The Spring 2024 regulatory agenda (the “Agenda”) of the Commodity Futures Trading Commission was recently published as part of the government-wide Unified Agenda of Federal Regulatory and Deregulatory Actions.[1]  These semiannual submissions set out the CFTC’s Agenda of rulemakings that it expects to propose or finalize over the next year.

I do not object to the rulemaking matters that are listed in the CFTC’s Agenda.  Rather, I object to what is missing because it was withdrawn from the Agenda—with neither transparency nor explanation.

The matter conspicuously missing from this Agenda is an important proposed rulemaking regarding the CFTC’s uncleared swap margin rules, which was approved by the Commission during an Open Meeting just last year (the “Proposal”), based on recommendations from a CFTC Global Markets Advisory Committee (“GMAC”) report.[2]

The Facts:  What the Proposal Is, and More Importantly, what it is NOT

The Proposal addressed two recommendations in the comprehensive GMAC Report.  Specifically, it proposed to—

• Revise the definition of a margin affiliate to prevent triggering the requirement to exchange initial margin with certain eligible seeded investment funds for a limited, three-year period (the “Seeded Funds Proposal”); and
• Eliminate the disqualification of securities in certain money market funds that would otherwise be acceptable from being used as eligible initial margin collateral (the “MMF Proposal”).[3]

I set out the Proposal’s merits in lengthy remarks that I delivered during the CFTC’s Open Meeting on July 26, 2023, at which the Commission voted to adopt the Proposal.[4]  For convenience, I am re-printing those remarks in full at the conclusion of this Statement.

But, in short:  1) the Seeded Funds Proposal was an effort to tailor the CFTC’s uncleared margin rules—which were written with uncleared swap transactions between the largest, most systemic and interconnected banks in mind—to account for very real challenges arising when they are applied to financial end-users; and 2) the MMF Proposal would have addressed an instance where the Commission’s rules fail to achieve the Commission’s objective in adopting them.

The Proposal was thus an effort to calibrate margin requirements for uncleared swaps to the circumstances of (and modest risk presented by) certain end-user market participants, and to better achieve the Commission’s original goals.  This Proposal was NOT an attempt to water down any existing CFTC rules.  And this proposal certainly was NOT an attempt to roll-back rules implementing the Dodd-Frank Act.[5]

As happens with most proposed rulemakings, after the Commission voted to approve the Proposal, it was then published in the Federal Register (on August 8, 2023) for public comment.  The Commission received comment letters both supporting and opposing the Proposal, which is what usually occurs for most proposed rules with a public comment period.  But what I find very unusual, and questionable, is the decision to withdraw the Proposal from the agency’s regulatory Agenda more than 6 months after the close of the comment period on October 10, 2023.

Unfortunately, the Unified Agenda does not require a public explanation as to why a proposed rulemaking was withdrawn,[6] so we are left to make assumptions as to motivation.  Without a stated reason, the only logical conclusion is that the agency has decided that the opposing, minority views in the comments to this Proposal were more important than those supporting the Proposal, which made up the majority of comments.  Under these circumstances, I feel I have a duty to publicly address some of the shortcomings in the arguments offered by the opponents.

The Argument:  Opposing Comment Letters Fail to Substantively Address the Proposal’s Provisions

To start, any suggestion that this Proposal somehow calls into question the importance of the uncleared swap margin requirements of the Dodd-Frank Act is factually incorrect.  NOT a single supporter of this Proposal disputes the importance of the Dodd-Frank Act margin requirements for uncleared swaps.

With respect to the Seeded Funds Proposal, the opponents’ comments lack any analysis of the numerous safeguards and conditions that our Staff included in the Proposal to assure that it would not endanger the objectives of the Dodd-Frank Act.  Indeed, several comment letters supportive of the intent underlying the Seeded Funds Proposal voiced concern that this intent would go unfulfilled because its conditions were too restrictive.

Similarly, none of the Proposal’s opponents acknowledged that the Commission’s uncleared margin rules already include money market fund securities in their “expansive” list of collateral that can be pledged as initial margin in order to provide flexibility,[7] or that what the Proposal is addressing is another aspect of the rules that effectively removes that intended flexibility.[8]

The Proposal received strong support from the buy-side community, representing financial end-users such as, among others, pension plans, endowments, and insurance providers.  Financial end-users are vital to American investors and to the U.S. economy, and they utilize uncleared swaps to manage their risks.  Yet, these end-users’ voices were deemed completely irrelevant when the decision was made to withdraw the Proposal from the CFTC’s Agenda.

