Today, the Commission considers a proposal intended to safeguard the resilience of six swap dealers in the United Kingdom (“UK”) supervised by the Prudential Regulation Authority (“PRA”).[1]  The proposal is part of the Commission’s “substituted compliance” framework.

Substituted compliance must leave U.S. markets at no greater risk than full compliance with our rules.  It is a framework that promotes global harmonization with like-minded foreign regulators that have rules, supervision, and enforcement that are comparable in purpose and effect to the CFTC.  Our capital rules are a critical pillar of the Dodd-Frank Act reforms, ones that continue to evolve with the risks that our financial system faces.  We must ensure that our comparability assessments are sound and do not increase risk to U.S. markets.

The CFTC’s capital framework for swap dealers heeds the lessons of the 2008 financial crisis.

The 2008 financial crisis precipitated the failure or near-failure of almost every major investment bank and a number of systemically important banks.  It demonstrated all too clearly the financial stability risks presented by undercapitalized financial institutions, including a sprawling network of globally interconnected derivatives dealers.  That is why Congress mandated that the Commission establish capital requirements for non-bank swap dealers.  The Dodd-Frank Act provided that swap dealer capital requirements should “offset the greater risk to the swap dealer. . . and the financial system arising from the use of swaps that are not cleared”[2] and “help ensure the safety and soundness of the swap dealer.”[3]  The Commission’s capital requirements, adopted in 2020,[4] are intended to do exactly that.

Our capital requirements promote the resilience of swap dealers and protect the U.S. financial system.  They ensure that swap dealers can weather economic downturns, and remain resilient during periods of stress to continue their critical market functions.  Our capital requirements also help prevent contagion of losses spreading to other financial institutions.

The CFTC must ensure that capital requirements eligible for substituted compliance are comparable in outcomes, supervision, and enforcement.

The Commission has to proceed cautiously in making a substituted compliance determination given the importance of capital to financial stability and the complexity of capital frameworks.  The Commission also has to consider the interconnected nature of global derivatives markets, and the speed of contagion in the global financial system.

Four of the swap dealers who would be able to avail themselves of our determination today are affiliated with the largest Troubled Asset Relief Program recipients.  That fact alone is a good reminder of what is at stake in terms of risk.  It is not just danger to financial institutions, but also American families and businesses.  Under this proposal in addition to the Commission’s three prior capital comparability proposals,[5] 16 of 106 registered swap dealers would be eligible to rely on substituted compliance.[6]  We have a responsibility to ensure that our substituted compliance framework recognizes only those frameworks that are legitimately a substitute for the capital protections provided by U.S. law.

The fact that a foreign regulator may have comparable capital rules will not be enough on its own.  We have to look beyond the four corners of rules.  Substituted compliance requires a like-minded foreign regulator with comparable supervision and enforcement to the CFTC.  The CFTC and the Prudential Regulation Authority (PRA) are already cooperating on supervision and oversight of clearinghouses.[7]  The PRA also has a long history of regulatory and supervisory coordination with the U.S. banking regulators.  I am cognizant that the PRA recently received a secondary mandate to promote the UK economy’s international competitiveness and growth.  The PRA issued a statement that it will only advance this mandate when it does not conflict with safety and soundness of regulated entities.[8]  I expect our staff will continue to work closely with the PRA to understand how it will implement this mandate, and work with the PRA to safeguard the safety and soundness of non-bank swap dealers and the stability of our global financial system.

Our substituted compliance decisions should not allow for regulatory arbitrage for swap dealers to escape strong U.S. capital rules—a situation that could erode Dodd-Frank Act post-crisis reforms.  Today’s determination is grounded in the PRA’s capital rules being comparable to the CFTC’s “Bank-Based Capital Approach” to swap dealer capital requirements, which reflects requirements the Federal Reserve imposes for bank holding companies.

The Federal Reserve and other U.S. prudential banking regulators have proposed updates to the U.S. capital rules to implement international standards known as “Basel Endgame” or Basel 3.1.[9]  The U.S. updates are also informed by the failure of several banks in early 2023.[10]  The current proposal includes proposed changes that could affect capital requirements for swap dealers subject to prudential regulation.  I would expect the Commission to monitor these changes and update its own capital rules for swap dealers to remain harmonized with the U.S. prudential regulators.  The PRA is also updating its capital requirements to implement the Basel standards.[11]  As updates are finalized in the U.S. and globally, the Commission should review whether capital requirements imposed by jurisdictions with comparability determinations remain aligned with capital requirements imposed by other U.S. financial regulators and with the changes that the Commission makes to align its own capital requirements.

Strong capital requirements and areas where the Commission would particularly benefit from public comment.

All six of the UK swap dealers are dual-registered with the U.S. Securities and Exchange Commission (“SEC”).  The SEC has issued final comparability determination orders permitting them to satisfy certain SEC capital requirements through substituted compliance with applicable UK requirements.[12]

In conducting the CFTC’s own analysis, it is important to remember that substituted compliance is not an all-or-nothing proposition.  The Commission retains examinations and enforcement authority and it can, should, and will, impose any conditions and take all actions appropriate to protect the safety and soundness of swap dealers and the U.S. financial system.  Today, the Commission proposes 25 conditions, including conditions requiring capital reporting and Commission notification that are essential to monitoring the financial condition and capital adequacy of swap dealers.

Just as with swap dealers in Japan, Mexico and the European Union,[13] one of the most important conditions is that the Commission will continue to require compliance with the CFTC’s minimum capital requirement of $20 million in common equity tier 1 capital.[14]  This is one of the most critical components of the CFTC’s capital requirements.  It helps to ensure that each nonbank swap dealer, whether current or a future new entrant, maintains at all times, $20 million of the highest quality capital to meet its financial obligations without becoming insolvent.

Today, the Commission preliminarily finds that UK capital rules requiring 8 percent of risk-weighted assets and an additional 2.5 percent buffer, for a total of 10.5 percent, are higher than the CFTC’s requirement of 8 percent of risk-weighted assets.  This capital requirement helps ensure that the swap dealer has sufficient capital levels to cover for example, unexpected losses from business activities.

There are proposed deviations from the Commission’s bank-based capital requirements that should be closely scrutinized.  Some of these deviations are similar to those raised by commenters to other proposed determinations.[15]  For example, the Commission proposes to permit compliance with UK capital rules that are not necessarily anchored by a threshold percentage of uncleared swap margin as the CFTC requires.  The proposed determination discusses that UK capital rules address liquidity, operational risks, as well as other risks arising from derivatives exposures, through other mechanisms.  I look forward to public comment on the comparability of the approaches and expect the Commission to publish additional analysis to address concerns raised by commenters as part of any final determination.

In these areas, and others, public comments will be tremendously beneficial.  I approve.