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.

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.

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.

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.   

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.