and
electricity swaps. Overall, commodity swaps tend to represent less
than 1% of all swap trades. See BIS Statistic Explorer, Global OTC
derivatives market (July 30, 2020), https://stats.bis.org/statx/srs/table/d5.1?f=pdf.
---------------------------------------------------------------------------
In the Commission's preliminary view, based on the OCE analysis
discussed above, switching from daily AANA calculations to month-end
calculations for the purpose of determining MSE would likely have a
limited impact on the protections provided by the CFTC Margin Rule. The
Commission also preliminary believes that the benefits of aligning with
the BCBS/IOSCO Framework and the approach of other major market
jurisdictions outweigh the window dressing concerns.\51\
---------------------------------------------------------------------------
\51\ The prudential regulators have not indicated whether they
intend to amend their margin requirements consistent with the BCBS/
IOSCO Framework and the proposed amendments to the definition of MSE
discussed herein. Below, the Commission requests comment on the
impact of this potential regulatory divergence on market
participants. Also of note, the U.S. Securities and Exchange
Commission (``SEC'') has adopted a different approach that does not
use MSE for identifying entities that come within the scope of the
SEC margin requirements. See Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and Major Security-
Based Swap Participants and Capital and Segregation Requirements for
Broker-Dealers, 84 FR 43872 (Aug. 22, 2019).
---------------------------------------------------------------------------
The Commission requests comments regarding the general approach
proposed for changes to Commission regulation 23.151. The Commission
also specifically requests comment on the following questions:
Are the proposed amendments appropriate in light of the
CFTC's overall approach to uncleared margin requirements and the manner
in which firms currently undertake the calculation of AANA to determine
MSE? Should the Commission consider any alternative to aligning with
the BCBS/IOSCO Framework with respect to the methodology for the AANA
calculation and the timing for compliance after the last phase of
compliance?
Should the Commission proceed to adopt the proposed
amendments if the U.S. prudential regulators do not adopt similar
regulatory changes? Would this divergence between the CFTC and the
prudential regulators' margin requirements for uncleared swaps affect
market participants? Is there a potential for industry confusion if
that were to be the case?
In adopting the CFTC Margin Rule, the Commission stated
that the daily AANA calculation method was intended to provide a more
comprehensive assessment of an FEU's participation in the swaps
markets. Would the proposed month-end AANA calculation method requiring
the averaging of month-end dates during the three-month calculation
period be representative of a market participant's participation in the
swaps markets? Is it
[[Page 59708]]
possible that the proposed month-end calculation would result in the
exclusion or undercounting of certain products because of their terms,
such as tenure and time of execution, or for any other reason, that are
required to be included in the AANA calculation? Could the calculation
lead to skewed results for entities that have an AANA calculation on
the three end-of-month dates that is uncharacteristically high compared
to their typical positions?
How likely and significant is the risk that market
participants may ``window dress'' their exposures to avoid the CFTC's
margin requirements? In the event that this is a significant impediment
to an accurate calculation of AANA over a three month period, are the
existing tools at the Commission's disposal sufficient to address this
concern? Are there additional steps the Commission should consider if
the Commission were to implement the month-end calculation methodology?
B. Commission Regulation 23.154--Alternative Method of Calculation of
IM
The CFTC Margin Rule requires CSEs to collect and post IM with
covered counterparties.\52\ Commission regulation 23.154(a) directs
CSEs to calculate, on a daily basis, the IM amount to be collected from
covered counterparties and to be posted to FEU counterparties with
MSE.\53\ CSEs have the option to calculate the IM amount by using
either a risk-based model or the standardized IM table set forth in
Commission regulation 23.154(c)(1).\54\ For a CSE that elects to use a
risk-based model to calculate IM, Commission regulation 23.154(b)(1)
requires the CSE to obtain the written approval of the Commission or a
registered futures association \55\ to use the model to calculate IM
required by the Commission's margin requirements for uncleared
swaps.\56\
---------------------------------------------------------------------------
\52\ See 17 CFR 23.152.
\53\ See 17 CFR 23.154(a).
\54\ See id.
\55\ See 17 CFR 23.154(b)(1)(i). In this context, the term
``registered futures association'' refers to the National Futures
Association (``NFA''), which is the only futures association
registered with the Commission.
\56\ See 17 CFR 23.154(b)(1)(i).
---------------------------------------------------------------------------
The Commission is proposing to amend Commission regulation
23.154(a) along the lines of Letter 19-29 by adding proposed paragraph
(a)(5). The proposed paragraph would permit a CSE that enters into
uncleared swaps with a swap entity to use the swap entity's risk-based
model calculation of IM in lieu of its own IM calculation. The risk-
based model used for the calculation of IM would need to satisfy the
requirements set out in Commission regulation 23.154(b) or would need
to be approved by the swap entity's prudential regulator.
Letter 19-29 sets out certain situations in which DSIO would not
recommend an enforcement action under Commission regulation
23.154(a)(1), which requires CSEs to calculate, on a daily basis, IM to
be collected from a covered counterparty, including swap entities and
FEUs with MSE. Letter 19-29 conveyed the staff's view that Cargill, the
requester for relief, could use the risk-based model calculation of IM
of a counterparty that is a swap entity to determine the amount of IM
to be collected from that counterparty and to determine whether the IM
threshold amount has been exceeded, which would require the parties to
have documentation addressing the collection, posting, and custody of
IM. The proposed amendment, consistent with Letter 19-29, would modify
the requirement that CSEs calculate the IM to be collected from a swap
entity counterparty and would give CSEs the option to use such
counterparty's risk-based IM calculation to determine the amount of IM
to be collected from the counterparty.
The Commission acknowledges that expanding the use of the
alternative method in Letter 19-29 to a wider group of CSEs could raise
some concerns. Being able to rely on the IM risk-based calculation of a
swap entity counterparty, as would be permitted under the proposal,
CSEs may forgo altogether the adoption of a risk-based model and may be
less incentivized to monitor IM exposures on a regular basis. Without a
model to compute its own IM, a CSE may lack reasonable means to verify
the IM provided by its counterparty or recognize any shortfalls in the
IM calculation or flaws in the counterparty's risk-based model. As a
result, the CSE may collect insufficient amounts of IM to offset
counterparty risk. There is also the concern that the swap entity
calculating the IM for the CSE may be conflicted,\57\ as it may have a
bias in favor of calculating and posting lower amounts of IM to its CSE
counterparty.
---------------------------------------------------------------------------
\57\ The Commission notes, however, that the potential for
conflict may be reduced as the swap entity, as a CFTC-registered SD
or MSP, would be subject to Commission regulation 23.600, which
requires SDs and MSPs to establish a risk management program for the
management and monitoring of risk, including credit and legal risk,
associated with their swaps activities. See 17 CFR 23.600.
---------------------------------------------------------------------------
In light of these concerns, Letter 19-29 imposed certain conditions
for the application of the relief.\58\ The Commission believes that it
is appropriate that the proposed amendment incorporate in the rule text
two conditions set forth in the no-action letter. Other conditions from
the no-action letter would not be reflected in the rule text, because
the Commission believes that the conditions are adequately addressed by
existing requirements under the Commission's regulations, as explained
below. In addition, if the proposed amendment is adopted, the
Commission notes that it will monitor its implementation by CSEs and
may consider further rulemaking as appropriate.
---------------------------------------------------------------------------
\58\ Letter 19-29 at 4.
---------------------------------------------------------------------------
First, consistent with Letter 19-29, the proposed rule text would
require that the applicable model meet the requirements of Commission
regulation 23.154(b) (requiring the approval of the use of the model by
either the Commission or the NFA), or that it be approved by a
prudential regulator.\59\
---------------------------------------------------------------------------
\59\ The prudential regulators have not amended their margin
requirements for uncleared swaps consistent with the proposed
amendment to Commission regulation 23.154(b) discussed herein. As
such, the CFTC's margin requirements would diverge from the
prudential regulators' approach. Below, the Commission seeks comment
on how this regulatory divergence may impact market participants.
---------------------------------------------------------------------------
Second, the proposed rule text would provide that the CSE would be
able to use the risk-based model calculation of IM of a swap entity
counterparty only if the uncleared swaps for which IM is calculated are
entered into for the purpose of hedging the CSE's own risk. In this
context, the risk to be hedged would be the risk that the CSE would
incur when entering into swaps with non-swap entity counterparties. By
proposing to limit the application of this alternative method of
calculation of IM only to uncleared swaps entered into for the purpose
of hedging risk arising from swaps entered into with non-swap entities,
the Commission would ensure its narrow application.
The Commission contrasts the risk of customer-facing swaps with the
risk that CSEs incur when entering into a swap in a dealing capacity
``to accommodate the demand'' of a swap entity counterparty.\60\ The
Commission believes that it would be inappropriate to allow a CSE to
use the IM calculation of the swap entity counterparty in this latter
case. The Commission notes that the latter case (i.e., where the CSE is
acting in a dealing capacity for a
[[Page 59709]]
counterparty that is itself calculating IM) would occur in the inter-
dealer market for swaps. The Commission believes that a CSE
participating in the inter-dealer market in a dealing capacity should
have the capacity to develop, implement, and use an approved risk-based
model.
