Overview

I am pleased to support the two final rulemakings that the Commission is adopting with respect to margin requirements for uncleared swaps.  These rulemakings address several recommendations that the Commission received from its Global Markets Advisory Committee (GMAC), which I am proud to sponsor, and are based on a comprehensive report prepared by GMAC’s Subcommittee on Margin Requirements for Non-Cleared Swaps (GMAC Margin Subcommittee).[1]  They 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 two rulemakings we are adopting make 4 changes to the Commission’s uncleared margin rules.  The four changes have much to commend them – indeed, we did not receive any comment letters opposing them.  These rule changes further objectives that I have commented on before:

• the need to tailor our rules to assure that they are workable for those required to comply with them;
• the benefits of codifying relief that has been issued by our Staff and re-visiting our rules, where appropriate; and
• the imperative of harmonizing our margin requirements with those of our international colleagues in order to facilitate compliance and coordinated regulatory oversight. 

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) on which they are based,[2] 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.  Today, these institutions and transactions are subject to uncleared margin requirements that have taken effect since the rules were adopted.

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 – will soon be coming into scope of the margin rules.  It is only now, as we enter 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 thoughtfully consider whether the regulatory parameters that we have designed for the largest financial institutions in the earlier phases of margin implementation need to be tailored to account for the practical and 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.

The rulemaking regarding the “minimum transfer amount” does exactly that.  The Commission’s uncleared margin rules provide that a swap dealer is not required to collect or post initial margin (IM) or variation margin (VM) with a counterparty until the combined amount of such IM and VM exceeds the minimum transfer amount (MTA) of $500,000.  Yet, the application of the MTA presents a significant operational challenge for institutional investors that typically hire asset managers to exercise investment discretion over portions of their assets in separately managed accounts (SMAs) for purposes of diversification.  As a practical matter, neither the owner of the SMA, the manager of the assets in the SMA, nor the swap dealer that is a counterparty to the SMA is in a position to readily determine when the MTA has been exceeded on an aggregate basis (or to assure that it is not). 

To address this challenge, the Commission is amending the definition of MTA in its margin rules to allow a swap dealer to apply an MTA of up to $50,000 to each SMA owned by a counterparty with which the swap dealer enters into uncleared swaps.  As noted in the release, any potential increase in uncollateralized credit risk as a result would be mitigated both by the conditions set out in the rules we are adopting, as well as existing safeguards in the Commodity Exchange Act (CEA) and the Commission’s regulations.[3]

This is a sensible approach and an appropriate refinement to make the Commission’s uncleared margin rules workable for SMAs given the realities of the modern investment management environment.  As I have stated before, no matter how well-intentioned a rule may be, if it is not workable, it cannot deliver on its intended purpose.[4]   

The Benefits of Codifying Staff Relief and Re-Visiting our Rules

Application of MTA to SMAs:  The rule change that I have discussed above regarding the application of the MTA to SMAs would codify no-action relief in Letter No. 17-12 that our Staff issued in 2017.[5]  The Commission’s 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]  Experience with the Staff no-action relief in Letter No. 17-12 supports our rule change to tailor the application of the MTA under the Commission’s uncleared margin rules in the SMA context. 

Two of the other rule changes that we are adopting similarly would codify existing Staff no-action relief in recognition of market realities:

Separate MTAs for IM and VM:  Our second rule change regarding the MTA, consistent with Staff no-action Letter No. 19-25,[8] would recognize that a swap dealer may apply separate MTAs for IM and VM with each counterparty, provided that the MTAs corresponding to IM and VM are specified in the margin documentation required under the Commission’s regulations, and that the MTAs, on a combined basis, do not exceed the prescribed MTA. 

Staff’s no-action relief, and the Commission’s rule amendments to codify that relief, take into account the separate settlement workflows that swap counterparties maintain to reflect, from an operational perspective, the different regulatory treatment of IM and VM.[9]  And given that the total amount of combined IM and VM exchanged would not exceed the prescribed MTA, separate MTAs for IM and VM would not materially increase the amount of credit risk at a given time.  Under Letter No. 19-25 and this codification, swap dealers and their counterparties can manage MTA in an operationally practicable way that aligns with the market standard. 

