I support today’s two final rules that make tailored amendments to the CFTC’s Margin Rule.[1]  The Margin Rule requires swap dealers (SDs) and major swap participants (MSPs) for which there is no prudential regulator to post and collect, each business day, initial and variation margin for uncleared swap transactions with each counterparty that is an SD, MSP, or a financial end user with material swaps exposure (MSE). [2]  The Margin Rule is a lynchpin of the Dodd-Frank reforms for swaps markets, and critical to mitigating risks in the financial system that might otherwise arise from uncleared swaps.[3]  I support the final rules because they provide targeted, operational improvements to the Margin Rule; include backstops to deter any potential abuse; and are unlikely to increase risk to the U.S. financial system.

The two final rules address: (1) the definition of MSE and an alternative method for calculating initial margin (MSE and Initial Margin Final Rule); and (2) the application of the minimum transfer amount (MTA) for initial and variation margin (MTA Final Rule).  The final rules align Commission requirements with international frameworks developed by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (BCBS/IOSCO),[4] and incorporate recommendations made to the CFTC’s Global Markets Advisory Committee.[5]  The final rules also build off existing CFTC staff no-action letters that in some cases have been in place since 2017, and that have operated with no apparent detrimental effects. 

MSE and Initial Margin Final Rule

The MSE and Initial Margin Final Rule amends the definition of MSE to align it with the BCBS/IOSCO framework, including the method for calculating the average daily aggregate notional amount (AANA) of swaps.  The final rule provides for calculations based on the average of the last business day in each month of a three-month period.  The Commission previously raised concerns that this method of AANA calculation could potentially become less representative of an entity’s true AANA and swaps exposure, potentially through the use of “window dressing” to artificially reduce AANA during the measurement period.[6] 

The MSE and Initial Margin Final Rule includes an important new provision to address this issue.  The final rule explicitly prohibits any “[a]ctivities not carried out in the regular course of business and willfully designed to circumvent calculation at month-end to evade meeting the definition of material swaps exposure . . . .”[7]  The addition of this language to the final rule’s regulatory text will help ensure that CFTC efforts at international harmonization will not come at the expense of the safety and soundness of the U.S. financial system.[8]   I thank the Chairman and the CFTC staff for working with my office to include this provision.        

The MSE and Initial Margin Final Rule will also allow SDs and MSPs for which there is no prudential regulator (Covered Swap Entities or CSEs) to rely on the initial margin calculations of the more sophisticated counterparties with whom they transact swaps to manage their risks.  This flexibility is limited to circumstances where a CSE enters into uncleared swaps with an SD, MSP, or swap entity to hedge its customer-facing swaps.  This amendment to the Commission’s existing rules could help promote liquidity and competition in swaps markets by increasing choice for end-users that are CSE customers. 

The MSE and Initial Margin Final Rule provides helpful direction regarding the scope of hedging swaps for purposes of relying on a CSE counterparty’s initial margin calculations.  As set forth in the preamble to the final rule, a hedging swap must be consistent (although not identical) with the statutory definition of “bona fide hedging transaction or position” in CEA section 4a(c)(2)(B).[9]  The final rule also makes clear that existing Commission regulations require a CSE that relies on its counterparty’s initial margin calculations to also take steps to “monitor, identify, and address potential shortfalls in the amounts of [initial margin] generated by the counterparty on whose [initial margin] model the CSE is relying.”[10]

MTA Final Rule

To reduce operational burdens associated with de minimis margin transfers, the Margin Rule provides that a CSE is not required to collect or post margin until the combined amount of initial margin and variation margin that is required to be collected or posted and that has not been collected or posted with respect to the counterparty exceeds $500,000—the MTA.[11]  This MTA level, in part, helps limit the amount of a counterparty’s uncollateralized, uncleared swaps exposure and mitigate any systemic risk arising from such swaps. 

The MTA Final Rule addresses the application of the $500,000 MTA level to a counterparty’s “separately managed accounts,” as well as the use of separate MTAs for initial and variation margin.[12]  The MTA Final Rule codifies separate treatment for separately managed accounts and permits an MTA of $50,000 for each such account of a counterparty.  This approach responds to practical limits on the ability of asset managers, for example, to aggregate initial and variation margin obligations across multiple separately managed accounts owned by the same counterparty.  The MTA Final Rule also provides that if certain entities agree to separate MTAs for initial margin and variation margin, the respective amounts of MTA must be reflected in their required margin documentation.

These new provisions balance concerns over operational inefficiencies and practical challenges in the Commission’s MTA rules against concerns that they may result in the exchange of less total margin than would be the case under the Commission’s current requirements.  Comments in response to the proposed rule noted the difficulties that would be associated with creating numerous separately managed accounts solely to evade the comparatively low $50,000 MTA for separately managed accounts.  The MTA Final Rule also defines separately managed account so that the swaps of such account are not subject to a netting of initial or variation margin obligations.  This potentially provides further disincentive to create separately managed accounts solely for the purpose of evading the $50,000 MTA level for such accounts.  

Conclusion

Mitigating systemic risk to the U.S. financial system was a primary objective of the Dodd-Frank Act in 2010, and of subsequent Commission rulemakings to implement Dodd-Frank, including the Margin Rule adopted in 2016.  The Commission must remain committed to the Margin Rule and vigilant for any large pool of uncollateralized, uncleared swaps exposure.  Today’s targeted final rules, which codify existing practices, include embedded backstops, and provide tailored operational enhancements to the Margin Rule, are unlikely to present systemic risks.  

I thank staff of the Market Participants Division for their work on these final rules.
 

[1] Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016) (Margin Rule).

[2] Although addressed in the final rules, there are currently no registered MSPs.

[3] Section 4s(e) of the Commodity Exchange Act (CEA), as amended by the Dodd-Frank Act, requires the Commission to adopt rules for minimum initial and variation margin for uncleared swaps entered into by SDs and MSPs for which there is no prudential regulator.

[4] BCBS/IOSCO, Margin requirements for non-centrally cleared derivatives (July 2019), available at https://www.bis.org/bcbs/publ/d475.pdf.  The BCBS/IOSCO framework was originally promulgated in 2013 and later revised in 2015.

[5] 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 (Apr. 2020), available at https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.

[6] See Margin Rule, 81 FR at 645.

[7] MSE and Initial Margin Final Rule at new § 23.151 (defining “Material Swaps Exposure”).

[8] The preamble to the MSE and Initial Margin Final Rule also notes an analysis by the CFTC’s Office of the Chief Economist indicating that the new month-end AANA calculation method captures substantially the same entities and total number of entities as the Commission’s previous daily AANA calculation method.  As with any rulemaking, the Commission is free in the future to periodically review its data and confirm that the new AANA calculation method is performing as expected.   

[9] 7 U.S.C. 6a(c)(2).

[10] MSE and Initial Margin Final Rule at section II(B).

[11] 17 CFR 23.151

[12] Both aspects of the MTA Final Rule were the subject of CFTC staff no-action letters issued in 2017 and 2019, respectively.