---------------------------------------------------------------------------
\60\ See Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR
30596, 30608 (May 23, 2012) (noting that a distinguishing
characteristic of swap dealers is being known in the industry as
being available to accommodate demand for swaps.).
---------------------------------------------------------------------------
The Commission expects that the alternative method of calculation
would be used primarily by CSEs that are not obtaining approval to use
a risk-based model for the calculation of IM but rather elect to use
the table-based calculation described in Commission regulation
23.154(c) for swaps with non-swap entity counterparties. The Commission
anticipates that such CSEs would enter into uncleared swaps mostly with
end-user, non-swap entity counterparties, and would then hedge the risk
of those swaps with uncleared swaps entered into with a few swap entity
counterparties. The CSEs and their swap entity counterparties would be
required to exchange IM for the uncleared swaps entered into for the
purpose of hedging. Because maintaining a model would impose a
disproportionate burden on the CSEs relative to the discrete and
limited nature of their uncleared swap activities, the CSEs may not
have a risk-based model for the calculation of IM and may opt to use
instead the risk-based model calculation of their swap entity
counterparties.
To obtain relief under Letter 19-29, Cargill, prior to using the
risk-based model calculation of IM of a swap entity counterparty, must
agree with the counterparty in writing that the IM calculation will be
provided to Cargill in a manner and time frame that would allow Cargill
to comply with the CFTC Margin Rule and other applicable Commission
regulations, and that the calculation will be used to determine the
amount of IM to be collected from the counterparty and to determine
whether the IM threshold amount has been exceeded, which would require
documentation addressing the posting, collection, and custody of IM.
The Commission preliminarily believes that the documentation
requirements in Commission regulations 23.158 and 23.504 address this
no-action letter condition.
Commission regulation 23.158(a) requires CSEs to comply with the
documentation requirements set forth in Commission regulation
23.504.\61\ In turn, Commission regulation 23.504(b)(4)(i) requires
CSEs to have written documentation reflecting the agreement with a
counterparty concerning methods, procedures, rules, and inputs, for
determining the value of each swap at any time from execution to the
termination, maturity, or expiration of such swap for the purposes of
complying with the margin requirements under section 4s(e) of the Act
and regulations under this part.\62\ Regulation 23.504(b)(3)(i) also
provides that the documentation shall include credit support
arrangements, including initial and variation margin requirements, if
any.\63\
---------------------------------------------------------------------------
\61\ 17 CFR 23.158(a).
\62\ 17 CFR 23.504(b)(4)(i).
\63\ Commission regulation 23.504(b)(1) further provides that
the documentation shall include all terms governing the trading
relationship between the swap dealer or major swap participant and
its counterparty, including without limitation terms addressing
payment obligations calculation of obligations upon termination
valuation, and dispute resolution. 17 CFR 23.504(b)(1).
---------------------------------------------------------------------------
The last two conditions of Letter 19-29 \64\ were designed to
ensure that Cargill would undertake adequate risk management of its
uncleared swaps, notwithstanding the lack of a proprietary risk-based
model and hence the inability to calculate IM, which is representative
of potential future exposure of uncleared swaps.\65\ The Commission
believes that these conditions are addressed by CSEs' risk management
obligations under the CEA and the Commission's regulations. Section
4s(j)(2) of the CEA requires SDs and MSPs, including CSEs, to establish
robust and professional risk management systems adequate for the
management of their day-to-day swap business.\66\ In addition,
Commission regulation 23.600 requires SDs and MSPs to establish and
maintain a risk management program to monitor and manage risk
associated with their swap activities.\67\
---------------------------------------------------------------------------
\64\ Letter 19-29 at 4. The last two conditions in Letter 19-29
(which refers to Cargill's swap dealer as ``CRM SD'') read as
follows:
4. To the extent CRM SD uses an SD counterparty's IM calculation
generated pursuant to an Approved IM Calculation Method, CRM SD must
monitor the Approved IM Calculation Method's output, in particular,
to ensure the sufficiency of the calculated IM amounts. CRM SD must
keep track of exceedances, that is, price movements above the
amounts of IM generated pursuant to an Approved IM Calculation
Method. If the exceedances indicate that the Approved IM Calculation
Method being used fails to meet the relevant regulators' standards,
CRM SD must take appropriate steps to ensure compliance with its
risk management obligations and address the exceedances with its SD
counterparty. If any adjustments or enhancements are applied to the
amount of IM calculated pursuant to the Approved IM Calculation
Method to ensure CRM SD's collection of adequate amounts of IM, CRM
SD must provide written notice by email to NFA and Commission staff
at [email protected] and [email protected],
respectively. CRM SD must also have an independent risk management
unit, as prescribed in Commission regulation 23.600, perform an
annual review of the Approved IM Calculation Method's output. CRM SD
should be prepared to produce, upon request, records relating to the
monitoring of the Approved IM Calculation Method output and any
other records demonstrating CRM SD's ongoing monitoring.
5. As part of its risk management program pursuant to Commission
regulation 23.600, CRM SD must independently monitor on an ongoing
basis credit risk, including potential future exposure associated
with uncleared swaps subject to the CFTC Margin Rule, to determine,
among other things, whether CRM SD is approaching the $50 million IM
Threshold with respect to a counterparty.
\65\ See 17 CFR 23.154(b)(2) (explaining that IM is equal to the
potential future exposure of the uncleared swap or netting portfolio
of uncleared swaps covered by an eligible master netting
agreement.).
\66\ 7 U.S.C. 6s(j)(2).
\67\ See 17 CFR 23.600.
---------------------------------------------------------------------------
To obtain relief under Letter 19-29, Cargill also must ``keep track
of exceedances'' and ``[if] the exceedances indicate that the Approved
IM Calculation Method fails to meet the relevant regulators' standards,
[Cargill] must take appropriate steps to ensure compliance with its
risk management obligations and address exceedances with its SD
counterparty.'' \68\ The purpose of this requirement is to ensure that
Cargill monitors, identifies, and addresses potential shortfalls in the
amount of IM generated by the counterparty. Cargill must also report to
the CFTC ``any adjustments and enhancements . . . applied to the amount
of IM calculated pursuant to the Approved IM Calculation Method to
ensure [Cargill's] collection of adequate amounts of IM.''
---------------------------------------------------------------------------
\68\ Letter 19-29 at 4.
---------------------------------------------------------------------------
The Commission preliminarily believes that Commission regulation
23.600 addresses these concerns by requiring SDs and MSPs to account
for credit risk in conducting their risk oversight and to ensure
compliance with the CFTC margin requirements. In the case of a CSE
relying on the provisions of proposed paragraph (a)(5), adequate risk
oversight would include steps by the CSE to monitor, identify, and
address potential shortfalls in the amounts of IM generated by the
counterparty on whose IM model the CSE is relying. While the Commission
does not propose to prescribe the CSE's oversight process, it believes
that a risk management program that is unable to identify or to address
shortfalls in IM would be insufficient to comply with Regulation
23.600.
Moreover, Commission regulation 23.600 requires SDs and MSPs to
furnish to the Commission risk exposure reports setting forth credit
risk exposures and any other applicable risk exposures relating to
their swap activities. Here again, the Commission believes that an
adequate risk exposure
[[Page 59710]]
report pursuant to Regulation 23.600 would require a CSE to identify
any adjustments and enhancements to the amount of IM calculated
pursuant to the risk-based model of its swap entity counterparty to
ensure the CSE's collection of adequate amounts of IM.
The Commission requests comment regarding the proposed amendment to
Commission regulation 23.154(a). The Commission also specifically
requests comment on the following questions:
The proposed amendment to Regulation 23.154(a) would allow
a CSE to use the risk-based model calculation of IM of a swap entity
counterparty to comply with Regulation 23.154(a)(1), which requires
CSEs to calculate IM to be collected from counterparties. The
alternative method of IM calculation would be available only with
respect to uncleared swaps entered into for the purpose of hedging.
Should this restriction be eliminated, narrowed, or expanded? If the
restriction should be narrowed or expanded, please describe any
appropriate modifications to the restriction. If it should be
eliminated, please explain why.
The proposed amendment to Regulation 23.154(a) intends to
provide an alternative method for the calculation of IM for CSEs with
highly specialized and discrete swap business models that primarily
enter into swaps with non-SDs or MSPs but, enter into offsetting swaps
with SDs and MSPs to hedge the risk of such customer-facing swaps, and
opt to use the standardized IM table set forth in Commission regulation
23.154(c) rather than adopt and maintain a risk-based model for the
calculation of IM. As such, the use of the alternative method of
calculation is not expected to be widespread. Is this a reasonable
expectation, or would this alternative method of IM calculation be
likely to be used by all CSEs or a larger subset of CSEs than
anticipated under the proposed rule? If a larger subset, please
describe the characteristics of this wider group. Should the
availability of this alternative method of IM calculation include all
classes of swaps, or only a subset (e.g., commodity swaps)?
