2023-13446
[Federal Register Volume 88, Number 122 (Tuesday, June 27, 2023)]
[Proposed Rules]
[Pages 41774-41813]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-13446]
[[Page 41773]]
Vol. 88
Tuesday,
No. 122
June 27, 2023
Part III
Commodity Futures Trading Commission
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17 CFR Chapter I
Notice of Proposed Order and Request for Comment on an Application for
a Capital Comparability Determination Submitted on Behalf of Nonbank
Swap Dealers Domiciled in the French Republic and Federal Republic of
Germany and Subject to Capital and Financial Reporting Requirements of
the European Union; Proposed Rule
Federal Register / Vol. 88 , No. 122 / Tuesday, June 27, 2023 /
Proposed Rules
[[Page 41774]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Notice of Proposed Order and Request for Comment on an
Application for a Capital Comparability Determination Submitted on
Behalf of Nonbank Swap Dealers Domiciled in the French Republic and
Federal Republic of Germany and Subject to Capital and Financial
Reporting Requirements of the European Union
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed order and request for comment.
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SUMMARY: The Commodity Futures Trading Commission is soliciting public
comment on an application submitted by the Institute of International
Bankers, International Swaps and Derivatives Association, and
Securities Industry and Financial Markets Association requesting that
the Commission determine that the capital and financial reporting laws
and regulations of the European Union applicable to CFTC-registered
swap dealers organized and domiciled in the French Republic and Federal
Republic of Germany provide sufficient bases for an affirmative finding
of comparability with respect to the Commission's swap dealer capital
and financial reporting requirements adopted under the Commodity
Exchange Act. The Commission is also soliciting public comment on a
proposed order providing for the conditional availability of
substituted compliance in connection with the application.
DATES: Comments must be received on or before August 28, 2023.
ADDRESSES: You may submit comments, identified by ``EU Swap Dealer
Capital Comparability Determination,'' by any of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this proposed order and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (``FOIA''), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Commission Regulation 145.9.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to in this
release are found at 17 CFR chapter I, and are accessible on the
Commission's website: https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the proposed determination and order will be retained in
the public comment file and will be considered as required under the
Administrative Procedure Act and other applicable laws, and may be
accessible under the FOIA.
FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, 202-418-
5283, [email protected]; Thomas Smith, Deputy Director, 202-418-5495,
[email protected]; Rafael Martinez, Associate Director, 202-418-5462,
[email protected]; Liliya Bozhanova, Special Counsel, 202-418-6232,
[email protected]; Joo Hong, Risk Analyst, 202-418-6221,
[email protected]; Justin McPhee, Risk Analyst, 202-418-6223;
[email protected], Market Participants Division; Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION: The Commodity Futures Trading Commission
(``Commission'' or ``CFTC'') is soliciting public comment on an
application dated September 24, 2021 (the ``EU Application'') submitted
by the Institute of International Bankers, International Swaps and
Derivatives Association, and Securities Industry and Financial Markets
Association (together, the ``Applicants'').\2\ The Applicants request
that the Commission determine that registered nonbank swap dealers \3\
(``nonbank SDs'') organized and domiciled within the European Union
(``EU'') (``EU nonbank SDs'') may satisfy certain capital and financial
reporting requirements under the Commodity Exchange Act (``CEA'') \4\
by being subject to, and complying with, comparable capital and
financial reporting requirements under EU laws and regulations. As
described below, the EU Application addresses nonbank SDs located in
the French Republic (``France'') and the Federal Republic of Germany
(``Germany''), the two member states of the EU (``EU Member States'')
in which EU nonbank SDs currently registered with the Commission are
located.\5\ The Commission also is soliciting public comment on a
proposed order under which EU nonbank SDs organized and domiciled in
France and Germany would be able, subject to defined conditions, to
comply with certain CFTC nonbank SD capital and financial reporting
requirements in the manner set forth in the proposed order.
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\2\ See Letter dated September 24, 2021 from Stephanie Webster,
General Counsel, Institute of International Bankers, Steven Kennedy,
Global Head of Public Policy, International Swaps and Derivatives
Association, and Kyle Brandon, Managing Director, Head of
Derivatives Policy, Securities Industry and Financial Markets
Association. The EU Application is available on the Commission's
website at: https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
\3\ As discussed in Section I.A. immediately below, the
Commission has the authority to impose capital requirements on
registered swap dealers (``SDs'') that are not subject to regulation
by a U.S. prudential regulator (i.e., nonbank SDs).
\4\ 7 U.S.C. 1 et seq. The CEA may be accessed through the
Commission's website at: https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
\5\ As further discussed below, there are currently four EU
nonbank SDs registered with the Commission: BofA Securities Europe
SA and Goldman Sachs Paris Inc. et Cie are organized and domiciled
in France; Citigroup Global Markets Europe AG and Morgan Stanley
Europe SE are organized and domiciled in Germany.
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I. Introduction
A. Regulatory Background--Swap Dealer and Major Swap Participant
Capital and Financial Reporting Requirements
Section 4s(e) of the CEA \6\ directs the Commission and
``prudential regulators'' \7\ to impose capital requirements on all SDs
and major swap participants (``MSPs'') registered with the
Commission.\8\ Sections 4s(e) of the
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CEA also directs the Commission and prudential regulators to adopt
regulations imposing initial and variation margin requirements on swaps
entered into by SDs and MSPs that are not cleared by a registered
derivatives clearing organization (``uncleared swaps'').
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\6\ 7 U.S.C. 6s(e).
\7\ The term ``prudential regulator'' is defined in the CEA to
mean the Board of Governors of the Federal Reserve System (``Federal
Reserve Board''); the Office of the Comptroller of the Currency; the
Federal Deposit Insurance Corporation; the Farm Credit
Administration; and the Federal Housing Finance Agency. See 7 U.S.C.
1a(39).
\8\ Subject to certain exceptions, the term ``swap dealer'' is
generally defined as any person that (i) holds itself out as a
dealer in swaps; (ii) makes a market in swaps; (iii) regularly
enters into swaps with counterparties as an ordinary course of
business for its own account; or (iv) engages in any activity
causing the person to be commonly known in the trade as a dealer or
market maker in swaps. See 7 U.S.C. 1a(49). The term ``major swap
participant'' is generally defined as any person who is not an SD,
and (i) subject to certain exclusions, maintains a substantial
position in swaps for any of the major swap categories as determined
by the Commission; (ii) whose outstanding swaps create substantial
counterparty exposure that could have serious adverse effects on the
financial stability of the U.S. banking system or financial markets;
or (iii) maintains a substantial position in outstanding swaps in
any major swap category as determined by the Commission. See 7
U.S.C. 1a(33).
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Section 4s(e) applies a bifurcated approach with respect to the
above Congressional directives, requiring each SD and MSP that is
subject to the regulation of a prudential regulator (``bank SD'' and
``bank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the applicable
prudential regulator, and requiring each SD and MSP that is not subject
to the regulation of a prudential regulator (``nonbank SD'' and
``nonbank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the Commission.\9\
Therefore, the Commission's authority to impose capital requirements
and margin requirements for uncleared swap transactions extends to
nonbank SDs and nonbank MSPs, including nonbanking subsidiaries of bank
holding companies regulated by the Federal Reserve Board.\10\
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\9\ 7 U.S.C. 6s(e)(2).
\10\ 7 U.S.C. 6s(e)(1) and (2).
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The prudential regulators implemented Section 4s(e) in 2015 by
amending existing capital requirements applicable to bank SDs and bank
MSPs to incorporate swap transactions into their respective bank
capital frameworks, and by adopting rules imposing initial and
variation margin requirements on bank SDs and bank MSPs that engage in
uncleared swap transactions.\11\ The Commission adopted final rules
imposing initial and variation margin obligations on nonbank SDs and
nonbank MSPs for uncleared swap transactions on January 6, 2016.\12\
The Commission also approved final capital requirements for nonbank SDs
and nonbank MSPs on July 24, 2020, which were published in the Federal
Register on September 15, 2020 with a compliance date of October 6,
2021 (``CFTC Capital Rules'').\13\
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\11\ See Margin and Capital Requirements for Covered Swap
Entities, 80 FR 74840 (Nov. 30, 2015).
\12\ See Margin Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
\13\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 85 FR 57462 (Sept. 15, 2020).
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Section 4s(f) of the CEA addresses SD and MSP financial reporting
requirements.\14\ Section 4s(f) of the CEA authorizes the Commission to
adopt rules imposing financial condition reporting obligations on all
SDs and MSPs (i.e., nonbank SDs, nonbank MSPs, bank SDs, and bank
MSPs). Specifically, Section 4s(f)(1)(A) of the CEA provides, in
relevant part, that each registered SD and MSP must make financial
condition reports as required by regulations adopted by the
Commission.\15\ The Commission's financial reporting obligations were
adopted with the Commission's nonbank SD and nonbank MSP capital
requirements, and have a compliance date of October 6, 2021 (``CFTC
Financial Reporting Rules'').\16\
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\14\ 7 U.S.C. 6s(f).
\15\ 7 U.S.C. 6s(f)(1)(A).
\16\ See 85 FR 57462.
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B. Commission Capital Comparability Determinations for Non-U.S. Nonbank
Swap Dealers and Non-U.S. Nonbank Major Swap Participants
Commission Regulation 23.106 establishes a substituted compliance
framework whereby the Commission may determine that compliance by a
non-U.S. domiciled nonbank SD or non-U.S. domiciled nonbank MSP with
its home country's capital and financial reporting requirements will
satisfy all or parts of the CFTC Capital Rules and all or parts of the
CFTC Financial Reporting Rules (such a determination referred to as a
``Capital Comparability Determination'').\17\ The availability of such
substituted compliance is conditioned upon the Commission issuing a
determination that the relevant foreign jurisdiction's capital adequacy
and financial reporting requirements, and related financial
recordkeeping requirements, for non-U.S. nonbank SDs and/or non-U.S.
nonbank MSPs are comparable to the corresponding CFTC Capital Rules and
CFTC Financial Reporting Rules. The Commission will issue a Capital
Comparability Determination in the form of a Commission order
(``Capital Comparability Determination Order'').\18\
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\17\ 17 CFR 23.106. Commission Regulation 23.106(a)(1) provides
that a request for a Capital Comparability Determination may be
submitted by a non-U.S. nonbank SD or a non-U.S. nonbank MSP, a
trade association or other similar group on behalf of its SD or MSP
members, or a foreign regulatory authority that has direct
supervisory authority over one or more non-U.S. nonbank SDs or non-
U.S. nonbank MSPs. In addition, Commission regulations provide that
any non-U.S. nonbank SD or non-U.S. nonbank MSP that is dually-
registered with the Commission as a futures commission merchant
(``FCM'') is subject to the capital requirements of Commission
Regulation 1.17 (17 CFR 1.17) and may not petition the Commission
for a Capital Comparability Determination. See 17 CFR 23.101(a)(5)
and (b)(4), respectively. Furthermore, non-U.S. bank SDs and non-
U.S. bank MSPs may not petition the Commission for a Capital
Comparability Determination with respect to their respective
financial reporting requirements under Commission Regulation
23.105(p) (17 CFR 23.105(p)). Commission staff has issued, however,
a time-limited no-action letter stating that the Market Participants
Division will not recommend enforcement action against a non-U.S.
bank SD that files with the Commission certain financial information
that is provided to its home country regulator in lieu of certain
financial reports required by Commission Regulation 23.105(p). See
CFTC Staff Letter 21-18, issued on August 31, 2021.