The Process:  Notice-and-Comment Public Rulemaking is the “Gold Standard” for Transparency in Regulatory Efforts

The decision to withdraw the Proposal from the Agenda was not made by our Staff.  In fact, our Staff was ready to prepare a final rulemaking that, as required by the Administrative Procedures Act, would consider the comments received (both supporting and opposing), and recommend any changes to the Proposal that Staff felt were appropriate as a result.

Rather, the withdrawal of the Proposal secretly rescinded a decision that was publicly voted on during an Open Meeting of the Commission.  But if Commissioners were having any second thoughts and regrets, then we as Commissioners should have done what we were nominated by the President and confirmed by Congress to do—deliberate, debate, and seek consensus.  Ultimately, if three or more Commissioners felt that a final rulemaking on the Proposal was unwarranted, they could have cast their vote to that effect, and publicly explained it.

Instead, a decision was made outside of the public eye to withdraw the Proposal from the Agenda, apparently based on a view that neither market participants nor the public are entitled to any explanation.  This runs directly counter to the Commission’s stated Core Value of transparency about our rules and processes.[9]

The Outcome:  Withdrawal of the Proposal Diminishes the Work of Our Advisory Committees and Staff, and Undermines the Agency’s Historical Comity

Opposition to the Proposal included suggestions that it should not be adopted because it was recommended by an Advisory Committee consisting largely of industry representatives during the last Administration.  The suggestion that our Advisory Committees’ recommendations amount to nothing more than partisan political statements not only diminishes the hard work and independent analysis that go into making formal Advisory Committee recommendations—it is harmful to one of the most valuable tools for public engagement at the CFTC.

Pursuant to the Federal Advisory Committee Act,[10] which governs GMAC, agencies are required to ensure that Advisory Committee membership is fairly balanced in terms of the viewpoints represented and the functions to be performed by the committee.[11]  And it is hardly surprising (and entirely appropriate) that the membership of an Advisory Committee to assist the CFTC on global issues relating to the regulation of the derivatives markets would include representatives of those who actually participate in the derivatives markets.

Regardless of which political party has a majority on the Commission, our Advisory Committees are sponsored by Commissioners from both parties.  And I am not aware of any other instance in which the work of a CFTC Advisory Committee has been criticized based on the political party that holds the White House at the time.  To be clear, we may not all agree with the recommendations offered by an Advisory Committee, but questioning the integrity of the recommendations that were put forth by the Advisory Committee members—who all volunteer to do this work without compensation—is disrespectful and demeaning to those members and diminishes the collaborative process and hard work that goes into producing these recommendations.

In this particular case, the Subcommittee that produced the GMAC Report did so on a very tight timeline—while enduring the challenges of shutdowns that occurred at the start of the pandemic during the first half of 2020.  It is truly frustrating to see the Commission acquiesce to opponents’ attacks, rather than recognize and appreciate the dedication of the professionals who served on GMAC and its Subcommittee when it presented the GMAC Report.[12]

I will stand up for CFTC Staff here as well, since their hard work and efforts are also disregarded by the decision to withdraw the Proposal.  As noted, our Staff included several safeguards and conditions in the Proposal to assure that achieving the policy goals of the recommendations in the GMAC Report would be done without undercutting the protections that Congress enacted in the Dodd-Frank Act to avoid a recurrence of the financial crisis.  I have no doubt that our Staff would have welcomed a robust debate (as would I) as to whether the Proposal struck the right balance, and whether its safeguards and conditions were too loose, too restrictive, or just right.  But opponents of the Proposal engaged in no such debate, simply dismissing it out-of-hand without any analysis of our Staff’s efforts to get it right.  The Commission similarly ignores the conscientious efforts of our Staff by “pulling the plug” on the Proposal altogether.

The CFTC is an independent financial regulatory agency.[13]  It is not part of the Administration, and it does not work for, or at the direction of, the White House.  It is bipartisan—when fully empaneled as it is now, there are three Commissioners from one political party and two from the other.[14]  And most of the Commission’s actions also are bipartisan.  In fact, the Commission’s approval of the Proposal was itself bipartisan, a fact that seems lost in the subsequent withdrawal of the Proposal.

Conclusion

To be crystal clear:  The Proposal would NOT “roll back” the Commission’s uncleared margin requirements that apply to the largest financial institutions for their swap transactions with one another.  Rather, it reflects carefully considered steps to refine our rules to achieve the Commission’s objectives in adopting them, and to account for adverse consequences their application has for financial end-users of our derivatives markets in specific circumstances. 

If given the chance, we could have done what CFTC Commissioners are supposed to do:  Work together, in a bipartisan manner, to adopt acceptable revisions to the Proposal in order to find a path forward for a final rule.  Sadly, in this instance, the Commission instead has abandoned the public comity for which we historically have been known, and which has always served the agency well.