How many CSEs would likely take advantage of this
amendment? How many of these CSEs do not trade uncleared swaps
currently? How many use the standardized IM table? How many use a model
developed by a third-party vendor? How many of the Phase 5 entities are
likely to take advantage of this amendment? What might they do for IM
calculation absent the amendment? To the extent possible, please
provide a basis for these estimates.
The Commission believes that the requirement to furnish
risk exposure reports under Commission regulation 23.600, while not
matching exactly all the terms of the CFTC notification required by
Letter 19-29, addresses the overall purpose of the requirement. Should
the Commission include a more tailored reporting requirement in the
proposed amendment?
Does the proposed amendment to effectively codify Letter
19-29 include sufficient risk management tools in place to guard
against any potential conflict of interest arising from the fact that a
CSE will rely on its swap entity counterparty's IM calculation to
determine the amount of IM to be collected from such counterparty?
Should the Commission proceed to adopt the proposed
amendment to effectively codify Letter 19-29 if the U.S. prudential
regulators do not adopt similar regulatory changes? Would this
divergence between the CFTC and the prudential regulators' margin
requirements for uncleared swaps impact market participants? Is there a
potential for industry confusion if that were to be the case?
III. Administrative Compliance
The Regulatory Flexibility Act (``RFA'') requires Federal agencies
to consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis respecting the impact.\69\
Whenever an agency publishes a general notice of proposed rulemaking
for any rule, pursuant to the notice-and-comment provisions of the
Administrative Procedure Act,\70\ a regulatory flexibility analysis or
certification typically is required.\71\ The Commission previously has
established certain definitions of ``small entities'' to be used in
evaluating the impact of its regulations on small entities in
accordance with the RFA.\72\ The proposed amendments only affect
certain SDs and MSPs and their counterparties, which must be eligible
contract participants (``ECPs'').\73\ The Commission has previously
established that SDs, MSPs and ECPs are not small entities for purposes
of the RFA.\74\
---------------------------------------------------------------------------
\69\ 5 U.S.C. 601 et seq.
\70\ 5 U.S.C. 553. The Administrative Procedure Act is found at
5 U.S.C. 500 et seq.
\71\ See 5 U.S.C. 601(2), 603, 604, and 605.
\72\ See Registration of Swap Dealers and Major Swap
Participants, 77 FR 2613 (Jan. 19, 2012).
\73\ Pursuant to section 2(e) of the CEA, 7 U.S.C. 2(e), each
counterparty to an uncleared swap must be an ECP, as defined in
section 1a(18) of the CEA, 7 U.S.C. 1a(18).
\74\ See Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' `` `Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR
30596, 30701 (May 23, 2012).
---------------------------------------------------------------------------
Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the proposed amendments will
not have a significant economic impact on a substantial number of small
entities.
A. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \75\ 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 Commission may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid Office of Management
and Budget control number. The proposed amendments contain no
requirements subject to the PRA.
---------------------------------------------------------------------------
\75\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
B. Cost-Benefit Considerations
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA.\76\ Section 15(a) further specifies that the costs and
benefits shall be evaluated in light of the following 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. The Commission
considers the costs and benefits resulting from its discretionary
determinations with respect to the section 15(a) considerations, and
seeks comments from interested persons regarding the nature and extent
of such costs and benefits.
---------------------------------------------------------------------------
\76\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
The Commission is proposing to amend the CFTC Margin Rule to revise
the method for calculating AANA for determining whether an FEU has MSE
and the timing for determining whether an FEU has MSE after the end of
the phased compliance schedule (``timing of post-phase-in
compliance''). These amendments would align the CFTC Margin Rule with
the BCBS/IOSCO Framework with respect to these matters.
The Commission is also proposing to amend Commission regulation
23.154(a) along the lines of Letter 19-29, and thus allow CSEs to use
the risk-based model calculation of IM of a counterparty that
[[Page 59711]]
is a swap entity.\77\ The proposed rule would make this accommodation
available only with respect to uncleared swaps entered into for the
purpose of hedging swap risk.
---------------------------------------------------------------------------
\77\ For the definition of the term ``swap entity,'' see supra
note 34.
---------------------------------------------------------------------------
The baseline against which the benefits and costs associated with
the proposed amendments are compared is the uncleared swaps markets as
they exist today and the currently applicable timing for compliance
with the IM requirements after the expiration of the phased compliance
schedule. Concerning the amendment of Commission regulation 23.154(a),
the Commission believes that to the extent market participants may have
relied on Letter 19-29, the actual costs and benefits of the proposed
amendment, as realized by the market, may not be as significant at a
practical level. With respect to the proposed amendment to align
aspects of the CFTC Margin Rule with the BCBS/IOSCO Framework, the
Commission acknowledges that the Dodd-Frank Act calls on the CFTC to
``consult and coordinate on the establishment of consistent
international standards'' with respect to the regulation of swaps.\78\
The proposed rule therefore would advance the Congressional mandate to
harmonize the CFTC's requirements with international standards, thereby
removing a regulatory impediment that might hinder the competitiveness
of the U.S. swaps industry.\79\
---------------------------------------------------------------------------
\78\ See supra note 42.
\79\ A starting point in determining the potential benefit of
alignment with the BCBS/IOSCO Framework is various statutory
provisions where the U.S. Congress has called on the CFTC and other
financial regulators to align U.S. regulatory requirements with
international standards. For example, the Commodity Futures
Modernization Act of 2000 (``CFMA'') focused on the potential threat
to competitiveness for U.S. industry where there is divergence with
international standards. In particular, section 126 of the CFMA
provides that regulatory impediments to the operation of global
business interests can compromise the competitiveness of United
States businesses. See CFMA section 126(a), Appendix E of Public Law
106-554, 114 Stat. 2763 (2000).
---------------------------------------------------------------------------
The Commission notes that the consideration of costs and benefits
below is based on the understanding that the markets function
internationally, with many transactions involving U.S. firms taking
place across international boundaries; with some Commission registrants
being organized outside of the United States; with leading industry
members typically conducting operations both within and outside the
United States; and with industry members commonly following
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
below discussion of costs and benefits refers to the effects of these
proposed amendments on all activity subject to the proposed amended
regulations, whether by virtue of the activity's physical location in
the United States or by virtue of the activity's connection with
activities in, or effect on, U.S. commerce under section 2(i) of the
CEA.\80\
---------------------------------------------------------------------------
\80\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------
1. Benefits
By harmonizing the method for calculating AANA for determining MSE
and the timing of post-phase-in compliance with the BCBS/IOSCO
Framework, the proposed amendment would create a benefit because it
would reduce complexity--for example, the proposed AANA month-end
calculation would require consideration of only three observation dates
rather than daily AANAs over the three-month calculation period--and
the potential for confusion in the application of the margin
requirements. Firms would no longer need to undertake separate AANA
calculations using different calculation periods, nor would they need
to conform to two separate compliance timings, varying according to the
location of their swap counterparties and jurisdictional requirements
applicable to the counterparties.
The proposed amendment would impact FEUs with average AANA between
$8 billion and $50 billion (Phase 6 entities) that come into the scope
of compliance with the IM requirements under the CFTC Margin Rule in
the last compliance phase beginning on September 1, 2021, as well as
those entities that come into scope after the end of the last
compliance phase. The Commission believes that the proposed amendment
would benefit these entities, which, given their level of swap
activity, pose a lower risk to the uncleared swaps market and the U.S
financial system in general than entities who came into scope in
earlier phases. The OCE has estimated that there are approximately 514
of such entities representing 4% of total AANA across all phases.\81\
This means that the proposed amendment addresses entities that tend to
engage in less uncleared swap trading activity and, and in the
aggregate, pose less systemic risk than entities in previous phases.
Because these entities are smaller, they presumably have fewer
resources to devote to IM compliance and hence would benefit from the
alignment of the method of calculation of AANA across jurisdictions
without contributing substantially to systemic risk.
---------------------------------------------------------------------------
\81\ Using March-May of 2020 as the calculation period. The
methodology for calculating AANA is described in Richard Haynes,
Madison Lau, & Bruce Tuckman, Initial Margin Phase 5, at 4 (Oct. 24,
2018), https://www.cftc.gov/sites/default/files/About/Economic%20Analysis/Initial%20Margin%20Phase%205%20v5_ada.pdf.
---------------------------------------------------------------------------
For Phase 6 entities with average AANA between $8 billion and $50
billion that will begin collecting initial margin on September 1, 2021,
moving the calculation period from June, July, and August 2020 to
March, April, and May 2021 would better align with current practices.
While the Commission cannot anticipate exactly how the second quarter
of 2021 will differ from the third quarter of 2020, based on comparable
past experience, the OCE estimates that approximately 75-100 entities
would come into scope, and a similar number would fall below the
threshold by virtue of moving the calculation period. The adjusted
calculation period would reduce the regulatory burden for firms that
have reduced their MSE below the $8 billion threshold while requiring
the collection of margin for those firms that have increased their
swaps business above the threshold. While aggregate AANA for firms that
fall into or out of scope is small relative to the overall market (less
than one percent of total aggregate AANA), moving the calculation
period close to the compliance date may have a significant impact on
the entities that have reduced their MSE.