\18\ 17 CFR 23.106(a)(3).
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The Commission's approach for conducting a Capital Comparability
Determination with respect to the CFTC Capital Rules and the CFTC
Financial Reporting Rules is a principles-based, holistic approach that
focuses on whether the applicable foreign jurisdiction's capital and
financial reporting requirements achieve comparable outcomes to the
corresponding CFTC requirements.\19\ In this regard, the approach is
not a line-by-line assessment or comparison of a foreign jurisdiction's
regulatory requirements with the Commission's requirements.\20\ In
performing the analysis, the Commission recognizes that jurisdictions
may adopt differing approaches to achieving comparable outcomes, and
the Commission will focus on whether the foreign jurisdiction's capital
and financial reporting requirements are comparable to the Commission's
in purpose and effect, and not whether they are comparable in every
aspect or contain identical elements.
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\19\ See 85 FR 57462 at 57521.
\20\ Id.
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A person requesting a Capital Comparability Determination is
required to submit an application to the Commission containing: (i) a
description of the objectives of the relevant foreign jurisdiction's
capital adequacy and financial reporting requirements applicable to
entities that are subject to the CFTC Capital Rules and the CFTC
Financial Reporting Rules; (ii) a description (including specific legal
and regulatory provisions) of how the relevant foreign jurisdiction's
capital adequacy and financial reporting requirements address
[[Page 41776]]
the elements of the CFTC Capital Rules and CFTC Financial Reporting
Rules, including, at a minimum, the methodologies for establishing and
calculating capital adequacy requirements and whether such
methodologies comport with any international standards; and (iii) a
description of the ability of the relevant foreign regulatory authority
to supervise and enforce compliance with the relevant foreign
jurisdiction's capital adequacy and financial reporting requirements.
The applicant must also submit, upon request, such other information
and documentation as the Commission deems necessary to evaluate the
comparability of the capital adequacy and financial reporting
requirements of the foreign jurisdiction.\21\
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\21\ 17 CFR 23.106(a)(2).
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The Commission may consider all relevant factors in making a
Capital Comparability Determination, including: (i) the scope and
objectives of the relevant foreign jurisdiction's capital and financial
reporting requirements; (ii) whether the relevant foreign
jurisdiction's capital and financial reporting requirements achieve
comparable outcomes to the Commission's corresponding capital
requirements and financial reporting requirements; (iii) the ability of
the relevant foreign regulatory authority or authorities to supervise
and enforce compliance with the relevant foreign jurisdiction's capital
adequacy and financial reporting requirements; and (iv) any other facts
or circumstances the Commission deems relevant, including whether the
Commission and foreign regulatory authority or authorities have a
memorandum of understanding (``MOU'') or similar arrangement that would
facilitate supervisory cooperation.\22\
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\22\ See 17 CFR 23.106(a)(3) and 85 FR 57520-57522.
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In performing the comparability assessment for foreign nonbank SDs,
the Commission's review will include the extent to which the foreign
jurisdiction's requirements address: (i) the process of establishing
minimum capital requirements for nonbank SDs and how such process
addresses risk, including market risk and credit risk of the nonbank
SD's on-balance sheet and off-balance sheet exposures; (ii) the types
of equity and debt instruments that qualify as regulatory capital in
meeting minimum requirements; (iii) the financial reports and other
financial information submitted by a nonbank SD to its relevant
regulatory authority and whether such information provides the
regulatory authority with the means necessary to effectively monitor
the financial condition of the nonbank SD; and (iv) the regulatory
notices and other communications between a nonbank SD and its foreign
regulatory authority that address potential adverse financial or
operational issues that may impact the firm. With respect to the
ability of the relevant foreign regulatory authority to supervise and
enforce compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements, the Commission's review will include
a review of the foreign jurisdiction's surveillance program for
monitoring nonbank's SDs compliance with such capital adequacy and
financial reporting requirements, and the disciplinary process imposed
on firms that fail to comply with such requirements.
In performing the comparability assessment for foreign nonbank
MSPs,\23\ the Commission's review will include the extent to which the
foreign jurisdiction's requirements address: (i) the process of
establishing minimum capital requirements for a nonbank MSP and how
such process establishes a minimum level of capital to ensure the
safety and soundness of the nonbank MSP; (ii) the financial reports and
other financial information submitted by a nonbank MSP to its relevant
regulatory authority and whether such information provides the
regulatory authority with the means necessary to effectively monitor
the financial condition of the nonbank MSP; and (iii) the regulatory
notices and other communications between a nonbank MSP and its foreign
regulatory authority that address potential adverse financial or
operational issues that may impact the firm. With respect to the
ability of the relevant foreign regulatory authority to supervise and
enforce compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements, the Commission's review will include
a review of the foreign jurisdiction's surveillance program for
monitoring nonbank MSPs' compliance with such capital adequacy and
financial reporting requirements, and the disciplinary process imposed
on firms that fail to comply with such requirements.
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\23\ Commission Regulation 23.101(b) requires a nonbank MSP to
maintain positive tangible net worth. There are no MSPs currently
registered with the Commission. 17 CFR 23.101(b).
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Commission Regulation 23.106 further provides that the Commission
may impose any terms or conditions that it deems appropriate in issuing
a Capital Comparability Determination.\24\ Any specific terms or
conditions with respect to capital adequacy or financial reporting
requirements will be set forth in the Commission's Capital
Comparability Determination Order. As a general condition to all
Capital Comparability Determination Orders, the Commission expects to
require notification from applicants of any material changes to
information submitted by the applicants in support of a comparability
finding, including, but not limited to, changes in the relevant foreign
jurisdiction's supervisory or regulatory regime.
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\24\ See 17 CFR 23.106(a)(5).
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The Commission's capital adequacy and financial reporting
requirements are designed to address and manage risks that arise from a
firm's operation as a SD or MSP. Given their functions, both sets of
requirements and rules must be applied on an entity-level basis
(meaning that the rules apply on a firm-wide basis, irrespective of the
type of transactions involved) to effectively address risk to the firm
as a whole. Therefore, in order to rely on a Capital Comparability
Determination, a nonbank SD or nonbank MSP domiciled in the foreign
jurisdiction and subject to supervision by the relevant regulatory
authority (or authorities) in the foreign jurisdiction must file a
notice with the Commission of its intent to comply with the applicable
capital adequacy and financial reporting requirements of the foreign
jurisdiction set forth in the Capital Comparability Determination in
lieu of all or parts of the CFTC Capital Rules and/or CFTC Financial
Reporting Rules.\25\ Notices must be filed electronically with the
Commission's Market Participants Division (``MPD'').\26\ The filing of
a notice by a non-U.S. nonbank SD or non-U.S. nonbank MSP provides MPD
staff, acting pursuant to authority delegated by the Commission,\27\
with the opportunity to engage with the firm and to obtain
representations that it is subject to, and complies with, the laws and
regulations cited in the Capital Comparability Determination and that
it will comply with any listed conditions. MPD will issue a letter
under its delegated authority from the Commission confirming that the
non-U.S. nonbank SD or non-U.S. nonbank MSP may comply with foreign
laws and regulations cited in the Capital Comparability Determination
in lieu of
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complying with the CFTC Capital Rules and the CFTC Financial Reporting
Rules upon MPD's determination that the firm is subject to and complies
with the applicable foreign laws and regulations, is subject to the
jurisdiction of the applicable foreign regulatory authority (or
authorities), and can meet any conditions in the Capital Comparability
Determination.
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\25\ 17 CFR 23.106(a)(4).
\26\ Notices must be filed in electronic form to the following
email address: [email protected].
\27\ See 17 CFR 140.91(a)(11).
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Each non-U.S. nonbank SD and/or non-U.S. nonbank MSP that receives,
in accordance with the applicable Commission Capital Comparability
Determination Order, confirmation from the Commission that it may
comply with a foreign jurisdiction's capital adequacy and/or financial
reporting requirements will be deemed by the Commission to be in
compliance with the corresponding CFTC Capital Rules and/or CFTC
Financial Reporting Rules.\28\ Accordingly, if a nonbank SD or nonbank
MSP fails to comply with the foreign jurisdiction's capital adequacy
and/or financial reporting requirements, the Commission may initiate an
action for a violation of the corresponding CFTC Capital Rules and or
CFTC Financial Reporting Rules.\29\ In addition, a non-U.S. nonbank SD
or non-U.S. nonbank MSP that receives confirmation of its ability to
use substituted compliance remains subject to the Commission's
examination and enforcement authority.\30\
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\28\ 17 CFR 23.106(a)(4).
\29\ Id.
\30\ Id.
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The Commission will consider an application for a Capital
Comparability Determination to be a representation by the applicant
that the laws and regulations of the foreign jurisdiction that are
submitted in support of the application are finalized and in force,
that the description of such laws and regulations is accurate and
complete, and that, unless otherwise noted, the scope of such laws and
regulations encompasses the relevant non-U.S. nonbank SDs and/or non-
U.S. nonbank MSPs domiciled in the foreign jurisdiction.\31\ A non-U.S.
nonbank SD or non-U.S. nonbank MSP that is not legally required to
comply with a foreign jurisdiction's laws or regulations determined to
be comparable in a Capital Comparability Determination may not
voluntarily comply with such laws or regulations in lieu of compliance
with the CFTC Capital Rules or the CFTC Financial Reporting Rules. Each
non-U.S. nonbank SD or non-U.S. nonbank MSP that seeks to rely on a
Capital Comparability Determination Order is responsible for
determining whether it is subject to the foreign laws and regulations
found comparable in the Capital Comparability Determination and the
Capital Comparability Determination Order.
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\31\ The Commission has provided the Applicants with an
opportunity to review for accuracy and completeness, and comment on,
the Commission's description of relevant EU laws and regulations on
which this proposed Capital Comparability Determination is based.