Reliance on Counterparty’s Model Calculation of IM:  A third rule change we are adopting codifies a Staff no-action position taken in Letter No. 19-29,[10] providing 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 release states the Commission’s expectation that this alternative method of IM collection will be used by swap dealers with a discrete and limited swap business consisting primarily of entering into uncleared customer-facing swaps with end-user counterparties, and then hedging the risk of those swaps with uncleared swaps entered into with a few other swap dealers.   

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 it is appropriate to codify that result.

Yet, under the rule amendments being adopted, this alternative method is subject to the condition that 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 customer-facing swaps with non-swap dealer counterparties.  This is a departure from the GMAC Margin Subcommittee, which did not recommend such a condition.

I am concerned by comments we received suggesting that this condition may cause this rule change to prove unworkable in practice.[11]  I am encouraged that the rulemaking release addresses some of these comments by, among other things, confirming: 1) the flexibility of swap dealers as part of their hedging strategy to match a set of customer-facing swaps with one or more hedging swaps undertaken with other swap dealer counterparties; and 2) that customer-facing swaps entered into through anticipatory hedging or that are subsequently terminated would be deemed hedges for purposes of the alternative method of IM calculation.  Nevertheless, if over time, market participants find that the hedging condition causes this rule change to fail to fulfill its intended purpose, I urge them to alert the Commission so that it can consider appropriate adjustments.

International Harmonization to Enhance Compliance and Coordinated Regulation

The Commission’s fourth and final rule change would revise the calculation method for determining whether financial end-users come within the scope of the IM requirements, and the timing for compliance with the IM requirements after the end of the 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 swaps exposure” (MSE).  The Commission’s margin rules currently 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[12] during March, April, and May of that year.

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 reasoned policy determination.  Rather, it is the result of a quirk that the U.S. 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, as noted in the rulemaking release, 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.  It has been suggested that this rule change theoretically might incentivize a firm to “window dress” its swap exposures as the month-end approaches in order to avoid margin requirements.  But the GMAC Margin Subcommittee observed that it would be neither practicable nor financially desirable for parties to tear-up their positions on a recurring basis prior to the month-end calculation,[13] because doing so would interfere with hedging strategies and cause the firm to incur realized profit and loss.[14]

Accordingly, the Commission is amending 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.  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 . . .”[15]  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.[16]

Our rule change regarding MSE 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 disconnect 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.  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.

There Remains Unfinished Business

While I am pleased with the steps the Commission is taking, there remains unfinished business in the implementation of uncleared margin requirements.  As an initial matter, U.S. prudential regulators with oversight authority over bank swap dealers have not yet adopted the corresponding rule changes relevant for consistent applications.  As a result, although commenters expressed support for the Commission proceeding with these rule changes even in the absence of parallel action by the U.S. prudential regulators, the operational difficulties confronting market participants that are coming into scope of the margin rules will not be fully addressed when they enter into uncleared swaps with bank swap dealers.  I look forward to continuing the dialogue with our regulatory colleagues at other U.S. agencies to support addressing these challenges.

In addition, the report of the GMAC Margin Subcommittee recommended several actions, beyond those that we are adopting, to address the hurdles associated with the application of uncleared margin requirements to end-users.  Having been present for the development of the Dodd-Frank Act, I recall that the concerns expressed by many lawmakers at the time focused on the application of the new requirements to end-users.  The unique 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.  As the calendar turns into the new year, I look forward to continuing to work together to address the other recommendations contained in the GMAC Margin Subcommittee’s report regarding applying the uncleared margin rules to financial end-users.  The need to do so will only become more urgent as time marches on.

Conclusion

To be clear, these four changes to the 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, they 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 the rules impose substantial practical and operational challenges (i.e., they are not workable) when applied to financial end-users that are now coming within the scope of their mandates.