The Commission also notes that the benefits of alignment with the
BCBS/IOSCO Framework will continue to accrue in future years, as the
determination of MSE for an FEU under the CFTC Margin Rule is an annual
undertaking, triggered by the entry into an uncleared swap between the
FEU and a CSE counterparty and the need to determine whether the FEU
has MSE, which triggers the application of the IM requirements and the
exchange of regulatory IM between a CSE and a FEU for their uncleared
swap transactions.
With respect to the amendment of Commission regulation 23.154(a),
the Commission believes that the uncleared swap markets would benefit
from the extension of the targeted relief provided to Cargill, the
requester in Letter 19-29, to a wider group of CSEs with similar unique
swap business models. In taking a no-action position, DSIO took account
of Cargill's representation that its swap trading activity primarily
involved physical agricultural commodities and certain other asset
classes and that it ``may maintain positions that require collection of
IM from SDs.'' Cargill
[[Page 59712]]
further stated that given the highly specialized and discrete nature of
its swap business, risk-based modeling would impose a disproportionate
burden.
The more widespread availability of the alternative method of
calculation of IM provided by regulation 23.154(a), as proposed to be
amended, may incentivize some market participants to expand their swap
business. In particular, given that certain market participants would
have the option to forgo the cost of risk-based modeling, this
potential reduction in compliance costs may encourage certain entities
to increase their swaps trading. This may be especially true after
September 1, 2021, as a large number of entities will be newly-subject
to mandatory margin.\82\ By increasing the pool of potential swap
counterparties, the proposed amendment could enhance competition,
increase overall liquidity, and facilitate price discovery in the
uncleared swaps markets.
---------------------------------------------------------------------------
\82\ Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 85 FR 41346 (July 10, 2020).
---------------------------------------------------------------------------
2. Costs
While the proposed changes to the CFTC Margin Rule would have the
effect of creating efficiencies for market participants, the Commission
acknowledges that the changes would also result in some costs. Among
other things, the proposed revision of the AANA calculation period for
determining MSE to align it with the BCBS/IOSCO AANA calculation period
would reduce the time frame for determining whether an FEU is subject
to the IM requirements and for preparing for compliance with the
requirements during the final phase-in period of 2021.
Under the current margin requirements, in the period leading to the
final phase-in date of September 1, 2021, FEUs would have a full year
to prepare, as MSE for an FEU would be determined by using the AANA for
June, July and August of the prior year. However, the proposed
amendment to the period of calculation of AANA for determining MSE
would result in entities only having a three-month advance notice in
2021, as AANA would be calculated using the March, April and May period
of that year. Entities would have a shorter time frame to engage in
preparations to comply with IM requirements, including, among other
things, procuring rule-compliant documentation, establishing processes
for the exchange of regulatory IM, and setting up IM custodial
arrangements. Because the proposed amendment would align the AANA
calculation for determining MSE with BCBS/IOSCO's AANA calculation and
the compliance date would remain unchanged, the Commission believes
that the cost would be mitigated. In particular, the Commission notes
market participants' statements indicating that the differences in the
U.S. regulations could create complexity and confusion and lead to
additional effort, cost and compliance challenges for smaller market
participants that are generally subject to margin requirements in
multiple global jurisdictions.\83\
---------------------------------------------------------------------------
\83\ Margin Subcommittee Report at 49.
---------------------------------------------------------------------------
The Commission further notes that the proposed amendment to the
timing of post-phase-in compliance would defer compliance with the IM
requirements with respect to uncleared swaps entered into by a CSE with
an FEU that comes into the scope of IM compliance after the end of the
last compliance phase. Under the current rule, FEUs with MSE as
measured in June, July, and August 2021 would come into the scope of
compliance post-phase-in beginning on January 1, 2022. On the other
hand, under the proposed amendment, FEUs with MSE as measured in March,
April, and May 2022 would be subject to compliance beginning on
September 1, 2022. As a result, for FEUs with MSE in both periods, less
collateral for uncleared swaps may be collected between January 1,
2022, and September 1, 2022, rendering uncleared swap positions entered
into during the nine-month period riskier, which could increase the
risk of contagion and the potential for systemic risk. Conversely,
under the proposed amendment, a CSE would be required to exchange IM
with a previously in-scope FEU that fell below the MSE level by January
1, 2022, for nine months longer than the otherwise required.
With respect to changing the daily AANA calculation method to a
month-end calculation method for determining MSE, the Commission
acknowledges that there are potential costs. The utilization of a
month-end calculation method could result in an AANA calculation that
is not representative of a market participant's participation in the
swaps markets. As previously discussed, the proposed AANA month-end
calculation may result in the exclusion or undercounting of certain
financial contracts that are required to be included in the calculation
(e.g., uncleared swaps, uncleared security-based swaps, foreign
exchange forwards, or foreign exchange swaps) because of certain
combinations of tenure and time of execution, such as those often
present in some intra-month natural gas and electricity swaps.\84\ The
Commission also notes the potential that market participants might
``window dress'' their exposures to avoid MSE status and compliance
with the CFTC's margin requirements. At the same time, it is possible
that the month-end methodology, which uses only three data points,
could result in some entities having an AANA calculation on the three
end-of-month dates that is uncharacteristically high relative to their
typical positions.
---------------------------------------------------------------------------
\84\ See supra note 49.
---------------------------------------------------------------------------
If products are excluded from the AANA calculation, or if exposures
are ``window dressed,'' the month-end calculation may have the effect
of deferring the time by which market participants meet the MSE
classification resulting in additional swaps between market
participants and CSEs being deemed legacy swaps that are not subject to
the IM requirements.\85\ This may increase the level of counterparty
credit risk to the financial system. While potentially meaningful, this
risk would be mitigated because the legacy swap portfolios would be
entered into with FEUs that engage in lower levels of notional trading.
---------------------------------------------------------------------------
\85\ Pursuant to Commission regulation 23.161, the compliance
dates for the IM and VM requirements under the CFTC Margin Rule are
staggered across a phased schedule that extends from September 1,
2016, to September 1, 2021. The compliance period for the VM
requirements ended on March 1, 2017 (though the CFTC and other
regulators provided guidance permitting a six-month grace period to
implement the requirements following the implementation date), while
the IM requirements continue to phase in through September 1, 2021.
An uncleared swap entered into prior to an entity's IM compliance
date is a ``legacy swap'' that is not subject to IM requirements.
See CFTC Margin Rule, 81 FR at 651 and Commission regulation 23.161.
17 CFR 23.161.
---------------------------------------------------------------------------
Finally, given the possibility that the U.S. prudential regulators
may not adopt the changes to the method of calculation of AANA proposed
in this rulemaking, there is the potential that firms that engage in
swaps transactions with both CSEs and swaps dealers subject to the
margin requirements of the U.S. prudential regulators may incur
additional costs by continuing to have to undertake their AANA
calculations under two different methods of calculation.
However, the Commission preliminarily is of the view that the
benefits of aligning with the BCBS/IOSCO Framework outweigh these
potential costs. In this regard, in the aforementioned OCE exercise
utilizing a sample of days, the OCE estimated that calculations based
on end-of-month
[[Page 59713]]
AANA would yield fairly similar results as the calculations based on
the current daily AANA approach (setting aside the window dressing
issue). Based on 2020 swap data, the OCE estimated that approximately
492 entities of 514 entities that would come into scope during Phase 6
based on the current methodology would also come into scope based on
the proposed methodology. Put differently, all but 22 of the entities
that are above MSE under the current methodology would also be above
MSE under the proposed methodology. In addition, there are 20 entities
that would be in scope under the proposed methodology, but would not be
under the current methodology, so that the aggregate number of Phase 6
entities differs only by two. In aggregate, the two methodologies would
capture quite similar sets of entities. In addition, the entities that
fall out of scope when one changes methodology tend to be among the
smallest of the Phase 6 entities. That is, entities that are in-scope
under the current methodology but not the proposed methodology average
$6.95 billion in AANA, compared to $20 billion for all Phase 6
entities.\86\
---------------------------------------------------------------------------
\86\ See supra note 50.
---------------------------------------------------------------------------
Taking account of the small number of FEUs that would therefore
have MSE and thus be subject to the Commission's IM requirements, the
Commission believes that the potential exclusion of certain financial
products in determining MSE would have a limited impact on the
effectiveness of the CFTC Margin Rule. In addition, with respect to the
potential that a market participant might ``window dress'' its
exposure, the Commission has sufficient regulatory authority, including
anti-fraud powers under section 4b of the CEA,\87\ to take appropriate
enforcement actions against any market participant that may engage in
deceptive conduct with respect to the AANA calculation, and CSEs must
also have written policies and procedures in place to prevent evasion
or the facilitation of an evasion by an FEU counterparty.\88\
---------------------------------------------------------------------------
\87\ 7 U.S.C. 6b.
\88\ See 17 CFR 23.402(a)(ii).