The Commission relies on this review and any corrections received
from the Applicants in making its proposal. Thus, to the extent that
the Commission relies on an inaccurate description of foreign laws
and regulations submitted by the Applicants, the comparability
determination may not be valid.
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C. Application for a Capital Comparability Determination for Certain EU
Nonbank Swap Dealers
The Applicants submitted the EU Application requesting that the
Commission issue a Capital Comparability Determination finding that an
EU nonbank SD's compliance with the capital requirements of the EU and
the financial reporting requirements of the EU, as specified in the EU
Application, satisfies corresponding CFTC Capital Rules and the CFTC
Financial Reporting Rules applicable to a nonbank SD under Sections
4s(e)-(f) of the CEA and Commission Regulations 23.101 and 23.105.\32\
There are currently four EU nonbank SDs registered with the Commission:
BofA Securities Europe SA and Goldman Sachs Paris Inc. et Cie are
organized and domiciled in France; Citigroup Global Markets Europe AG
and Morgan Stanley Europe SE are organized and domiciled in Germany.
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\32\ EU Application, p. 1. There are currently no MSPs
registered with the Commission, and the Applicants have not
requested that the Commission issue a Capital Comparability
Determination concerning EU nonbank MSPs. Accordingly, the
Commission's Capital Comparability Determination and proposed
Capital Comparability Determination Order do not address EU nonbank
MSPs.
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The capital and financial reporting framework applicable to EU
financial institutions is established by EU regulations and directives.
Specifically, the Capital Requirements Regulation \33\ and the Capital
Requirements Directive \34\ set forth capital and financial reporting
requirements applicable to entities defined as ``credit institutions''
or ``investment firms,'' including EU nonbank SDs.
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\33\ Regulation (EU) No 575/2013 of the European Parliament and
of the Council of 26 June 2013 on prudential requirements for credit
institutions and amending Regulation (EU) No 648/2012, as amended
(``Capital Requirements Regulation'' or ``CRR'').
\34\ Directive 2013/36/EU of the European Parliament and of the
Council of 26 June 2013 on access to the activity of credit
institutions and the prudential supervision of credit institutions,
amending Directive 2002/87/EC and repealing Directives 2006/48/EC
and 2006/49/EC, as amended (``Capital Requirements Directive'' or
``CRD'').
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The term ``credit institution'' includes an entity engaged in
taking deposits or other repayable funds from the public and granting
credits for its own account (``Banking Activities'').\35\ An entity
engaged in Banking Activities is subject to the capital and financial
reporting requirements of CRR and CRD.
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\35\ CRR, Article 4(1)(1) (defining the term ``credit
institution'').
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The term ``credit institution'' also includes an entity engaged in
(i) dealing for its own account, (ii) underwriting financial
instruments, or (iii) placing financial instruments on a firm
commitment basis (collectively, ``Investment Activities''), provided
that the entity also meets certain defined financial thresholds set
forth in the definition.\36\ Specifically, an entity engaged in
Investment Activities that maintains a total value of consolidated
assets equal to or in excess of EUR 30 billion is required to be
authorized as a ``credit institution'' and is subject to the capital
and financial reporting requirements of CRR and CRD.\37\
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\36\ Id.
\37\ Id. and CRD, Articles 8 and 8a (requiring an entity that
engages in Investment Activities and meets the financial thresholds
to submit an application for authorization as a ``credit
institution'' under the relevant provisions of the applicable
national law).
CRR, Article 4(1)(1) provides that an entity carrying out
Investment Activities meets the financial threshold for
authorization as a credit institution if: (i) the total value of the
consolidated assets of the entity is equal to or in excess of EUR 30
billion; (ii) the total value of the assets of the entity is less
than EUR 30 billion, and the entity is part of a group in which the
total value of the consolidated assets of all entities in that group
that individually have total assets of less than EUR 30 billion and
that engage in Investment Activities is equal to or in excess of EUR
30 billion; or (iii) the total value of the assets of the entity is
less than EUR 30 billion, and the entity is part of a group in which
the total value of the consolidated assets of all entities in the
group that engage in Investment Activities is equal to or in excess
of EUR 30 billion, where the consolidated supervisor, in
consultation with the supervisory college, decides that the entity
must be authorized as a credit institution in order to address
potential risks of circumvention and potential risks for financial
stability of the EU.
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Credit institutions that qualify as ``significant supervised
entities'' are subject to the direct prudential supervision of the
European Central Bank (``ECB'').\38\ Credit institutions that
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are ``less significant supervised entities'' are prudentially
supervised by the applicable prudential supervisory authority in the
entity's home EU Member State (``national competent authority'').\39\
The term ``competent authority'' is used in this document to refer to
the ECB or the national competent authority, as appropriate.
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\38\ See generally, Council Regulation (EU) 1024/2013 of 15
October 2013 Conferring Specific Tasks to the European Central Bank
Concerning Policies Relating to the Prudential Supervision of Credit
Institutions (''SSM Regulation'') and Regulation (EU) No 468/2014 of
the European Central Bank of 16 April 2014 Establishing the
Framework for Cooperation within the Single Supervisory Mechanism
Between the European Central Bank and the National Competent
Authorities and with National Designated Authorities (''SSM
Framework Regulation'').
The criteria for determining whether credit institutions are
considered ``significant supervised entities'' include size,
economic importance for the specific EU Member State or the EU
economy, significance of cross-border activities, and request for or
receipt of direct public financial assistance. See SSM Regulation,
Article 6 and SSM Framework Regulation, Articles 39-44 and 50-62.
\39\ SSM Regulation, Article 6. Less significant entities are
supervised by their national competent authorities in close
cooperation with the ECB. With respect to the prudential supervision
of less significant entities, the ECB has the power to issue
regulations, guidelines or general instructions to the national
competent authorities. SSM Regulation, Article 6(5)(a). At any time,
the ECB can also decide to directly supervise a less significant
entity to ensure that high supervisory standards are applied
consistently. SSM Regulation, Article 6(5)(b).
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The term ``investment firm'' is defined as an entity authorized
under the Markets in Financial Instruments Directive,\40\ and whose
regular business is the provision of one or more investment services to
third parties and/or the performance of one or more investment-related
activities on a professional basis (including Investment Activities as
defined above).\41\ An investment firm that engages in Investment
Activities and maintains total consolidated assets of at least EUR 15
billion is also subject to the capital and financial reporting
requirements of CRR and CRD.\42\ The investment firm, however, is not
required to be authorized as a ``credit institution'' under the
relevant provisions of the applicable national law in the EU Member
State and is prudentially supervised by the national competent
authority.
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\40\ Directive 2014/65/EU of the European Parliament and of the
Council of 15 May 2014 on markets in financial instruments and
amending Directive 2002/92/EC and Directive 2011/61/EU (``Markets in
Financial Instruments Directive'' or ``MiFID'').
\41\ CRR, Article 4(1)(2) cross-referencing Article 4(1)(1) of
MiFID.
\42\ See Regulation (EU) 2019/2033 of the European Parliament
and of the Council of 27 November 2019 on the prudential
requirements of investment firms and amending Regulations (EU) No
1093/2010, (EU) No 575/2013, (EU) No 600/2014 and (EU) No 806/2014
(``Investment Firms Regulation'' or ``IFR''), Article 1(1) and
(1)(2) (indicating that an investment firm that engages in
Investment Activities is subject to CRR (and by cross-reference to
CRD) if any of the following applies: (i) the total value of the
consolidated assets of the investment firm is equal to or exceeds
EUR 15 billion; (ii) the total value of the consolidated assets of
the investment firm is less than EUR 15 billion, and the investment
firm is part of a group in which the total value of the consolidated
assets of all investment firms in the group that individually have
total assets of less than EUR 15 billion and that engage in
Investment Activities is equal to or exceeds EUR 15 billion; or
(iii) the total value of the consolidated assets of the investment
firm is equal to or exceeds EUR 5 billion, the investment firm
engages in Investment Activities, and the competent authority has
determined that the investment firm should be subject to CRR based
on criteria set forth in Article 5 of Directive (EU) 2019/2034). See
also, Directive (EU) 2019/2034 of the European Parliament and of the
Council of 27 November 2019 on the prudential supervision of
investment firms and amending Directives 2002/87/EC, 2009/65/EC,
2011/61/EU, 2013/36/EU, 2014/59/EU and 2014/65/EU (``Investment
Firms Directive'' or ``IFD''), Article 5 (providing that the
competent authority may decide to apply the requirements of CRR to
an investment firm whose consolidated assets are equal or exceed EUR
5 billion and that engages in Investment Activities if one or more
of the following criteria apply: (i) the investment firm engages in
Investment Activities on a scale that the failure or distress of the
investment firm could lead to systemic risk; (ii) the investment
firm is a clearing member; and/or (iii) the competent authority
considers it to be justified in light of the size, nature, scale and
complexity of the activities of the investment firm considering the
importance of the investment firm for the economy of the EU or of
the relevant EU Member State, the significance of the investment
firm's cross-border activities, and the interconnectedness of the
investment firm with the financial system).
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Lastly, an entity defined as an ``investment firm'' that does not
engage in Investment Activities, or that engages in Investment
Activities but does not meet the criteria of either maintaining
consolidated assets of at least EUR 15 billion or maintaining
consolidated assets of at least EUR 5 billion and meeting certain
criteria of significance and interconnectedness, is not subject to CRR
and CRD.\43\ Such an investment firm is subject to new capital and
financial reporting requirements established by IFR and IFD, which EU
Member States were required to adopt and apply by June 26, 2021.\44\
The new IFR and IFD capital and financial reporting requirements are
tailored to the risks faced and posed by smaller investment firms that
operate differently from banking entities and larger investment firms.
Such smaller investment firms are also prudentially supervised by the
national competent authority.
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\43\ See IFD, Article 5 (setting forth the criteria that may
justify a decision by the competent authority to apply the
requirements of CRR to an investment firm that engages in Investment
Activities and whose consolidated assets equal or exceed EUR 5
billion).
\44\ IFR, Article 66 and IFD, Article 67.