* * * * * * * * * *

Remarks of Commissioner Summer K. Mersinger on Proposed Uncleared Margin Rule Amendments Regarding Seeded Funds and Money Market Funds at the Open Meeting of the CFTC on July 26, 2023

I support the proposed rulemaking before us today, which addresses two recommendations regarding margin requirements for uncleared swaps that the Commission received from the Global Markets Advisory Committee, and are based on a comprehensive report proposed by GMAC’s Subcommittee on Margin Requirements for Non-Cleared Swaps back in 2020 under former Commissioner Dawn Stump’s leadership.  These proposals demonstrate 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.

The Commission promptly and unanimously undertook two rulemakings that implemented four of the recommendations put forward in the GMAC Margin Subcommittee report.  Before us today is a proposal to adopt two more of those recommendations.  These two rule changes further several important objectives: first, the need to tailor our rules to ensure they are suited to the circumstances of those required to comply with them; second, the imperative of harmonizing our margin requirements with those of our international colleagues in order to facilitate compliance and coordinated regulatory oversight; and third, our obligation to periodically review our rules to ensure they’re achieving the purposes that led the Commission to adopt them in the first instance.

Specifically, the two proposals before us would, first, revise the definition of a “margin affiliate” to prevent triggering the requirement for an eligible seeded investment fund to exchange initial margin for a limited, three-year period, and second, eliminate a provision disqualifying securities in certain money market funds from being used as initial margin collateral.

With respect to the proposal regarding seeded funds, it’s necessary to first recognize that 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 on which they are based, were designed primarily to ensure the exchange of margin between the largest, most systemic and interconnected financial institutions for their uncleared swap transactions with one another.  These institutions and transactions have been subject to the uncleared margin requirements of the Dodd-Frank Act for several years now.  However, due to a phased-in implementation schedule, our uncleared margin rules only recently took effect for a different type of swap counterparty: financial end-users, such as pension plans, endowments, insurance providers, and as relevant here, seeded investment funds.  And we as regulators have a responsibility to make sure the rules are appropriate for that purpose.

A seeded investment fund is seeded by a sponsor entity that provides a portion or all the fund’s start-up capital as the fund starts out to develop a performance track record in the expectation of attracting unaffiliated investors going forward.  The sponsor does not have transparency into the management or trading of the seeded fund, and does not guarantee its obligations.  Seeded funds often have limited individual swap exposure themselves.

Because the Commission’s margin rules require that the fund’s exposure be aggregated with that of the sponsor and all the sponsor’s other affiliates, the fund may become subject to initial margin obligations on uncleared swaps, and this can present a serious challenge.  For example, management of margin obligations in the context of seeded funds is difficult since they are legally and operationally distinct entities that may not be able to share information about their exposure with the sponsor or other affiliates.  And given their typically small size, seeded funds may encounter difficulties in establishing the necessary margin documentation and processes, as counterparties and custodians, which face competing demands for resources and services, may prioritize larger counterparties.

Accordingly, the proposal would provide that for purposes of determining whether a seeded fund must exchange initial margin for uncleared swaps, the fund would be treated as a separate legal entity not affiliated with the sponsor entity.  This is a very sensible approach and an appropriate refinement to make the Commission’s uncleared margin rules workable for seeded funds, given the realities of the modern investment management environment.  Equally important, it is consistent with the principle that margin requirements be commensurate with the risk of uncleared swaps.  Given their generally small size and limited swap exposure, seeded investment funds do not pose significant risks to their swap counterparties or the financial system.

Nevertheless, the proposal includes a series of safeguards and conditions.  Most notably, the proposal adopts the recommendation of the GMAC Margin Subcommittee that this margin treatment be applicable only for a period of three years from the date that the seeded fund begins trading as it works towards establishing a performance track record and attracting unaffiliated investors.  Further, the fund’s sponsor and its other affiliates would still have to include the seeded fund’s exposure in their calculation of whether they’re subject to initial margin requirements, and the proposed treatment would only apply to initial margin, as the uncleared swaps entered into by seeded funds would remain subject to applicable variation margin requirements.

Finally, the proposal contains a host of conditions designed to ensure that it can be relied on only by funds that are sufficiently independent and risk-remote from their sponsor and its other affiliates, and that are engaging in genuine efforts to test their investment strategy and attract unaffiliated investors.  These conditions were not included in the GMAC Margin Subcommittee report, and, frankly, I question whether they’re all necessary, but I support proposing them for public comment in order to make clear that we are seeking to craft a rule that is narrowly tailored to address a particular set of challenges presented by the application of our uncleared margin rules to a particular set of financial end-users, and no more.