---------------------------------------------------------------------------
Roughly 514 entities, as estimated by the OCE, would come into the
scope of the IM requirements beginning on September 1, 2021, and would
be affected by the foregoing proposed amendments. In advance of the
September 1, 2021 compliance date, many of these entities may engage in
planning and preparations relating to the exchange of regulatory IM.
With the revision of the AANA method of calculation, these entities may
need to adjust their systems to reflect changes in the calculation and
update related financial infrastructure arrangements. While requesting
comments on this issue, the Commission believes that the cost of
shifting the MSE calculation period to the new time frame would be
negligible, and the adoption of the month-end AANA calculation method
would likely be cost-reducing for impacted firms.
Regarding the amendment of Commission regulation 23.154(a), there
may be associated costs, as CSEs would be allowed to rely on the risk-
based model calculation of IM computed by a swap entity counterparty.
Specifically, the safeguard of requiring both the CSE and its SD
counterparty to maintain a margin model for any swap transaction that
does not utilize the table-based method would be eliminated. A CSE that
relies on a counterparty's risk-based model calculations would thus
avoid rigorous Commission requirements relating to risk-based
modeling,\89\ which may undercut the effectiveness of the CSE's risk
oversight.\90\
---------------------------------------------------------------------------
\89\ See generally 17 CFR 23.154(b).
\90\ But cf. 17 CFR 23.600 (requiring SDs and MSP to establish a
robust risk management program for the monitoring and management of
their swaps activities).
---------------------------------------------------------------------------
In addition, the safeguard of private market discipline that is
inherent in having each counterparty develop its own IM model, and
therefore the ability for the parties to scrutinize each other's IM
model and output, will not be present given that under the proposed
rule, a CSE would be permitted to rely on the risk-based model
calculation of a swap entity counterparty. As a result, there is the
potential that insufficient amounts of IM would be generated by the
swap entity counterparty, which may be attributable to a deficiency in
the model or the fact that the swap entity may be inherently conflicted
and interested in generating lower amounts of IM collectable by the
CSE.\91\ Given that the CSE without a model may lack adequate means to
verify the amount of IM produced by the swap entity counterparty, the
CSE may not be capable to contest it. As a result, insufficient amounts
of IM may be collected by the CSE to protect itself against the risk of
default by the swap entity counterparty, increasing the risk of
contagion and the potential for systemic risk.
---------------------------------------------------------------------------
\91\ But cf. 17 CFR 23.600 (requiring swap entities to have a
risk management program for the management and monitoring of risk
associated with their swaps, which may reduce the risk that such
entities may act in a conflicted manner).
---------------------------------------------------------------------------
The Commission, however, believes that these costs are mitigated by
the proposed rule, which would be narrowly tailored to make available
the alternative method of IM calculation set forth in Letter 19-29 only
with respect to uncleared swaps entered into for the purpose of
hedging. In addition, the Commission notes that there are other
requirements in the Commission's regulations that address the
monitoring of exposures and swap risk.
3. Section 15(a) Considerations
In light of the foregoing, the CFTC has evaluated the costs and
benefits of the proposal pursuant to the five considerations identified
in section 15(a) of the CEA as follows:
(a) Protection of Market Participants and the Public
The proposed rule would align the CFTC Margin Rule's method for
calculating AANA for determining MSE and the timing of post-phase-in
compliance with the BCBS/IOSCO Framework. By aligning these
requirements with the international standard, the proposed rule would
reduce the potential for complexity and confusion that can result from
using different AANA calculation methods and different compliance
schedules for market participants that may be subject to margin
requirements in multiple jurisdictions. At the same time, the
Commission recognizes that some firms may have already begun
preparations to undertake AANA calculations under the existing
requirements. The proposed rule may require them to adjust their
calculations to reflect the new proposed method for calculating AANA
for determining MSE and to update infrastructure arrangements,
increasing the overall cost of compliance with the margin requirements.
Under the existing CFTC Margin Rule, firms that are FEUs, beginning
in Phase 6, which starts on September 1, 2021, would look back to the
2020 June-August period to determine whether they have MSE. As such,
the firms would have no less than twelve months to engage in
preparations for the exchange of regulatory IM, by, among other things,
procuring rule-compliant documentation, establishing processes and
systems for the calculation, collection and posting of IM collateral,
and setting up custodial arrangements. If the Commission determines to
adopt the proposed amendment changing the AANA calculation period for
determining MSE to March-May of the current year, such firms would have
only a three-month window to engage in preparations to exchange IM.
Nevertheless, the Commission notes that, under the existing
requirements,
[[Page 59714]]
after the end of the phased compliance schedule, firms would only have
four months in subsequent years since the calculation period for
determining MSE status would be June through August of the prior year,
with compliance starting January 1 of the following year. In addition,
because the proposed amendment would require only averaging three
month-end dates rather than averaging all business days during the
three-month calculation period, the potential burdens of a shorter
preparatory period for Phase 6 entities may be offset by the adoption
of the BCBS/IOSCO Framework's less onerous calculation method.
Moreover, the proposed amendment would shift the timing of post-
phase-in compliance to September 1 of each year. As such, entities that
otherwise would be required to exchange IM beginning January 1, 2022,
would be able to defer compliance to September 1, 2022.\92\ As a
result, less collateral for uncleared swaps may be collected between
January 1, 2022, and September 1, 2022, rendering the parties'
positions riskier during that nine-month period, which could raise the
risk of contagion and increase the potential for systemic risk. Firms
that would have fallen out of scope by January 1, 2022 would also be
subject to compliance for an additional nine months.
---------------------------------------------------------------------------
\92\ This would apply to entities that meet the MSE level based
on their AANA during the June, July, and August 2021 period, and
continue to have MSE in the March, April, and May 2022 period. Of
course, changing the calculation period to the March, April, and May
2022 period may lead to the inclusion of entities whose AANA is
below MSE in the June, July, and August 2021 period, but rises to
the MSE level or above by the March, April, and May 2022 period. The
OCE estimated that approximately 75-100 entities typically move from
one side of the MSE threshold to the other between measurement
periods.
---------------------------------------------------------------------------
Notwithstanding these potential costs, the Commission believes that
the proposed changes advance the Commission's goal, pursuant to
statutory direction, of coordination and harmonization with
international regulators. The costs that may arise as a result of the
proposed changes, as discussed above, would be mitigated by the overall
cost savings, as the need to undertake separate calculations of MSE to
address different requirements in different jurisdictions would be
obviated with respect to most jurisdictions.
The amendment of Commission regulation 23.154(a) would allow a CSE
to use the risk-based model calculation of IM of a counterparty that is
a swap entity. Without an alternative model, the CSE may not be able to
challenge the amounts generated by the swap entity counterparty, which
may be insufficient because of model error or malfunction or because
the swap entity may be inherently conflicted and may be interested in
generating low amounts of IM collectable by the CSE. In turn,
insufficient amounts of IM may be collected by the CSE to offset the
risk of counterparty default, increasing the risk of contagion and the
potential for systemic risk.
The Commission believes that these risks would be mitigated by the
proposed rule, which would be narrowly tailored to permit reliance on a
swap entity counterparty's risk-based model calculation only with
respect to uncleared swaps entered into for the purpose of hedging. In
addition, there are other requirements in the Commission's regulations
that address the monitoring of exposures and swap risk (i.e.,
Commission regulation 23.600, which requires SDs and MSPs to adopt a
robust risk management program for the monitoring and management of
risk related to their swap activities).
(b) Efficiency, Competitiveness, and Financial Integrity of Markets
The proposed rule would align the CFTC Margin Rule's AANA
calculation method for determining MSE and the timing of post-phase-in
compliance with the BCBS/IOSCO Framework. As such, the proposed rule
would reduce the need, at least for entities not also undertaking swaps
with U.S. prudentially regulated SDs, to undertake separate AANA
calculations accounting for different calculation methods and to
conform to separate compliance timings, varying according to the
location of swap counterparties and jurisdictional requirements
applicable to the counterparties. As such, the proposed changes would
promote market efficiency and would even the playing field for market
players, fostering competitiveness and reducing the incentive to engage
in regulatory arbitrage by identifying more accommodating margin
frameworks.
The amendment of Commission regulation 23.154(a) would allow CSEs
to rely on a swap entity counterparty's IM risk-based model
calculations. Without a model, the CSE would lack effective means to
verify its counterparty's IM calculations. As a result, if there are
shortfalls in the output, the CSE may collect less IM collateral to
offset the risk of default by the counterparty, which could increase
the risk of contagion, threatening the integrity of the U.S. financial
markets. The Commission, however, believes that the proposed rule is
sufficiently targeted to mitigate these risks. The proposed amendment
would apply only when uncleared swaps are entered into for hedging,
thus limiting widespread use and the potential for uncollateralized
uncleared swap risk.
In addition, by providing an alternative to risk-based modeling and
the associated costs, the proposed rule could encourage some market
participants to expand their swap business. The proposed amendment
would thus promote efficiency in the uncleared swaps market by
increasing the pool of swap counterparties and fostering competition.