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The four EU nonbank SDs currently registered with the Commission
are subject to CRR and CRD.\45\ The EU Application does not include an
analysis of the comparability of the capital and financial reporting
rules under the IFR and IFD to the CFTC Capital Rules and CFTC
Financial Reporting Rules. Therefore, the Commission is not assessing
the comparability of the capital and financial reporting requirements
imposed by IFR and IFD on smaller investment firms with the CFTC
Capital Rules and CFTC Financial Reporting Rules. Thus, an EU nonbank
SD, or a future EU nonbank SD applicant, that is subject to the IFR and
IFD framework and seeks substituted compliance for some or all of the
CFTC Capital Rules and CFTC Financial Reporting Rules must submit an
application to the Commission in accordance with Commission Regulation
23.106.\46\ The application must include a description of how IFR and
IFD address the elements of the Commission's capital adequacy and
financial reporting requirements for nonbank SDs, including, at a
minimum, the methodologies for establishing and calculating capital
adequacy requirements.\47\
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\45\ BofA Securities Europe SA, Citigroup Global Markets Europe
AG and Morgan Stanley Europe SE have been authorized as credit
institutions. The three EU nonbank SDs also qualify as ``significant
supervised entities'' subject to the direct supervision of the ECB.
Goldman Sachs Paris Inc. et Cie has a pending application for
authorization as a credit institution. CRD, Article 8a allows
entities engaged in Investment Activities to continue carrying out
such activities until they obtain authorization as credit
institutions. The Applicants represented that Goldman Sachs Paris
Inc et Cie would likely be a categorized as a ``less significant
supervised entity'' and subject to direct supervision by the
national competent authority. According to the Applicants, however,
the ECB is still considering whether it may exercise direct
supervisory authority over the entity, pursuant to SSM Regulation,
Article 6. See Responses to Staff Questions of May 15, 2023.
\46\ 17 CFR 23.106.
\47\ Commission Regulation 23.106(a)(2)(ii). 17 CFR
23.106(a)(2)(ii).
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In addition, as noted above, the four EU nonbank SDs that are
currently registered with the Commission are domiciled in the EU Member
States of France and Germany. As further described below, the
Commission's analysis therefore involves an assessment of how certain
EU directives were implemented into the national laws of France and
Germany. The Commission has not reviewed the implementation of the
relevant EU directives in other EU Member States. Therefore, an entity
organized and domiciled in an EU Member State other than France or
Germany that seeks to register with the Commission as an SD and to
comply with some or all of the Commission's capital and financial
reporting rules via substituted compliance would have to submit an
application for a Capital Comparability Determination under Commission
Regulation 23.106. Commission staff expects that it will engage with
such entities during the registration process
[[Page 41779]]
and rely to the extent practicable on the analysis performed in this
document to assess the comparability of the applicant's home country
capital and financial reporting requirements with the Commission's
corresponding requirements.
As noted above, the EU nonbank SDs currently registered with the
Commission are subject to CRR and CRD. CRR, as a regulation, is binding
in its entirety and directly applicable in all EU Member States.\48\
CRD, as a directive, was required to be transposed into EU Member
States' national law.\49\ France implemented CRD in various provisions
of its Monetary and Financial Code (``MFC'') \50\ and through several
ministerial orders, including Ministerial Order on Capital Buffers \51\
and Ministerial Order on Internal Control.\52\ France also adopted
Ministerial Order on Distribution Restrictions \53\ and amended
relevant national law provisions, including the above-referenced
ministerial orders, to implement CRD V.\54\ Germany implemented CRD via
amendments to the Banking Act (Kreditwesengesetz, ``KWG'') and its
subordinate statutory instruments.\55\ In addition, Germany adopted and
published the Risk Reduction Act (Risikoreduzierungsgesetz, ``RiG'') on
December 14, 2020 to implement CRD V, with most of the relevant changes
becoming effective on December 28, 2020. CRR and CRD as implemented in
French and German law are collectively referred to hereafter as the
``EU Capital Rules.''
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\48\ Consolidated Version of the Treaty on the Functioning of
the European Union, OJ (C 326) 171, Oct. 26, 2012 (``TFEU''),
Article 288. Accordingly, CRR is directly applicable and binding law
in France and Germany, the two EU Member States where EU nonbank SDs
are currently organized and operating. Most CRR requirements,
including provisions introduced by Regulation (EU) 2019/876 of the
European Parliament and of the Council of 20 May 2019 amending
Regulation (EU) No 575/2013 (``CRR II''), have been in effect since
June 28, 2021, with some provisions having an earlier effective
date. CRR II, Article 3. Several provisions have a delayed effective
date. These include market risk-related amendments to CRR, Article
106 (Internal Hedges) and new Article 204a (Eligible Types of Equity
Derivatives), which will come into effect on June 28, 2023. Id.
\49\ TFEU, Article 288 (stating that a directive is binding as
to the result to be achieved upon each EU Member State to which the
directive is addressed, and further provides, however, that each EU
Member State elects the form and method of implementing the
directive). In this connection, EU Member States were required to
implement and start applying amendments to CRD, introduced by
Directive (EU) 2019/878 of the European Parliament and of the
Council of 20 May 2019 amending Directive 2013/36/EU as regards
exempted entities, financial holding companies, mixed financial
holding companies, remuneration, supervisory measures and powers and
capital conservation measures (``CRD V'') by December 29, 2020. Some
CRD V provisions were subject to delayed implementation deadlines of
June 28, 2021 and January 1, 2022, but all CRD V provisions are
currently effective. CRD V, Article 2.
\50\ In particular, MFC, Articles L.511-41 to L.511-50-1 contain
provisions relating to prudential requirements applicable to credit
institutions. In addition, MFC, Articles L.612-1 to L.612-50 relate
to the role, functioning, and powers of the national competent
authority.
\51\ Arr[ecirc]t[eacute] of 3 November 2014 Relating to Capital
Buffers of Banking Services Providers and Investment Firms Other
Than Portfolio Management Companies.
\52\ Arr[ecirc]t[eacute] of 3 November 2014 on Internal Control
of Companies in the Banking, Payment Services and Investment
Services Sector Subject to the Control of Autorit[eacute] de
Contr[ocirc]le Prudentiel et de R[eacute]solution.
\53\ Arr[ecirc]t[eacute] of 25 February 2021 Relating to
Distribution Restrictions Applicable to Credit Institutions,
Financial Companies and Certain Investment Firms.
\54\ Specifically, to implement CRD V, France amended the MFC
via Ordinance No. 2020-1635 of December 21, 2020 and Decree No.
2020-1637 of December 22, 2020, with most of the relevant changes
becoming effective on December 29, 2020. France also introduced
consecutive amendments to Ministerial Order on Capital Buffers and
Ministerial Order on Internal Control, with the latest changes
effective as of August 1, 2021.
\55\ Specifically, the KWG includes, among other things,
provisions related to capital adequacy requirements, including
provisions granting power the Federal Ministry of Finance to issue
statutory instruments to provide details on capital adequacy
requirements (Section 10(1)), provisions specifying the basis for
imposing higher capital requirements (Section 10(3)), provisions
setting forth requirements related to capital buffers (Sections 10c
to 10i) and provisions describing the powers of the competent
authority (Sections 6b, 56, 60b).
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The Applicants also represent that in addition to CRR and CRD, the
Bank Recovery and Resolution Directive (``BRRD'') includes relevant EU
capital requirements.\56\ BRRD establishes a framework for recovery and
resolution of credit institutions and investment firms, and mandates
that EU Member States require such institutions to satisfy ``a minimum
requirement for own funds and eligible liabilities'' (``MREL'') if they
meet certain requirements.\57\ France implemented BRRD primarily via
amendments to the MFC.\58\ Germany transposed BRRD into national law by
the Recovery and Resolution Act (Sanierungs und Abwicklungsgesetz,
``SAG'').\59\
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\56\ Directive 2014/59/EU of the European Parliament and of the
Council of 15 May 2014 establishing a framework for the recovery and
resolution of credit institutions and investment firms and amending
Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC,
2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/
36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of
the European Parliament and of the Council. See EU Application, p.
5.
\57\ EU Member States were required to transpose BRRD into
national law and start applying the implementing measures from
January 1, 2015. BRRD, Article 130. BRRD was amended by Directive
(EU) 2019/879 of the European Parliament and of the Council of 20
May 2019 amending Directive 2014/59/EU as regards loss-absorbing and
recapitalization capacity of credit institutions and investment
firms and Directive 98/26/EC (``Bank Recovery and Resolution
Directive II'' or ``BRRD II'') and EU Member States were required to
start applying national law measures implementing BRRD II by
December 28, 2020. BRRD II, Article 3. BRRD as amended by BRRD II
will be referred to as ``BRRD'' in this document, unless otherwise
stated.
\58\ Among other provisions, MFC Article L.613-44 relates in
particular to the MREL requirement and Article R.613-46-1 defines
the conditions that items and instruments need to meet to qualify as
``eligible liabilities.''
\59\ In particular, SAG, Section 49(1) and (2) relate to the
MREL requirement.
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The Applicants further represent that with respect to supervisory
financial reporting, Commission Implementing Regulation (EU) 2021/451
\60\ supplements CRR with implementing technical standards (``CRR
Reporting ITS'') specifying, among other things, uniform formats and
frequencies for the financial reporting required under CRR.\61\ In
addition, the ECB has adopted a regulation setting forth a common
minimum set of financial information that should be reported by credit
institutions subject to CRR, including EU nonbank SDs, on the basis of
the CRR Reporting ITS (``ECB FINREP Regulation'').\62\ The Applicants
also represent that Directive 2013/34/EU \63\ contains provisions
related to financial reporting, including a mandate that entities of a
certain size be required to prepare annual audited financial statements
and a management report.\64\ CRR, CRR Reporting ITS, ECB FINREP
Regulation, relevant provisions of CRD regarding certain notice
requirements as implemented in French and German law, and the relevant
provisions of the Accounting Directive as implemented in French and
German law are collectively referred to hereafter as the ``EU Financial
Reporting Rules.''
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\60\ Commission Implementing Regulation (EU) 2021/451 of 17
December 2020 laying down implementing technical standards for the
application of Regulation (EU) No 575/2013 of the European
Parliament and of the Council with regard to supervisory reporting
of institutions and repealing Implementing Regulation (EU) No 680/
2014.
\61\ EU Application, p. 21 and Responses to Staff Questions of
May 15, 2023.
\62\ Regulation (EU) 2015/534 of the European Central Bank of 17
March 2015 on reporting of supervisory financial information.
\63\ Directive 2013/34/EU of the European Parliament and of the
Council of 26 June 2013 on the annual financial statements,
consolidated financial statements and related reports of certain
types of undertakings, amending Directive 2006/43/EC of the European
Parliament and of the Council and repealing Council Directives 78/
660/EEC and 83/394/EEC (``Accounting Directive'').
\64\ EU Application, p. 5. Accounting Directive, Articles 4, 19
and 34.