In addition, the proposed changes would align the Commission’s margin rules with respect to seeded funds with both the BCBS/IOSCO Framework and the manner in which these issues are handled by our regulatory colleagues in other major market jurisdictions, such as Australia, Canada, and the European Union.  Given the global nature of derivatives markets, international harmonization of our margin regulations is imperative.  Indeed, in the Dodd-Frank Act, Congress specifically directed the Commission, in order to “promote effective and consistent global regulation of swaps,” to “consult with foreign regulatory authorities on the establishment of consistent international standards” with respect to the regulation of swaps and swap entities.”

And when the G-20 leaders met in Pittsburgh in the midst of the financial crisis in 2009, they, too, recognized that solutions for global derivatives markets demand coordinated policies and cooperation.  Congress and the G-20 leaders thus recognized that because modern swap markets are not bound by jurisdictional borders, they cannot function absent consistent international standards.  Fragmented regulation can hinder compliance with margin requirements, encourage regulatory arbitrage, and undermine the resilience of global derivatives markets.  Harmonization and coordination, on the other hand, foster enhanced compliance and strengthen the effectiveness of our regulatory oversight.

Turning to the money market funds proposal, this is a case where the Commission’s rules are failing to achieve the Commission’s objective in adopting them.  The Commission’s rules provide that the types of collateral that can be posted or collected as initial margin include, among other things, securities issued by money market and similar funds (which I’ll refer to collectively as “money market funds”), but there is a catch: securities of money market funds are not eligible collateral if the assets of the fund can be transferred through securities lending, securities borrowing, or repurchase agreements, or similar means (which I’ll refer to as the “asset transfer restriction”).

When it adopted its uncleared margin rules, the Commission stated that it included money market fund securities in its expansive list of collateral that can be pledged as initial margin in order to provide flexibility, but the flexibility that the Commission granted with one hand, it took away with the other since most money market funds available to the institutional marketplace use repurchase or similar arrangements, or are authorized to do so, as part of their management strategy.

The widespread use of repurchase and similar agreements by money market funds severely limits the number that satisfy the Commission’s asset transfer restriction and qualify as eligible collateral.  In fact, research cited in the GMAC Subcommittee report suggests that the number of U.S. money market funds that may be available is as few as four.  Thus, the asset transfer restriction significantly restricts the availability of money market funds as a form of margin collateral for swap counterparties.  Not only can this contribute to a concentration of margin collateral in the securities of a few money market funds, which can be worrisome from a systemic risk perspective, it also runs contrary to the intent of the Commission underlying the uncleared margin rules.

Under these circumstances, I believe the Commission is rightly re-visiting a rule that is failing to achieve its intended purpose, and I support proposing the removal of the asset transfer restriction for public comment.  That’s a reasonable approach, particularly since: one, the proposal is limited in scope, in that it would not amend any other condition applicable to the use of money market fund securities as eligible initial margin collateral; two, the Commission’s rules permit the investment of customer margin by futures commission merchants in money market funds without an asset transfer restriction; and three, removal of the restriction would bring the Commission’s eligible collateral framework in line with the approach that has been adopted by our colleagues at the Securities and Exchange Commission.

In conclusion, I want to be very clear:  These two proposed changes to the uncleared margin rules do not constitute any kind of roll-back of the margin requirements that apply today to the largest financial institutions in their uncleared swap transactions with one another.  Rather, they reflect a reasonable refinement of our rules that: first, with respect to seeded investment funds, would take account, with significant guardrails, circumstances in which the rules impose significant practical and operational challenges when applied to a type of financial end-user that has recently come into their scope, and that aligns our rules with those of the international regulatory community; and second, would remedy the Commission’s hollow promise when it adopted the margin rules that securities of money market funds may be posted and collected as eligible initial margin collateral.

I want to express my deep appreciation for the efforts of the members of the GMAC, especially the GMAC Margin Subcommittee, who provided us with a well-reasoned and high-quality report on complex margin issues, and this was, no less, at the start of a pandemic.  The GMAC and its Margin Subcommittee that produced the report was comprised of a wide range of market participants with expertise and experience in the impact of uncleared margin requirements in the marketplace.  They devoted a tremendous amount of time to working through differences of opinion and reaching consensus.

I definitely want to also thank the staff of the Market Participants Division, whose efforts today with the Office of the General Counsel and the Chief Economist’s Office have enabled us to advance these initiatives to ensure that our uncleared margin rules are appropriately risk-based for all, are in line with international standards, and achieve their stated objectives, consistent with our oversight responsibilities under the Commodity Exchange Act.