On the other hand, the availability of an alternative less costly
method of IM calculation may encourage entities to shift their trading
to uncleared swaps from swaps that can be cleared, potentially reducing
liquidity in the cleared swap markets.
(c) Price Discovery
By aligning the CFTC Margin Rule and the BCBS/IOSCO Framework with
respect to the AANA calculation method for determining MSE and post-
phase-in compliance timing, the proposed rule would reduce the burden
and confusion inherent in implementing separate measures and processes
to address compliance in different jurisdictions. The proposed rule
could thus incentivize more firms to enter into uncleared swap
transactions, which would increase liquidity and lead to more robust
pricing that reflects market fundamentals.
By amending Commission regulation 23.154(a), the Commission would
relieve certain CSEs from having to adopt a risk-based margin model to
calculate IM or use the standardized IM table. Being able to rely on a
counterparty's risk-based model calculation of IM may encourage
entities to increase trading in uncleared swaps. As a result, firms may
take a more active role in the uncleared swap markets, which would lead
to increase liquidity and enhance price discovery. On the other hand,
the proposed amendment may encourage entities to shift their trading
from swaps that can be cleared, potentially reducing liquidity and
price discovery in those markets.
(d) Sound Risk Management
The proposed rule would reduce the need for firms to undertake
separate AANA calculations using different methods and to conform to
separate compliance timing, allowing firms to engage in sound risk
management by focusing on more substantive requirements.
Under the current rule, after the last phase of compliance, FEUs
would be subject to IM compliance beginning on
[[Page 59715]]
January 1, 2022. The proposed rule would defer such compliance until
September 1, 2022. Uncleared swaps entered between January 1, 2022, and
September 1, 2022, may be uncollateralized. As such, less collateral
may be collected, and positions created during that nine-month period
may be riskier, increasing the risk of contagion and systemic risk. The
Commission notes, however, that keeping the January 1, 2022 compliance
date could likewise result in the collection of less collateral. Some
FEUs, after coming into scope during the last phase of compliance, may
exit MSE status on January 1, 2022, as their AANA during the relevant
calculation period may decline below the MSE threshold, and CSEs
entering into uncleared swaps with these FEUs would no longer be
required to exchange IM with the FEUs.
Also, it is possible that under the proposed month-end method for
calculating AANA to determine MSE, FEUs trading certain financial
products may avoid MSE status, as month-end calculations may not
capture certain financial products that are required to be included in
the calculation. As result, CSEs transactions with such FEUs would not
be subject to the IM requirements and may be insufficiently
collateralized, increasing the risk of contagion and systemic risk.
Conversely, because more than 96% of FEUs are unlikely to have MSE, as
estimated by the OCE, and come within the scope of the IM requirements,
the exclusion of such products would have a limited impact on the
effectiveness of the Commission's IM requirements.
Moreover, month-end AANA calculations compared to daily AANA
calculations may be more susceptible to ``window dressing'' and less
conducive to sound risk management. FEUs may manage their exposures as
they approach the month-end date during the three month calculation
period to avoid MSE status. The Commission, however, notes that it has
sufficient regulatory authority, including anti-fraud powers under
section 4b of the CEA, to take appropriate enforcement actions against
any market participant that may engage in deceptive conduct with
respect to the AANA calculation, and CSEs must also have written
policies and procedures in place to prevent evasion or the facilitation
of an evasion by an FEU counterparty.
By allowing CSEs to use the risk-based model calculation of a swap
entity counterparty consistent with Letter 19-29, CSEs may no longer be
incentivized to adopt their own risk-based models. If a CSE uses a
counterparty's IM model calculation without developing its own model,
the CSE may lack reasonable means to verify the IM provided by its
counterparty, recognize shortfalls in the IM calculation, and identify
potential flaws in the swap entity counterparty's risk-based model. As
a result, insufficient amounts of IM may be collected by the CSE to
protect itself against the risk of default by the swap entity
counterparty, increasing the risk of contagion and the potential for
systemic risk. The Commission, however, believes that these risks are
mitigated because, under the proposed amendment, CSEs would be able to
use a counterparty's risk-based model IM calculation only with respect
to uncleared swaps entered into for the purpose of hedging. In
addition, the Commission notes that there are other requirements in the
Commission's regulations that address the monitoring of exposures and
swap risk.
(e) Other Public Interest Considerations
The Commission believes that the proposed amendments to align the
CFTC Margin Rule with the BCBS/IOSCO Framework would promote
harmonization with international regulatory requirements and would
reduce the potential for regulatory arbitrage. However, given that the
U.S. prudential regulators may not amend their margin requirements in
line with the proposed amendments, the possibility exists that the CFTC
and U.S. prudential regulators' differing rules may induce certain
firms to undertake swaps with particular SDs based on which U.S.
regulatory agency is responsible for setting margin requirements for
such SDs.
Request for Comments on Cost-Benefit Considerations. The Commission
invites public comment on its cost-benefit considerations, including
the section 15(a) factors described above. Commenters are also invited
to submit any data or other information they may have quantifying or
qualifying the costs and benefits of the proposed amendments.
C. Antitrust Laws
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of this Act, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule or regulation of a
contract market or registered futures association established pursuant
to section 17 of this Act.\93\
---------------------------------------------------------------------------
\93\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requests comment on whether the proposed amendments implicate any other
specific public interest to be protected by the antitrust laws.
The Commission has considered the proposed amendments to determine
whether they are anticompetitive, and has preliminarily identified no
anticompetitive effects. The Commission requests comment on whether
these rule proposals are anticompetitive and, if they are, what the
anticompetitive effects are.
Because the Commission has preliminarily determined that the
proposed amendments are not anticompetitive and have no anticompetitive
effects, the Commission has not identified any less competitive means
of achieving the purposes of the Act. The Commission requests comment
on whether there are less anticompetitive means of achieving the
relevant purposes of the Act that would otherwise be served by adopting
the proposed amendments.
List of Subjects in 17 CFR Part 23
Capital and margin requirements, Major swap participants, Swap
dealers, Swaps.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 23 as set forth below:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
1. The authority citation for part 23 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b),
Pub. L. 111-203, 124 Stat. 1641 (2010).
0
2. In Sec. 23.151, revise the definition of ``Material swaps
exposure'' to read as follows:
Sec. 23.151 Definitions applicable to margin requirements.
* * * * *
Material swaps exposure for an entity means that, as of September 1
of any year, the entity and its margin affiliates have an average
month-end aggregate notional amount of uncleared swaps, uncleared
security-based swaps, foreign exchange forwards, and foreign
[[Page 59716]]
exchange swaps with all counterparties for March, April, and May of
that year that exceeds $8 billion, where such amount is calculated only
for the last business day of the month. An entity shall count the
average month-end aggregate notional amount of an uncleared swap, an
uncleared security-based swap, a foreign exchange forward, or a foreign
exchange swap between the entity and a margin affiliate only one time.
For purposes of this calculation, an entity shall not count a swap that
is exempt pursuant to Sec. 23.150(b) or a security-based swap that
qualifies for an exemption under section 3C(g)(10) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c-3(g)(4)) and implementing
regulations or that satisfies the criteria in section 3C(g)(1) of the
Securities Exchange Act of 1934 (15 U.S.C. 78-c3(g)(4)) and
implementing regulations.
* * * * *
0
3. In Sec. 23.154, add paragraph (a)(5) to read as follows:
Sec. 23.154 Calculation of initial margin.
(a) * * *
(5) A covered swap entity would be deemed to calculate initial
margin as required by paragraph (a)(1) of this section if it uses the
amount of initial margin calculated by a counterparty that is a swap
entity and the initial margin amount is calculated using the swap
entity's risk-based model that meets the requirements of paragraph (b)
of this section or is approved by a prudential regulator, provided that
initial margin calculated in such manner is used only with respect to
uncleared swaps entered into by the covered swap entity and the swap
entity for the purpose of hedging the covered swap entity's swaps with
non-swap entity counterparties.
* * * * *
Issued in Washington, DC, on August 17, 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 Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Commission Voting Summary and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Supporting Statement of Commissioner Dawn D. Stump Overview
I am pleased to support the proposed rulemaking that the
Commission is issuing with respect to the definition of ``material
swap exposure'' and an alternative margin calculation method in
connection with the Commission's margin requirements for uncleared
swaps.
This proposed rulemaking addresses recommendations that the
Commission has received from its Global Markets Advisory Committee
(``GMAC''), which I am proud to sponsor, and is based on a
comprehensive report prepared by GMAC's Subcommittee on Margin
Requirements for Non-Cleared Swaps (``GMAC Margin
Subcommittee'').\1\ It demonstrates the value added to the
Commission's policymaking by its Advisory Committees, in which
market participants and other interested parties come together to
provide us with their perspectives and potential solutions to
practical problems.