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The Applicants also note that the U.S. Securities and Exchange
Commission (``SEC'') has issued orders permitting an SEC-registered
nonbank security-based swap dealer domiciled in France or
[[Page 41780]]
Germany (``EU nonbank SBSD'') to satisfy SEC capital \65\ and financial
reporting requirements via substituted compliance with applicable
French and German capital and financial reporting.\66\ The French Order
and German Order conditioned substituted compliance for capital
requirements on an EU nonbank SBSD complying with specified laws and
regulations, including CRR, CRD, and BRRD, and also maintaining total
liquid assets in an amount that exceeds the EU nonbank SBSD's total
liabilities by at least $100 million and by at least $20 million after
applying certain deductions to the value of the liquid assets to
reflect market, credit, and other potential risks to the value of the
assets.\67\
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\65\ Section 15F(e)(1)(B) of the Exchange Act (15 U.S.C. 78o-10)
directs the SEC to adopt capital rules for security-based swap
dealers (``SBSDs'') that do not have a prudential regulator.
\66\ See Amended and Restated Order Granting Conditional
Substituted Compliance in Connection with Certain Requirements
Applicable to Non-U.S. Security-Based Swap Dealers and Major
Security-Based Swap Participants Subject to Regulation in the
Federal Republic of Germany; Amended Orders Addressing Non-U.S.
Security-Based Swap Entities Subject to Regulation in the French
Republic or the United Kingdom; and Order Extending the Time to Meet
Certain Conditions Relating to Capital and Margin, 86 FR 59797 (Oct.
28, 2021) (``German Order''); Order Granting Conditional Substituted
Compliance in Connection with Certain Requirements Applicable to
Non-U.S. Security-Based Swap Dealers and Major Security-Based Swap
Participants Subject to Regulation in the French Republic, 86 FR
41612 (Aug. 8, 2021) (``French Order''); and Order Specifying the
Manner and Format of Filing Unaudited Financial and Operational
Information by Security-Based Swap Dealers and Major Security-Based
Swap Participants that are not U.S. Persons and are Relying on
Substituted Compliance with Respect to Rule 18a-7, 86 FR 59208 (Oct.
26, 2021) (``SEC Order on Manner and Format of Filing Unaudited
Financial and Operational Information'').
\67\ The conditioning of the German and French substituted
compliance orders on EU nonbank SBSDs maintaining liquid assets in
an amount that exceeds the EU nonbank SBSD's total liabilities by at
least $100 million and by at least $20 million after applying
certain deductions to the value of the liquid assets reflects that
the SEC's capital rule for nonbank SBSDs is a liquidity-based
requirement and that the SEC capital requirements are not based on
the Basel bank capital standards. See 17 CFR 240.18a-1(a)(1)
(requiring a SBSD to maintain, in relevant part, net capital of $20
million or, if approved to use capital models, $100 million of
tentative net capital and $20 million of net capital).
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II. General Overview of Commission and EU Nonbank Swap Dealer Capital
Rules
A. General Overview of the CFTC Nonbank Swap Dealer Capital Rules
The CFTC Capital Rules provide nonbank SDs with three alternative
capital approaches: (i) the Tangible Net Worth Capital Approach (``TNW
Approach''); (ii) the Net Liquid Assets Capital Approach (``NLA
Approach''); and (iii) the Bank-Based Capital Approach (``Bank-Based
Approach'').\68\
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\68\ 17 CFR 23.101.
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Nonbank SDs that are ``predominantly engaged in non-financial
activities'' may elect the TNW Approach.\69\ The TNW Approach requires
a nonbank SD to maintain a level of ``tangible net worth'' \70\ equal
to or greater than the higher of: (i) $20 million plus the amount of
the nonbank SD's ``market risk exposure requirement'' \71\ and ``credit
risk exposure requirement'' \72\ associated with the nonbank SD's swap
and related hedge positions that are part of the nonbank SD's swap
dealing activities; (ii) 8 percent of the nonbank SD's ``uncleared swap
margin'' amount; \73\ or (iii) the amount of capital required by a
registered futures association of which the nonbank SD is a member.\74\
The TNW Approach is intended to ensure the safety and soundness of a
qualifying nonbank SD by requiring the firm to maintain a minimum level
of tangible net worth that is based on the nonbank SD's swap dealing
activities to provide a sufficient level of capital to absorb losses
resulting from its swap dealing and other business activities.
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\69\ 17 CFR 23.101(a)(2). The term ``predominantly engaged in
non-financial activities'' is defined in Commission Regulation
23.100 and generally provides that: (i) the nonbank SD's, or its
parent entity's, annual gross financial revenues for either of the
previous two completed fiscal years represents less than 15 percent
of the nonbank SD's or the nonbank SD's parent's, annual gross
revenues for all operations (i.e., commercial and financial) for
such years; and (ii) the nonbank SD's, or its parent entity's, total
financial assets at the end of its two most recently completed
fiscal years represents less than 15 percent of the nonbank SD's, or
its parent's, total consolidated financial and nonfinancial assets
as of the end of such years. 17 CFR 23.100.
\70\ The term ``tangible net worth'' is defined in Commission
Regulation 23.100 and generally means the net worth (i.e., assets
less liabilities) of a nonbank SD, computed in accordance with
applicable accounting principles, with assets further reduced by a
nonbank SD's recorded goodwill and other intangible assets. 17 CFR
23.100.
\71\ The terms ``market risk exposure'' and ``market risk
exposure requirement'' are defined in Commission Regulation 23.100
and generally mean the risk of loss in a financial position or
portfolio of financial positions resulting from movements in market
prices and other factors. 17 CFR 23.100. Market risk exposure is the
sum of: (i) general market risks including changes in the market
value of a particular asset that results from broad market
movements, which may include an additive for changes in market value
under stressed conditions; (ii) specific risk, which includes risks
that affect the market value of a specific instrument but do not
materially alter broad market conditions; (iii) incremental risk,
which means the risk of loss on a position that could result from
the failure of an obligor to make timely payments of principal and
interest; and (iv) comprehensive risk, which is the measure of all
material price risks of one or more portfolios of correlation
trading positions.
\72\ The term ``credit risk exposure requirement'' is defined in
Commission Regulation 23.100 and generally reflects the amount at
risk if a counterparty defaults before the final settlement of a
swap transaction's cash flows. 17 CFR 23.100.
\73\ The term ``uncleared swap margin'' is defined in Commission
Regulation 23.100 to generally mean the amount of initial margin
that a nonbank SD would be required to collect from each
counterparty for each outstanding swap position of the nonbank SD.
17 CFR 23.100. A nonbank SD must include all swap positions in the
calculation of the uncleared swap margin amount, including swaps
that are exempt or excluded from the scope of the Commission's
uncleared swap margin regulations. A nonbank SD must compute the
uncleared swap margin amount in accordance with the Commission's
margin rules for uncleared swaps. See 17 CFR 23.154.
\74\ The National Futures Association (``NFA'') is currently the
only entity that is a registered futures association. The Commission
will refer to NFA in this document when referring to the
requirements or obligations of a registered futures association.
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The TNW approach requires a nonbank SD to compute its market risk
exposure requirement and credit risk exposure requirement using
standardized capital charges set forth in SEC Rule 18a-1 \75\ that are
applicable to entities registered with the SEC as SBSDs or standardized
capital charges set forth in Commission Regulation 1.17 applicable to
entities registered as FCMs or entities dually-registered as an FCM and
nonbank SD.\76\ Nonbank SDs that have received Commission or NFA
approval pursuant to Commission Regulation 23.102 may use internal
models to compute market risk and/or credit risk capital charges in
lieu of the SEC or CFTC standardized capital charges.\77\
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\75\ 17 CFR 240.18a-1.
\76\ 17 CFR 23.101(a)(2)(ii)(A).
\77\ Id.
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A nonbank SD that elects the NLA Approach is required to maintain
``net capital'' in an amount that equals or exceeds the greater of: (i)
$20 million; (ii) 2 percent of the nonbank SD's uncleared swap margin
amount; or (iii) the amount of capital required by NFA.\78\ The NLA
Approach is intended to ensure the safety and soundness of a nonbank SD
by requiring the firm to maintain at all times at least one dollar of
highly liquid assets to cover each dollar of the nonbank SD's
liabilities.
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\78\ 17 CFR 23.101(a)(1)(ii)(A). ``Net capital'' consists of a
nonbank SD's highly liquid assets (subject to haircuts) less all of
the firm's liabilities, excluding certain qualified subordinated
debt. See 17 CFR 240.18a-1 for the calculation of ``net capital.''
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A nonbank SD is required to reduce the value of its highly liquid
assets by the market risk exposure requirement and/or the credit risk
exposure requirement in computing its net capital.\79\ A nonbank SD
that does not have Commission or NFA approval to use internal models
must compute its market risk exposure requirement and/
[[Page 41781]]
or credit risk exposure requirement using the standardized capital
charges contained in SEC Rule 18a-1 as modified by the Commission's
rule.\80\
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\79\ See 17 CFR 240.18a-1(c) and (d).
\80\ See 17 CFR 23.101(a)(1)(ii).
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A nonbank SD that has obtained Commission or NFA approval, may use
internal market risk and/or credit risk models to compute market risk
and/or credit risk capital charges in lieu of the standardized capital
charges.\81\ A nonbank SD that is approved to use internal market risk
and/or credit risk models is further required to maintain a minimum of
$100 million of ``tentative net capital.'' \82\
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\81\ See 17 CFR 23.102.
\82\ 17 CFR 23.101(a)(1)(ii)(A)(1). The term ``tentative net
capital'' is defined in Commission Regulation 23.101(a)(1)(ii)(A)(1)
by reference to SEC Rule 18a-1 and generally means a nonbank SD's
net capital prior to deducting market risk and credit risk capital
charges.
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The Commission's NLA Approach is consistent with the SEC's SBSD
capital rule, and is based on the Commission's capital rule for FCMs
and the SEC's capital rule for securities broker-dealers (``BDs''). The
quantitative and qualitative requirements for NLA Approach internal
market and credit risk models are also consistent with the quantitative
and qualitative requirements of the Commission's Bank-Based Approach as
described below.