I am very appreciative of the many people whose efforts have contributed to bringing these rulemakings to fruition.  First, the members of the GMAC, and especially the GMAC Margin Subcommittee, who devoted a tremendous amount of time to provide us with a high-quality report on complex margin issues during the turmoil of the start of the pandemic.  Second, Chairman Tarbert and my fellow Commissioners for working with me on these important issues.  And finally, the Staff of the Market Participants Division, 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 oversight responsibilities under the CEA.

[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) (Margin Subcommittee Report), available at https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.

[2] See generally BCBS/IOSCO, Margin requirements for non-centrally cleared derivatives (July 2019), available at https://www.bis.org/bcbs/publ/d475.pdf.

[3] Specifically, CEA Section 4s(j)(2), 7 U.S.C. 6s(j)(2), requires swap dealers to adopt a robust risk management system adequate for the management of their swap activities, and CFTC Rule 23.600, 17 CFR 23.600, requires swap dealers to establish a risk management program to monitor and manage risks associated with their swap activities.

[4] Statement of Commissioner Dawn D. Stump Regarding Final Rule:  Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to Swap Dealers and Major Swap Participants (July 23, 2020), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement072320.

[5] CFTC Letter No. 17-12, Commission Regulations 23.152(b)(3) and 23.153(c): No-Action Position for Minimum Transfer Amount with respect to Separately Managed Accounts (February 13, 2017), available at https://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-12.pdf.

[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.

[8] CFTC Letter No. 19-25, Commission Regulations 23.151, 23.152, and 23.153 – Staff Time-Limited No-Action Position Regarding Application of Minimum Transfer Amount under the Uncleared Margin Rules (December 6, 2019), available at https://www.cftc.gov/csl/19-25/download.

[9] Under the Commission’s uncleared margin rules, IM posted or collected by a swap dealer must be held by one or more custodians that are not affiliated with the swap dealer or the counterparty, whereas VM posted or collected by a swap dealer is not required to be segregated with an independent custodian.  See 17 CFR 23.157.

[10] CFTC Letter No. 19-29, Request for No-Action Relief Concerning Calculation of Initial Margin (December 19, 2019), available at https://www.cftc.gov/csl/19-29/download.

[11] See, e.g., Letter from BP Energy Company at 5 (given the uncertainty as to what constitutes hedging, swap dealers may be reluctant to rely on the alternative method of IM calculation) and 6 (limiting relief to hedge transactions may diminish its utility); Letter from Futures Industry Association at 8 (complexity and added risk of hedging condition will make the alternative method of IM calculation impractical as counterparties will shy away from undertaking swaps with swap dealers that rely on the alternative method of calculating IM; also, cost, operational and documentation burdens associated with hedging condition could lead small swap dealers to cease providing risk management services to end-user counterparties, leaving end users with unhedged risks).  Comment letters available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=4157.

[12] The MSE threshold under the BCBS/IOSCO Framework is stated in euros rather than dollars.

[13] Margin Subcommittee Report at 52.

[14] Commenters made this same point.  See, e.g., Joint Letter from ISDA, SIFMA, and GFXD at 3 (month-end window dressing is not a realistic risk since unwinding and then reestablishing positions on a recurring basis over the three-month period would take considerable effort, interrupt hedging strategies, and require counterparties to absorb the costs of realized profit and loss changes); Letter from SIFMA Asset Management Group at 3 (it would be neither practicable nor financially desirable for parties to tear-up positions on a recurring basis prior to each month end); Letter from Investment Company Institute at 5-6 (for regulated funds, adjusting swap exposures over the course of three periodic dates solely to avoid IM could impose transaction costs and inhibit a fund’s ability to manage its portfolio risk, which may be inconsistent with investment adviser’s fiduciary duty to act in the best interest of its clients).

[15] See section 752(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203, Title VII, 124 Stat. 1376 (2010) (Dodd-Frank Act).

[16] 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.