---------------------------------------------------------------------------
\1\ Recommendations to Improve Scoping and Implementation of
Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps (April 2020), available at
https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
---------------------------------------------------------------------------
The proposed rulemaking contains two proposals, which have much
to commend them. These proposals further objectives that I have
commented on before:
The imperative of harmonizing our margin requirements
with those of our international colleagues around the world in order
to facilitate compliance and coordinated regulatory oversight; and
the benefits of codifying relief that has been issued
by our Staff and re-visiting our rules, where appropriate.
I am very appreciative of the many people whose efforts have
contributed to bringing this proposed rulemaking to fruition. First,
the members of the GMAC, and especially the GMAC Margin
Subcommittee, who devoted a tremendous amount of time to quickly
provide us with a high-quality report on complex margin issues at
the same time they were performing their ``day jobs'' during a
global pandemic. Second, Chairman Tarbert, for his willingness to
include this proposed rulemaking on the busy agenda that he has laid
out for the Commission for the rest of this year. Third, my fellow
Commissioners, for working with me on these important issues. And
finally, the Staff of the Division of Swap Dealer and Intermediary
Oversight (``DSIO''), whose tireless efforts have enabled us to
advance these initiatives to assure that our uncleared margin rules
are workable for all and are in line with international standards,
thereby enhancing compliance consistent with our responsibilities
under the Commodity Exchange Act (``CEA'').
Background: A Different Universe Is Coming Into Scope of the Uncleared
Margin Rules
The Commission's uncleared margin rules for swap dealers, like
the Framework of the Basel Committee on Banking Supervision and the
Board of the International Organization of Securities Commissions
(``BCBS/IOSCO'') \2\ on which they are based, were designed
primarily to ensure the exchange of margin between the largest
financial institutions for their uncleared swap transactions with
one another. These institutions and transactions are already subject
to uncleared margin requirements.
---------------------------------------------------------------------------
\2\ See generally BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (July 2019), available at https://www.bis.org/bcbs/publ/d475.pdf.
---------------------------------------------------------------------------
Pursuant to the phased implementation schedule of the
Commission's rules and the BCBS/IOSCO Framework, though, a different
universe of market participants--presenting unique considerations--
is coming into scope of the margin rules. It is only now, as we
enter into the final phases of the implementation schedule, that the
Commission's uncleared margin rules will apply to a significant
number of financial end-users, and we have a responsibility to make
sure they are fit for that purpose. Accordingly, now is the time we
must explore whether the regulatory parameters that we have applied
to the largest financial institutions in the earlier phases of
margin implementation need to be tailored to account for the
practical operational challenges posed by the exchange of margin
when one of the counterparties is a pension plan, endowment,
insurance provider, mortgage service provider, or other financial
end-user.
International Harmonization To Enhance Compliance and Coordinated
Regulation
The first proposal in this proposed rulemaking would revise the
calculation method for determining whether financial end-users come
within the scope of the initial margin (``IM'') requirements, and
the timing for compliance with the IM requirements after the end of
the phased compliance schedule. These changes would align certain
timing and calculation issues under the Commission's margin rules
with both the BCBS/IOSCO Framework and the manner in which these
issues are handled by our regulatory colleagues in all other major
market jurisdictions.
Swap dealers must exchange IM with respect to uncleared swaps
that they enter into with a financial end-user counterparty that has
``material swap exposure'' (``MSE''). The Commission's margin rules
provide that after the last phase of compliance, MSE is to be
determined on January 1, and that an entity has MSE if it has more
than $8 billion in average aggregate notional amount (``AANA'')
during June, July, and August of the prior year. By contrast, under
the BCBS/IOSCO Framework and in virtually every other country in the
world, an entity is determined to come into scope of the IM
requirement on September 1, and an entity has MSE if it has the
equivalent of $8 billion in AANA \3\ during March, April, and May of
that year.
---------------------------------------------------------------------------
\3\ The MSE threshold under the BCBS/IOSCO Framework is stated
in euros rather than dollars.
---------------------------------------------------------------------------
The reason the United States is out-of-step with the rest of the
world on these timing and calculation issues is not because of any
[[Page 59717]]
considered policy determination. Rather, it is simply the result of
a quirk that the margin rules were adopted based on the BCBS/IOSCO
Framework that was in effect at the time--but the BCBS/IOSCO
Framework was revised two years later.
In a further disconnect, the Commission's margin rules look to
the daily average AANA during the three-month calculation period for
determining MSE, whereas the BCBS/IOSCO Framework and other major
market jurisdictions base the AANA calculation on an average of
month-end dates during that period. Yet, the proposing release notes
that the Commission's Office of the Chief Economist has estimated
that calculations based on end-of-month AANA generally would yield
similar results as calculations based on the Commission's current
daily AANA approach.
The Commission is proposing to amend these timing and
calculation provisions of its uncleared margin rules to harmonize
them with the BCBS/IOSCO Framework and the approach followed by our
international colleagues around the world. Given the global nature
of the derivatives markets, we should always seek international
harmonization of our regulations unless a compelling reason exists
not to do so--which is not the case here.
Indeed, in the Dodd-Frank Act, Congress specifically directed
the Commission, ``[i]n order to promote effective and consistent
global regulation of swaps,'' to ``consult and coordinate with
foreign regulatory authorities on the establishment of consistent
international standards with respect to the regulation . . . of
swaps [and] swap entities . . .'' \4\ And when the G-20 leaders met
in Pittsburgh in the midst of the financial crisis in 2009, they,
too, recognized that a workable solution for global derivatives
markets demands coordinated policies and cooperation.\5\
---------------------------------------------------------------------------
\4\ See section 752(a) of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010)
(``Dodd-Frank Act'').
\5\ See Leaders' Statement from the 2009 G-20 Summit in
Pittsburgh, Pa. at 7 (September 24-25, 2009) (``We are committed to
take action at the national and international level to raise
standards together so that our national authorities implement global
standards consistently in a way that ensures a level playing field
and avoids fragmentation of markets, protectionism, and regulatory
arbitrage''), available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
---------------------------------------------------------------------------
The MSE proposal being issued today is true to the direction of
Congress in the Dodd-Frank Act, and honors the commitment of the G-
20 leaders at the Pittsburgh summit. Differences between countries
in the detailed timing and calculation requirements with respect to
uncleared margin compel participants in these global markets to run
multiple compliance calculations--for no particular regulatory
reason. This not only forces market participants to bear unnecessary
costs, but actually hinders compliance with margin requirements
because of the entirely foreseeable prospect of calculation errors
in applying the different rules.
As noted above, now is the time to address this disjunction in
MSE timing and calculation requirements because the financial end-
users to which the MSE definition applies are coming into scope of
the margin rules. Both Congress and the G-20 leaders recognized that
because modern swap markets are not bound by jurisdictional borders,
they cannot function absent consistent international standards.
Harmonization fosters both improved compliance and effectively
regulated markets through coordinated oversight--which must always
be our goals.
During the unfortunate events of the financial crisis, we
learned that coordination among global regulators, working towards a
common objective, is essential. That lesson remains true today, and
we are reminded that disregarding this reality has the potential to
weaken, rather than strengthen, the effectiveness of our oversight
and the resilience of global derivatives markets.
The Benefits of Codifying Staff Relief and Re-Visiting Our Rules
The second proposal in the proposed rulemaking would codify
existing DSIO no-action relief in recognition of market realities.
Our Staff often has occasion to issue relief or take other action in
the form of no-action letters, interpretative letters, or advisories
on various issues and in various circumstances. This affords the
Commission a chance to observe how the Staff action operates in
real-time, and to evaluate lessons learned. With the benefit of this
time and experience, the Commission should then consider whether
codifying such staff action into rules is appropriate.\6\ As I have
said before, ``[i]t is simply good government to re-visit our rules
and assess whether certain rules need to be updated, evaluate
whether rules are achieving their objectives, and identify rules
that are falling short and should be withdrawn or improved.'' \7\
---------------------------------------------------------------------------
\6\ See comments of Commissioner Dawn D. Stump during Open
Commission Meeting on January 30, 2020, at 183 (noting that after
several years of no-action relief regarding trading on swap
execution facilities (``SEFs''), ``we have the benefit of time and
experience and it is time to think about codifying some of that
relief. . . . [T]he SEFs, the market participants, and the
Commission have benefited from this time and we have an obligation
to provide more legal certainty through codifying these provisions
into rules.''), available at https://www.cftc.gov/sites/default/files/2020/08/1597339661/openmeeting_013020_Transcript.pdf.
\7\ Statement of Commissioner Dawn D. Stump for CFTC Open
Meeting on: (1) Final Rule on Position Limits and Position
Accountability for Security Futures Products; and (2) Proposed Rule
on Public Rulemaking Procedures (Part 13 Amendments) (September 16,
2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement091619.
---------------------------------------------------------------------------
The proposal we are issuing today would codify the alternative
IM calculation method set out in DSIO no-action Letter No. 19-29.\8\
It would provide that a swap dealer may use the risk-based model
calculation of IM of a counterparty that is a CFTC-registered swap
dealer as the amount of IM that the former must collect from the
latter. The proposing release states the Commission's expectation
that the proposal generally would be used by swap dealers with a
discrete and limited swap business consisting primarily of entering
into uncleared swaps with end-user counterparties and then hedging
the risk of those swaps with uncleared swaps entered into with a few
swap dealers.