The Commission's Bank-Based Approach for computing regulatory
capital for nonbank SDs is based on certain capital requirements
imposed by the Federal Reserve Board for bank holding companies.\83\
The Bank-Based Approach also is consistent with the Basel Committee on
Banking Supervision's (``BCBS'') international framework for bank
capital requirements.\84\ The Bank-Based Approach requires a nonbank SD
to maintain regulatory capital equal to or in excess of each of the
following requirements: (i) $20 million of common equity tier 1
capital; (ii) an aggregate of common equity tier 1 capital, additional
tier 1 capital, and tier 2 capital (including qualifying subordinated
debt) equal to or greater than 8 percent of the nonbank SD's risk-
weighted assets (provided that common equity tier 1 capital comprises
at least 6.5 percent of the 8 percent minimum requirement); (iii) an
aggregate of common equity tier 1 capital, additional tier 1 capital,
and tier 2 capital equal to or greater than 8 percent of the nonbank
SD's uncleared swap margin amount; and (iv) an amount of capital
required by NFA.\85\ The Bank-Based Approach is intended to ensure that
the safety and soundness of a nonbank SD by requiring the firm to
maintain at all times qualifying capital in an amount sufficient to
absorb unexpected losses, expenses, decrease in firm assets, or
increases in firm liabilities without the firm becoming insolvent.
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\83\ See 17 CFR 23.101(a)(1)(i).
\84\ The BCBS is the primary global standard-setter for the
prudential regulation of banks and provides a forum for cooperation
on banking supervisory matters. Institutions represented on the BCBS
include the Federal Reserve Board, the European Central Bank,
Deutsche Bundesbank, Bank of England, Bank of France, Bank of Japan,
Banco de Mexico, and Bank of Canada. The BCBS framework is available
at https://www.bis.org/basel_framework/index.htm.
\85\ 17 CFR 23.101(a)(1)(i).
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The terms used in the Commission's Bank-Based Approach are defined
by reference to regulations of the Federal Reserve Board.\86\
Specifically, the term ``common equity tier 1 capital'' is defined for
purposes of the CFTC Capital Rules to generally mean the sum of a
nonbank SD's common stock instruments and any related surpluses,
retained earnings, and accumulated other comprehensive income.\87\ The
term ``additional tier 1 capital'' is defined to include equity
instruments that are subordinated to claims of general creditors and
subordinated debt holders, but contain certain provisions that are not
available to common stock, such as the right of nonbank SD to call the
instruments for redemption or to convert the instruments to other forms
of equity.\88\ The term ``tier 2 capital'' is defined to include
certain types of instruments that include both debt and equity
characteristics (e.g., certain perpetual preferred stock instruments
and subordinated term debt instruments).\89\ Subordinated debt also
must meet certain requirements to qualify as tier 2 capital, including
that the term of the subordinated debt instrument is for a minimum of
one year (with the exception of approved revolving subordinated debt
agreements which may have a maturity term that is less than one year),
and the debt instrument is an effective subordination of the rights of
the lender to receive any payment, including accrued interest, to other
creditors.\90\
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\86\ Id. Commission Regulation 23.101(a)(1)(i) references
Federal Reserve Board Rule 217.20 for purposes of defining the terms
used in establishing the minimum capital requirements under the
Bank-Based Approach. 17 CFR 23.101(a)(1)(i) and 12 CFR 217.20.
\87\ See 12 CFR 217.20(b).
\88\ See 12 CFR 217.20(c).
\89\ See 12 CFR 217.20(d).
\90\ The subordinated debt must meet the requirements set forth
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR
23.101(a)(1)(i)(B) providing that the subordinated debt used by a
nonbank SD to meet its minimum capital requirement under the Bank-
Based Approach must satisfy the conditions for subordinated debt
under SEC Rule 18a-1d.
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Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are unencumbered and generally long-term or permanent forms of
capital that help ensure that a nonbank SD will be able to absorb
losses resulting from its operations and maintain confidence in the
nonbank SD as a going concern. In addition, in setting an equity ratio
requirement, this limits the amount of asset growth and leverage a
nonbank SD can incur, as a nonbank SD must fund its asset growth with a
certain percentage of regulatory capital.
A nonbank SD also must compute its risk-weighted assets using
standardized capital charges or, if approved, internal models. Risk-
weighting assets involves adjusting the notional or carrying value of
each asset based on the inherent risk of the asset. Less risky assets
are adjusted to lower values (i.e., have less risk-weight) than more
risky assets. As a result, nonbank SDs are required to hold lower
levels of regulatory capital for less risky assets and higher levels of
regulatory capital for riskier assets.
Nonbank SDs not approved to use internal models to risk-weight
their assets must compute market risk capital charges using the
standardized charges contained in Commission Regulation 1.17 and SEC
Rule 18a-1, and must compute their credit risk charges using the
standardized capital charges set forth in regulations of the Federal
Reserve Board for bank holding companies in Subpart D of 12 CFR part
217.\91\
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\91\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the
term BHC risk-weighted assets in 17 CFR 23.100.
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Standardized market risk charges are computed under Commission
Regulation 1.17 and SEC Rule 18a-1 by multiplying, as appropriate to
the specific asset schedule, the notional value or market value of the
nonbank SD's proprietary financial positions (such as swaps, security-
based swaps, futures, equities, and U.S. Treasuries) by fixed
percentages set forth in the Regulation or Rule.\92\ Standardized
credit risk charges require the nonbank SD to multiply on-balance sheet
and off-balance sheet exposures (such as receivables from
counterparties, debt instruments, and exposures from derivatives) by
predefined percentages set forth in the applicable Federal Reserve
Board regulations contained in Subpart D of 12 CFR part 217.
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\92\ See 17 CFR 1.17(c)(5) and 17 CFR 240.15c3-1(c)(2).
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A nonbank SD also may apply to the Commission or NFA for approval
to use internal models to compute market risk exposure and/or credit
risk exposure for
[[Page 41782]]
purposes of determining its total risk-weighted assets.\93\ Nonbank SDs
approved to use internal models for the calculation of credit risk or
market risk, or both, must follow the model requirements set forth in
Federal Reserve Board regulations for bank holding companies codified
in Subpart E and F, respectively, of 12 CFR part 217. Credit risk and
market risk capital charges computed with internal models require the
estimation of potential losses, with a certain degree of likelihood,
within a specified time period, of a portfolio of assets. Internal
models allow for consideration of potential co-movement of prices
across assets in the portfolio, leading to offsets of gains and losses.
Internal credit risk models can also further include estimation of the
likelihood of default of counterparties.
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\93\ See 17 CFR 23.102.
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B. General Overview of EU Capital Rules for EU Nonbank SDs
The Applicants state that the EU Capital Rules impose bank-like
capital requirements on an EU nonbank SD that are consistent with the
BCBS framework for international bank-based capital standards.\94\ The
Applicants further state that the EU Capital Rules are intended to
require each EU nonbank SD to hold a sufficient amount of qualifying
equity capital and subordinated debt based on the EU nonbank SD's
activities, to absorb decreases in the value of firm assets, increases
in the value of firm liabilities, and to cover losses from business
activities, including possible counterparty defaults and margin
collateral shortfalls associated with swap dealing activities, without
the firm becoming insolvent.\95\
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\94\ See EU Application, p. 10.
\95\ See EU Application, pp. 5-6, 10 and 15.
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The EU Capital Rules require each EU nonbank SD to hold and
maintain regulatory capital in the form of qualifying common equity
tier 1 capital, additional tier 1 capital, and tier 2 capital in an
aggregate amount that equals or exceeds 8 percent of the EU nonbank
SD's total risk exposure amount, which is calculated as a sum of the
firm's risk-weighted assets and exposures.\96\ Common equity tier 1
capital must comprise a minimum of 4.5 percent of the 8 percent capital
ratio,\97\ and tier 1 capital (which is the aggregate of common equity
tier 1 capital and additional tier 1 capital) must comprise a minimum
of 6 percent of the total 8 percent capital ratio.\98\ Tier 2 capital
may comprise a maximum of 2 percent of the total 8 percent capital
ratio.\99\
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\96\ CRR, Articles 26, 28, 50-52, 61-63 and 92.
\97\ Id., Article 92(1)(a).
\98\ Id., Article 92(1)(b).
\99\ Id., Article 92(1)(c), which provides that the total
capital ratio must be equal to or greater than 8 percent, with a
minimum common equity and additional tier 1 capital comprising at
least 6 percent of the 8 percent minimum requirement. In addition to
the requirement to maintain minimum capital ratios, an EU nonbank SD
will not be authorized as a credit institution by its competent
authorities unless it maintains at least EUR 5 million of common
equity tier 1 capital. CRD, Article 12.
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Under the EU Capital Rules, common equity tier 1 capital is
composed of common equity capital instruments, retained earnings,
accumulated other comprehensive income, and other reserves of the EU
nonbank SD.\100\ Additional tier 1 capital is composed of capital
instruments other than common equity and retained earnings (i.e.,
common equity tier 1 capital), and includes certain long-term
convertible debt securities.\101\ Tier 2 capital instruments, which
provide an additional layer of supplementary capital, include other
reserves, hybrid capital instruments, and certain subordinated
debt.\102\
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\100\ CRR, Articles 26 and 28. Retained earnings, accumulated
other comprehensive income and other reserves qualify as common
equity tier 1 capital only where the funds are available to the EU
nonbank SD for unrestricted and immediate use to cover risks or
losses as such risks or losses occur. See CRR, Article 26(1).
\101\ Id., Articles 50-52.
\102\ Id., Articles 62-63.
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To qualify as tier 2 regulatory capital, capital instruments and
subordinated debt must meet certain conditions including that: (i) the
capital instruments are issued by the EU nonbank SD and are fully paid-
up; (ii) the capital instruments are not purchased by the EU nonbank SD
or its subsidiaries; (iii) the claims on the principal amount of the
capital instruments rank below any claim from instruments that are
``eligible liabilities,'' \103\ meaning that they are effectively
subordinated to claims of all non-subordinated creditors of the EU
nonbank SD; (iv) the capital instruments have an original maturity of
at least five years; and (v) the provisions governing the capital
instruments do not include any incentive for the principal amount to be
redeemed or repaid by the EU nonbank SD prior to the capital
instruments' respective maturities.\104\
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\103\ ``Eligible liabilities'' are non-capital instruments,
including instruments that are directly issued by the EU nonbank SD
and fully paid up with remaining maturities of at least a year. CRR,
Articles 72a and 72b. In addition, the liabilities cannot be owned,
secured, or guaranteed, by the EU nonbank SD itself, and the EU
nonbank SD cannot have either directly or indirectly funded their
purchase. CRR, Article 72b.
\104\ Id., Article 63 (listing the conditions that capital
instruments must meet to qualify as tier 2 instruments) and Articles
72a-72b (listing the conditions that liabilities must meet to
qualify as eligible liabilities). See also infra note 123.
