I cannot support the proposed rule.

Seeded Funds

I am concerned that the proposed exception to initial margin requirements for seeded funds rolls back Dodd-Frank Act reforms designed for financial stability.  I cannot support the Commission changing our existing requirements—requirements that match U.S. banking regulator requirements.  The proposed change would relieve initial margin requirements for uncleared swaps that are not prudentially regulated in certain affiliate transactions known as “seeded funds” for three years.[1]

The buildup of uncleared swap positions during the crisis exposed swap entities to losses, putting the financial system at risk.  Dodd-Frank Act reforms required all uncleared swaps be subject to initial and variation margin requirements, whether prudentially regulated or not.[2] Post Dodd-Frank, the Commission and federal banking agencies adopted margin rules to protect the safety and soundness of swap entities and to guard against risks to financial stability. 

Dodd Frank Act reforms in the Commodity Exchange Act required that to offset the greater risk to the swap dealer or major swap participant and the financial system arising from the use of uncleared swaps, the Commission’s margin requirements for uncleared swaps must (i) help ensure the safety and soundness of the swap dealer or major swap participant and (ii) be appropriate for the risk associated with the uncleared swaps held by the swap dealer or major swap participant.[3]

I do not find that standard to be met in the proposed rule.  Post Dodd-Frank, regulators recognized that derivatives transactions with affiliated parties can pose important risks that necessitate margin requirements.  The Commission and banking regulators adopted the same definition of “margin affiliate” to cover both swaps that are, and are not, prudentially regulated.  The proposed rule would depart from that definition where there is not a prudential regulator.

The proposed rule raises concerns about the prudence of the Commission having two different definitions of “margin affiliate” for swap dealers, particularly when the majority of swap dealers (55 of 106) are prudentially regulated, and they account for a substantial majority of swap activity.  In a regulatory system where jurisdiction is shared with other U.S. market and banking regulators, it is important that the Commission maintain regulatory harmonization with U.S. regulators where we can.  Otherwise, we risk a race to the bottom.

The proposed rule discusses the importance of harmonization with global regulation but not U.S. banking regulations.  And this proposed rule came from recommendations by the Global Markets Advisory Committee in 2020 (during the last Administration).  The majority of the nonbank swap dealers are U.S.-domiciled (27 of 51).  Also, importantly, the GMAC public interest representative from Better Markets at that time did not vote for these recommendations. 

I have serious concerns with potentially increasing risks related to uncleared swaps, including risks to financial stability by adopting a definition that harmonizes with global regulation, but not domestic banking regulation.  U.S. banking regulators are aware of the Basel Committee on Banking Supervision and the International Organization for Securities Commission’s “International Margin Framework,” but have chosen not to change their definition of “margin affiliate.”

Likewise, I do not support the Commission changing our existing definition.  I appreciate that Commission staff have tried to put constraints on this initial margin exception.[4] The constraints are not enough in my view to break from U.S. banking regulators on the definition of margin affiliate.  I am concerned that the effect of this proposal would be to roll back Dodd-Frank Act reforms.  Given that those reforms were designed to promote the safety and soundness of U.S. financial institutions and our financial system, I am concerned that this change could produce unacceptable levels of risk, possibly even systemic risk and harm to financial stability.  We do not know the full consequences of this change.  While it may save costs for these start-up funds, we cannot increase any risk to financial stability of institutions or our financial system.

Therefore, I must dissent.

Money Market Funds 

I have concerns about the Commission’s proposal to expand money market funds that could be used for eligible non-cash collateral for swap dealers for initial margin.  The proposal contemplates eliminating the restriction on the money market fund’s use of repurchase agreements or similar agreements.  

In Dodd-Frank Act reforms contained in the Commodity Exchange Act section 4s(e)(3)(C), Congress provided that “[i]n prescribing margin requirements,” the Commission “shall permit the use of noncash collateral” as “determine[d] to be consistent with - preserving the financial integrity of markets trading” non-cleared derivatives and “preserving the stability of the United States financial system.”  I have not seen an analysis that such standard is met.  I am very interested in public comment about whether that standard is met. 

We must not forget the lessons of the 2008 financial crises, including when the Reserve Primary Fund “broke the buck”, and the role it had in the 2008 crisis.  Money market funds are designed to give retail customers and institutional investors a market-based instrument that is highly liquid with lower risk and limited volatility.  For many Americans, money market funds often appear on their bank app, right next to checking and savings accounts, as they are financial vehicles often thought of as similar to a bank account.  That’s why it came as such a shock when the Reserve Primary Fund broke the buck.  

I was counsel to the SEC Chairman when the Reserve Primary Fund broke the buck, which contributed to Lehman failing, and short-term lending drying up.  Repurchase agreements also contributed to liquidity problems at financial institutions.  In my role as the Special Inspector General for TARP, I reported to Congress about the interconnectedness of these events.  These experiences show how interconnected money market funds and repurchase agreements are to the overall stability of our financial institutions and the broader financial system. 

As a result, the SEC and other regulators implemented reforms to make money market funds more stable and repurchase agreements more transparent.  Despite these reforms, in March 2020, during the Covid-19 pandemic, money market funds and the short-term funding markets experienced stress when institutional investors withdrew cash from money market funds to avoid liquidity fees and gates, safeguards that were part of post-crisis reforms.  

With 2008 and 2020 as the backdrop, the Commission must be careful how it approaches changes to our regulations that impact money market funds and the short-term funding markets.  These are highly interconnected markets.  Changes in one can impact changes in the other markets.  Before we take any action, it will be critical for the Commission to determine that the change is “consistent with preserving the financial integrity of markets trading” non-cleared derivatives and “preserving the stability of the United States financial system.”  I look forward to public comment on whether the rule meets this standard.  

I thank the staff for their work.  I am also grateful to the former GMAC members.  It must be remembered that advisory committees’ role is to advise the Commission.  While I may not agree with their recommendations, I am grateful for their service.