---------------------------------------------------------------------------
\8\ CFTC Letter No. 19-29, Request for No-Action Relief
Concerning Calculation of Initial Margin (December 19, 2019),
available at https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=&field_csl_letter_types_target_id%5B%5D=636&field_csl_divisions_target_id%5B%5D=596&field_csl_letter_year_value=2019&=Apply.
---------------------------------------------------------------------------
This proposal is subject to conditions that: (1) The applicable
risk-based model be approved by either the Commission, the National
Futures Association, or a prudential regulator; and (2) the
uncleared swaps for which a swap dealer uses the risk-based model
calculation of IM of its swap dealer counterparty are entered into
for the purpose of hedging the former's own risk from entering into
swaps with non-swap dealer counterparties.
Simply put, not all swap dealers are created equal. It is
therefore appropriate to tailor our uncleared margin regime
accordingly. Letter No. 19-29 recognized this reality and smoothed
the rough edges of our otherwise one-size-fits-all uncleared margin
rules, and I support the proposal to codify that result.
There Remains Unfinished Business
The report of the GMAC Margin Subcommittee recommended several
actions beyond those contained in this proposed rulemaking in order
to address the unique challenges associated with the application of
uncleared margin requirements to end-users. Having been present for
the development of the Dodd-Frank Act, I recall the concerns
expressed by many lawmakers about applying the new requirements to
end-users. The practical challenges with respect to uncleared margin
that caused uneasiness back in 2009-2010 are now much more immediate
as the margin requirements are being phased in to apply to these
end-users.
So, while I am pleased at the steps the Commission is taking in
this proposed rulemaking, I hope that we can continue to work
together to address the other recommendations included in the GMAC
Margin Subcommittee's report. The need to do so will only become
more urgent as time marches on.
Conclusion
To be clear, these proposals to amend the Commission's uncleared
margin rules are not a ``roll-back'' of the margin requirements that
apply today to the largest financial institutions in their swap
transactions with one another. Rather, the proposals reflect a
thoughtful refinement of our rules to align them with the rest of
the international regulatory community, and to take account of
specific circumstances in which they impose substantial operational
challenges (i.e., they are not workable) when applied to other
market participants that are coming within the scope of their
mandates. I look forward to receiving public input on any
improvements that can be made to the proposals to further enhance
compliance with the Commission's uncleared margin requirements.
[[Page 59718]]
Appendix 3--Statement of Commissioner Dan M. Berkovitz
I support issuing for public comments two notices of proposed
rulemaking to improve the operation of the CFTC's Margin Rule.\1\
The Margin Rule requires certain swap dealers (``SDs'') and major
swap participants (``MSPs'') to post and collect initial and
variation margin for uncleared swaps.\2\ The Margin Rule is critical
to mitigating risks in the financial system that might otherwise
arise from uncleared swaps. I support a strong Margin Rule, and I
look forward to public comments on the proposals, including whether
certain elements of the proposals could increase risk to the
financial system and how the final rule should address such risks.
---------------------------------------------------------------------------
\1\ Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants, 81 FR 636 (Jan. 6, 2016) (``Margin Rule'').
\2\ See also Commodity Exchange Act (``CEA'') section 4s(e). The
CEA, as amended by the Dodd-Frank Act, requires the Commission to
adopt rules for minimum initial and variation margin for uncleared
swaps entered into by SDs and MSPs for which there is no prudential
regulator. Although addressed in the rules, there are currently no
registered MSPs.
---------------------------------------------------------------------------
The proposals address: (1) The definition of material swap
exposure (``MSE'') and an alternative method for calculating initial
margin (``the MSE and Initial Margin Proposal''); and (2) the
application of the minimum transfer amount (``MTA'') for initial and
variation margin (``the MTA Proposal''). They build on frameworks
developed by the Basel Committee on Banking Supervision and
International Organization of Securities Commissions (``BCBS/
IOSCO''),\3\ existing CFTC staff no-action letters, and
recommendations made to the CFTC's Global Markets Advisory Committee
(``GMAC'').\4\ I thank Commissioner Stump for her leadership of the
GMAC and her work to bring these issues forward for the Commission's
consideration.
---------------------------------------------------------------------------
\3\ BCBS/IOSCO, Margin requirements for non-centrally cleared
derivatives (July 2019), https://www.bis.org/bcbs/publ/d475.pdf. The
BCBS/IOSCO framework was originally promulgated in 2013 and later
revised in 2015.
\4\ Recommendations to Improve Scoping and Implementation of
Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps, April 2020, https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
---------------------------------------------------------------------------
Today's proposed amendments to the Margin Rule could help
promote liquidity and competition in swaps markets by allowing the
counterparties of certain end-users to rely on the initial margin
calculations of the more sophisticated SDs with whom they enter into
transactions designed to manage their risks, subject to safeguards.
They would also address practical challenges in the Commission's MTA
rules that arise when an entity such as a pension plan or endowment
retains asset managers to invest multiple separately managed
accounts (``SMAs''). Similar operational issues are addressed with
respect to initial and variation margin MTA calculations.
These operational and other benefits justify publishing the MSE
and Initial Margin Proposal and the MTA Proposal in the Federal
Register for public comment. However, I am concerned that specific
aspects of each of these proposed rules could weaken the Margin Rule
and increase risk by creating a potentially larger pool of
uncollateralized, uncleared swaps exposure. My support for
finalizing these proposals will depend on how the potential
increased risks are addressed.
One potential risk in the MSE and Initial Margin Proposal arises
from amending the definition of MSE to align it with the BCBS/IOSCO
framework.\5\ One element of the proposal would amend the
calculation of the average daily aggregate notional amount
(``AANA'') of swaps. The proposed rule would greatly reduce the
number of days used in the calculation, reducing it from an average
of all business days in a three month period to the average of the
last business day in each month of a three month period.\6\ The
result would be that a value now calculated across approximately 60+
data points (i.e., business days) would be confined to only three
data points, and could potentially become less representative of an
entity's true AANA and swaps exposure. Month-end trading adjustments
could greatly skew the AANA average for an entity.
---------------------------------------------------------------------------
\5\ 17 CFR 23.151.
\6\ Existing Commission regulation 23.151 specifies June, July,
and August of the prior year as the relevant calculation months. The
proposed rule would amend this to March, April, and May of the
current year. The proposed rule would also amend the calculation
date from January 1 to September 1. These amendments would be
consistent with the BCBS/IOSCO framework.
---------------------------------------------------------------------------
When the Commission adopted the Margin Rule in 2016, it rejected
the MSE calculation approach now under renewed consideration. U.S.
prudential regulators also declined to follow the BCBS/IOSCO
framework in this regard. The Commission noted in 2016 that an
entity could ``window dress'' its exposure and artificially reduce
its AANA during the measurement period.\7\ Even in the absence of
window dressing, there are also concerns that short-dated swaps,
including intra-month natural gas and electricity swaps, may not be
captured in a month-end calculation window. While the MSE and
Initial Margin Proposal offers some analysis addressing these
issues, it may be difficult to extrapolate market participants'
future behavior based on current regulatory frameworks. I look
forward to public comment on these issues.
---------------------------------------------------------------------------
\7\ See CFTC Margin Rule, 81 FR at 645.
---------------------------------------------------------------------------
The MSE and Initial Margin Proposal and the MTA Proposal each
raise additional concerns that merit public scrutiny and comment.
The MTA Proposal, for example, would permit a minimum transfer
amount of $50,000 for each SMA of a counterparty. In the event of
more than 10 SMAs with a single counterparty (each with an MTA of
$50,000), the proposal would functionally displace the existing
aggregate limit of $500,000 on a particular counterparty's
uncollateralized risk for uncleared swaps. The proposal would also
state that if certain entities agree to have separate MTAs for
initial and variation margin, the respective amounts of MTA must be
reflected in their required margin documentation. Under certain
scenarios, these separate MTAs could result in the exchange of less
total margin than if initial and variation margin were aggregated.
The MSE and Initial Margin Proposal and the MTA Proposal both
articulate rationales why the Commission preliminarily believes that
the risks summarized above, and others noted in the proposals, may
not materialize. The Commission's experience with relevant staff no-
action letters may also appear to lessen concerns around the
proposals. While each item standing on its own may not be a
significant concern, the collective impact of the proposed rules may
be a reduction in the strong protections afforded by the 2016 Margin
Rule--and an increase in risk to the U.S. financial system. The
Commission must resist the allure of apparently small, apparently
incremental, changes that, taken together, dilute the comprehensive
risk framework for uncleared swaps.
I look forward to public comments and to continued deliberation
on what changes to the MSE and Initial Margin Proposal and the MTA
Proposal are appropriate. I thank Commissioner Stump, our fellow
Commissioners, and staff of the Division of Swap Dealer and
Intermediary Oversight for their extensive engagement with my office
on these proposals.
[FR Doc. 2020-18303 Filed 9-22-20; 8:45 am]
BILLING CODE 6351-01-P