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In addition to the requirement to maintain total regulatory capital
in an amount equal to or in excess of 8 percent of its risk-weighted
assets, the EU Capital Rules also require an EU nonbank SD to maintain
a capital conservation buffer composed exclusively of common equity
tier 1 capital in an amount equal to 2.5 percent of the firm's total
risk-weighted assets.\105\ The common equity tier 1 capital used to
meet the 2.5 percent capital conservation buffer must be separate and
independent of the 4.5 percent of common equity tier 1 capital used to
meet the 8 percent core capital requirement.\106\
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\105\ CRD, Articles 129. CRD, Article 129(1) directs EU Member
States to impose a capital conservation buffer on certain
institutions, including the four EU nonbank SDs that are currently
registered with the Commission, that requires each institution to
maintain a capital conservation buffer of common equity tier 1
capital equal to 2.5 percent of the institution's total risk
exposure amount. CRD, Article 129(1) was transposed into French law
by Article L.511-41-1-A of the French MFC and Article 2 of
Ministerial Order on Capital Buffers and was transposed into German
law by Section 10c(1) of KWG.
\106\ Id. In effect, the EU Capital Rules require an EU nonbank
SD to hold common equity tier 1 capital equal to or in excess of 7
percent of the firm's risk-weighted assets, and total capital equal
to or in excess of 10.5 percent of the firm's risk-weighted assets.
In addition, an EU nonbank SD may also be subject to: (i) an
institution-specific capital countercyclical buffer, if the EU
Member States in which the EU nonbank SD has exposures have
implemented a capital countercyclical buffer; (ii) a global
systemically important institution (``G-SII'') or other systemically
important institution (``O-SII'') buffer, if the EU nonbank SD has
been designated as a G-SII or O-SII; and (iii) a systemic risk
buffer if the EU Member State in which the EU nonbank SD is
domiciled, or at least one EU Member State in which the EU nonbank
SD has exposures, has implemented a systemic risk buffer. See CRD,
Articles 130, 131 and 133. To meet these additional capital buffer
requirements, the EU nonbank SD must maintain a level of common
equity tier 1 capital that is in addition to the common equity tier
1 capital required to meet its core capital requirement of 4.5
percent of its risk-weighted assets and the common equity tier 1
capital required to meet its capital conservation buffer. See CRR,
Article 92(1) and CRD, Article 130(5). The total amount of common
equity tier 1 capital required to meet all applicable capital buffer
requirements is referred to as the ``combined buffer requirement.''
CRD, Article 128. In practice, several EU Member States, including
France and Germany, have implemented countercyclical capital buffers
with rates ranging from 0.5 percent to 2.5 percent of risk-weighted
assets and several EU Member States, including Germany, have
implemented systemic risk buffers with rates ranging from 0.5 to 9
percent of risk-weighted assets, varying across subsets of
exposures. Germany's systemic risk buffer applies only with respect
to exposures secured by residential property. In addition, as of
January 2023, none of the four EU nonbank SDs registered with the
Commission has been designated as G-SII and only one entity,
Citigroup Global Markets Europe AG has been designated as an O-SII
and subject to a 0.25 percent additional capital requirement.
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[[Page 41783]]
The EU Capital Rules further impose a 3 percent leverage ratio
floor on EU nonbank SDs as an additional element of the capital
requirements.\107\ Specifically, each EU nonbank SD is required to
maintain tier 1 capital (i.e., an aggregate of common equity tier 1
capital and additional tier 1 capital) equal to or in excess of 3
percent of the firm's total on-balance sheet and off-balance sheet
exposures, including exposures on uncleared swaps, without regard to
any risk-weighting.\108\ The leverage ratio is a non-risk based minimum
capital requirement that is intended to prevent an EU nonbank SD from
engaging in excessive leverage, and complements the risk-based minimum
capital requirement that is based on the EU nonbank SD's risk-weighted
assets.
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\107\ CRR, Article 92(1).
\108\ Total exposures are required to be computed in accordance
with CRR, Article 429.
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As noted above, the amount of regulatory capital that an EU nonbank
SD is required to hold is determined by calculating the firm's total
risk exposure, which requires the EU nonbank SD to risk-weight its on-
balance sheet and off-balance sheet assets and exposures using
specified standardized weights or, if approved for use by competent
authorities, internal model-based methodologies.\109\ Risk-weighting
assets and exposures involves adjusting the notional or carrying value
of each asset and risk exposure based on the inherent risk of the asset
or exposure. Less risky assets and exposures are adjusted to lower
values (i.e., have less weight) than more risky assets or exposures. As
a result, EU nonbank SDs are required to hold lower levels of
regulatory capital for less risky assets and exposures and higher
levels of regulatory capital for riskier assets and exposures. The
categories of risk charges that an EU nonbank SD must include in
determining its total risk exposure include charges reflecting: (i)
market risk; (ii) credit risk; (iii) settlement risk; (iv) CVA risk of
OTC derivative instruments; and (v) operational risk.\110\ The methods
for calculating such risk charges are based on the BCBS framework.\111\
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\109\ With regulator permission, EU nonbank SDs may use internal
models to calculate credit risk (CRR, Article 143), including
certain counterparty credit risk exposures (CRR, Article 283),
operational risk (CRR, Article 312(2)), market risk (CRR, Article
363), and credit valuation adjustment risk (``CVA risk'') of over-
the-counter (``OTC'') derivatives instruments (CRR, Article 383).
The permission to use, and continue using, internal models is
subject to strict criteria and supervisory oversight by the
competent authorities.
\110\ CRR, Article 92(3).
\111\ EU Application, pp. 10-11.
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Standardized market risk charges are generally calculated by
multiplying the notional or carrying amount of net positions or of
adjusted net positions by risk-weighting factors, which are based on
the underlying market risk of each asset or exposure. The sum of the
calculated amounts comprises the portion of the risk exposure amount
attributable to market risk.\112\ Standardized credit risk charges are
generally calculated by multiplying the notional or carrying value of
the EU nonbank SD's on-balance sheet and off-balance sheet assets and
exposures by clearly defined risk-weighting factors, which are based on
the underlying credit risk of each asset or exposure. The sum of the
calculated amounts comprises the portion of the risk exposure amount
attributable to credit risk.\113\
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\112\ CRR, Articles 326-350.
\113\ Id., Articles 111-134.
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Settlement risk charges are intended to account for the price
difference to which an EU nonbank SD is exposed if its transactions
remain unsettled after the respective transaction's due delivery
date.\114\ CVA risk charges reflect the current market value of the
credit risk of the counterparty to the EU nonbank SD in an OTC
derivatives transaction.\115\ Operational risk charges reflect the risk
of loss resulting from inadequate or failed internal processes, people
and systems or from external events, and includes legal risk.\116\
---------------------------------------------------------------------------
\114\ Id., Article 378.
\115\ Id., Article 381.
\116\ Id., Article 4(1)(52).
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As noted above, EU nonbank SDs may use internal model-based
methodologies to calculate certain categories of risk charges in lieu
of standardized charges if they have obtained the requisite regulatory
approval.\117\ EU Capital Rules set out quantitative and qualitative
requirements that internal models must meet in order to obtain and
maintain approval.\118\ Quantitative and qualitative requirements
address, among other issues, governance, validation, monitoring, and
review. Modeled risk charges generally require the estimation of
potential losses, with a certain degree of likelihood, within a
specified time period, of a portfolio of assets.\119\ Internal models
allow for consideration of potential co-movement of prices across
assets in the portfolio, leading to offsets of gains and losses. Credit
risk models can also further include estimation of the likelihood of
default of counterparties.
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\117\ Id., Articles 143 (credit risk), 283 (counterparty credit
risk); 312(2) (operational risk), 363 (market risk), and 383 (CVA
risk).
\118\ See e.g., CRR, Articles 144, 283(2); 321-322 and 365-369.
\119\ The EU Capital Rules require EU nonbank SDs with internal
model approval for market risk to use a VaR model with a 99 percent,
one-tailed confidence interval with: (i) price change equivalent to
10 business-day movement in rates and prices; (ii) effective
historical observation periods of at least one year; and (iii) at
least monthly data set updates. See CRR, Article 365(1). EU nonbank
SDs approved to use internal ratings-based credit risk models must
support the assessment of credit risk, the assignment of exposures
to rating grades or pools, and the quantification of default and
loss estimates that have been developed for a certain type of
exposures, among other conditions. See CRR, Articles 142-144. In
addition, when EU nonbank SDs are approved to use a model to
calculate counterparty credit risk exposures for OTC derivatives
transactions, the model must specify the forecasting distribution
for changes in the market value of a netting set attributable to
joint changes in relevant market variables and calculate the
exposure value for the netting set at each of the future dates on
the basis of the joint changes in the market variables. See CRR,
Article 284. EU nonbank SDs allowed to follow the ``advanced
method'' of calculating CVA risk charges for OTC derivatives
transactions must also use an internal market risk model to simulate
changes in the credit spreads of counterparties, applying a 99
percent confidence interval and a 10-day equivalent holding period.
See CRR, Article 383. Finally, EU nonbank SDs using ``advanced
measurement approaches'' based on their own measurement systems to
compute operational risk exposures must calculate capital
requirements as comprising both expected loss and unexpected loss
and capture potentially severe tail events, achieving a sound
standard comparable to a 99.9 confidence interval over a one-year
period. See CRR, Article 322.
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Furthermore, the EU Capital Rules also impose separate requirements
on an EU nonbank SD to address liquidity risk. The liquidity
requirements are composed of three main obligations. First, an EU
nonbank SD is required to hold an amount of sufficiently liquid assets
to meet the firm's expected payment obligations under stressed
conditions for 30 days.\120\ Second, an EU nonbank SD is subject to a
stable funding requirement whereby the firm must hold a diversity of
stable funding instruments \121\ sufficient to meet long-term
obligations under both normal and stressed conditions.\122\ Third, to
ensure that an EU nonbank SD continues to meet its liquidity
requirements, the firm is required to maintain robust strategies,
policies, processes, and system for the
[[Page 41784]]
identification of liquidity risk over an appropriate set of time
horizons, including intra-day.\123\ The EU Capital Rules' liquidity
requirements are intended to help ensure that EU nonbank SDs can
continue to fund their operations over various time horizons, including
the timely making of payments to customers and counterparties.
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\120\ CRR, Article 412(1). Liquid assets primarily include cash,
exposures to central banks, government-backed assets and other
highly liquid assets with high credit quality. Id. Article 416(1).
\121\ Stable funding instruments include common equity tier 1
capital instruments, additional tier 1 capital instruments, tier 2
capital instruments, and other preferred shares and capital
instruments in excess of the tier 2 allowable amount with an
effective maturity of one year or greater. CRR, Article 427(1).
\122\ CRR, Article 413(1).
\123\ CRD, Article 86 provides that EU Member States' competent
authorities must ensure that institutions, including EU nonbank SDs,
have robust strategies, policies, processes and systems for the
identification, measurement, management and monitoring of liquidity
risk over an appropriate set of time horizons, including intra-day,
so as to ensure that entities maintain adequate levels of liquidity
buffers. The strategies, policies, processes, and systems must be
tailored to business lines, currencies, branches, and legal entities
and must include adequate allocation mechanisms of liquidity costs,
benefits and risks.
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In addition, resolution authorities \124\ in EU Member States may
require that EU nonbank SDs satisfy an institution-specific MREL
pursuant to provisions transposing BRRD.\125\ The MREL requirement is
separate from the minimum capital requirements imposed on EU nonbank
SDs under CRR and CRD and is designed to ensure that credit
institutions and investment firms, including the EU nonbank SDs subject
to the requirement,\126\ maintain at all times sufficient eligible
instruments to facilitate the implementation of the preferred
resolution strategy.\127\ Specifically, the MREL is intended to permit
loss absorption, where appropriate, such that the EU nonbank SD's
capital and leverage ratios could be restored to the level necessary
for compliance with its capital requirements.\128\ The MREL is set by
the relevant resolution authority and is expressed as two ratios that
have to be met in parallel: (i) a percentage of the entity's total risk
exposure amount, and (ii) a percentage of the entity's total leverage
ratio exposure measure.\129\ The MREL amount varies depending on the
entity's size, funding model, and risk profile, among other
considerations.\130\
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\124\ In application of BRRD, Article 3, EU Member States
designate resolution authorities that are empowered to apply the
resolution tools and exercise the resolution powers described in
BRRD. EU Member States may provide that the resolution authority is
the competent authority for supervision for the purposes of CRR and
CRD, provided an operational independence exists between the
resolution functions and the supervisory or other functions of the
relevant authority. BRRD, Article 3(3).
\125\ BRRD, Articles 45, 45a to 45h; French MFC, Article L.613-
44; and German SAG, Sections 49(1) and (2). Eligible liabilities
include, among others items, instruments that are directly issued by
the EU nonbank SD and fully paid up with remaining maturities of at
least a year. CRR, Articles 72a and 72b. In addition, the
liabilities cannot be owned, secured or guaranteed, by the EU
nonbank SD itself, and the EU nonbank SD cannot have either directly
or indirectly funded its purchase. CRR, Article 72b. The inclusion
of derivatives is possible if certain requirements are met. BRRD,
Article 45b(2); French MFC, Article R. 613-46-1; German SAG, Section
49b.
\126\ Of the four EU nonbank SDs currently registered with the
Commission, two--Citigroup Global Markets Europe AG and and Morgan
Stanley Europe SE--are subject to MREL. See Responses to Staff
Questions of May 15, 2023.
\127\ BRRD, Article 45c. See also Single Resolution Board,
Minimum Requirement for Own Funds and Eligible Liabilities (MREL),
June 2022 (``SRB MREL Policy 2022''), at 5, available at: https://www.srb.europa.eu/system/files/media/document/2022-06-08_MREL_clean.pdf.
\128\ BRRD, Article 45c.
\129\ BRRD, Articles 45 and 45c. Pursuant to BRRD, Article 45,
the total risk exposure amount is calculated in accordance with CRR,
Article 92(3) and the total leverage ratio exposure measure is
calculated in accordance with CRR, Articles 429 and 429a.
\130\ BRRD, Article 45c(1)(d).
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Furthermore, CRR imposes an additional supplemental standard of
total loss absorbing capacity (``TLAC'') for G-SII entities \131\
identified as resolution entities \132\ and requires such entities to
maintain a risk-based capital and eligible liabilities ratio of 18
percent of the entity's total risk exposure amount and a non-risk-based
capital and eligible liabilities ratio of 6.75 percent of the firm's
total leverage ratio exposure measure.\133\ In addition, CRR requires
that ``material subsidiaries'' of non-EU G-SIIs, including subsidiaries
of U.S. GSIBs, that are not resolution entities maintain MREL equal to
90 percent of the foregoing as applied to their parent entity at all
times.\134\
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\131\ ``G-SII entity'' is defined in CRR, Article 4(1)(136) as
entity that is a G-SII or is part of a G-SII or of a non-EU G-SII.
Although none of the EU nonbank SDs that are currently registered
with the Commission has been designated as a G-SII in France or
Germany as of January 2023, all four EU nonbank SDs are subsidiaries
of a U.S. global systemically important bank (``GSIB'') and
therefore considered a G-SII entity.
\132\ ``Resolution entity'' is defined in general terms to mean
a legal entity established in the EU, which has been identified by
the resolution authority as an entity in respect of which the
resolution plan provides for a resolution action. BRRD, Article
1(1)(83a). None of the four EU nonbank SDs is currently designated
as a resolution entity as of March 30, 2023. See Responses to Staff
Questions of May 15, 2023. As such, the EU nonbank SDs currently
registered with the Commission are not subject to a TLAC
requirement.
\133\ CRR, Article 92a(1). As indicated in CRR, Article 92a(1),
the total risk exposure amount is calculated in accordance with CRR,
Articles 92(3) and 92(4) and the total leverage ratio exposure
measure is calculated in accordance with CRR, Article 429(4).
\134\ Id., Article 92b(1). An EU nonbank SD may become subject
to the requirement of CRR, Article 92b should it become a ``material
subsidiary'' of non-EU G-SII. The term ``material subsidiary'' is
defined as a subsidiary that on an individual or consolidated basis
meets any of the following conditions: (i) the subsidiary holds more
than 5 percent of the consolidated risk-weighted assets of the
parent entity; (ii) the subsidiary generates more than 5 percent of
the total operating income of the parent entity; or (iii) the total
exposure measure (i.e., the total on-balance sheet and off-balance
sheet exposures) of the subsidiary is more than 5 percent of the
consolidated total exposure measure of the parent entity. See CRR,
Article 4(135) (defining the term ``material subsidiary'') and
Article 429 (setting forth the method for calculating the total
exposure measure). None of the EU nonbank SDs registered with the
Commission is currently considered a ``material subsidiary'' of a
non-EU G-SII and, therefore, subject to the 90 percent of MREL
requirement.
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III. Commission Analysis of the Comparability of the EU Capital Rules
and EU Financial Reporting Rules With CFTC Capital Rules and CFTC
Financial Reporting Rules
The following section provides a description and comparative
analysis of the regulatory requirements of the EU Capital Rules and EU
Financial Reporting Rules to the CFTC Capital Rules and CFTC Financial
Reporting Rules. Immediately following a description of the
requirement(s) of the CFTC Capital Rules or the CFTC Financial
Reporting Rules for which a comparability determination was requested
by the Applicants, the Commission provides a description of the EU's
corresponding laws, regulations, or rules. The Commission then provides
a comparative analysis of the EU Capital Rules or the EU Financial
Reporting Rules with the corresponding CFTC Capital Rules or CFTC
Financial Reporting Rules and identifies any material differences
between the respective rules.
The Commission performed this proposed Capital Comparability
Determination by assessing the comparability of the EU Capital Rules
for EU nonbank SDs as set forth in the EU Application with the
Commission's Bank-Based Approach. For clarity, the Commission did not
assess the comparability of the EU Capital Rules to the Commission's
TNW Approach or NLA Approach as the Commission understands that the EU
nonbank SDs, as of the date of the EU Application, are subject to the
current bank-based capital approach of the EU Capital Rules. In
addition, as noted in Section I.C. above, the Applicants did not
include the capital framework and requirements imposed on small
investment firms under the IFR and IFD as part of the EU Application,
and the Commission did not assess the comparability of the IFR and IFD
capital requirements with the CFTC Capital Rules. Accordingly, when the
Commission makes a preliminary determination herein regarding the
comparability of the EU Capital Rules with the CFTC Capital Rules, the
determination pertains to the comparability of the EU Capital Rules as
imposed under CRR and CRD with the
[[Page 41785]]
Bank-Based Approach under the CFTC Capital Rules.
As described below, it is proposed that any material changes to the
EU Capital Rules will require notification to the Commission.
Therefore, if there are subsequent material changes to the EU Capital
Rules to include, for example, another capital approach, the Commission
will review and assess the impact of such changes on the Capital
Comparability Determination Order as it is then in effect, and may
amend or supplement the Order.\135\
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\135\ The Commission also may amend or supplement the Capital
Comparability Determination Order to address any material changes to
the CFTC Capital Rules and CFTC Financial Reporting Rules that are
adopted after a final Order is issued.
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In addition, although the BCBS bank capital standards establish
minimum capital standards that are consistent with the requirements of
the Commission's Bank-Based Approach, the Commission notes that
consistency with the international standards is not determinative of a
finding of comparability with the CFTC Capital Rules. In the
Commission's view, a foreign jurisdiction's consistency with the BCBS
international bank capital standards is an element in the Commission's
comparability assessment, but, in and of itself, it may not be
sufficient to demonstrate comparability with the CFTC Capital Rules
without an assessment of the individual elements of the foreign
jurisdiction's capital framework.
Capital and financial reporting regimes are complex structures
comprised of a number of interrelated regulatory components.
Differences in how jurisdictions approach and implement these regimes
are expected, even among jurisdictions that base their requirements on
the principles and standards set forth in the BCBS international bank
capital framework. Therefore, the Commission's comparability
determination involves a detailed assessment of the relevant
requirements of the foreign jurisdiction and whether those
requirements, viewed in the aggregate, lead to an outcome that is
comparable to the outcome of the CFTC's corresponding requirements.
Consistent with this approach, the Commission has grouped the CFTC
Capital Rules and CFTC Financial Reporting Rules into the key
categories that focus the analysis on whether the EU capital and
financial reporting requirements are comparable to the Commission's SD
requirements in purpose and effect, and not whether the EU requirements
meet every aspect or contain identical elements as the Commission's
requirements.
Specifically, as discussed in detail below, the Commission used the
following key categories in its review: (i) the quality of the equity
and debt instruments that qualify as regulatory capital, and the extent
to which the regulatory capital represents committed and permanent
capital that would be available to absorb unexpected losses or
counterparty defaults; (ii) the process of establishing minimum capital
requirements for an EU nonbank SD and how such process addresses market
risk and credit risk of the firm's on-balance sheet and off-balance
sheet exposures; (iii) the financial reports and other financial
information submitted by an EU nonbank SD to its relevant regulatory
authorities to effectively monitor the financial condition of the firm;
and (iv) the regulatory notices and other communications between the EU
nonbank SD and its relevant regulatory authorities that detail
potential adverse financial or operational issues that may impact the
firm. The Commission also reviewed the manner in which compliance by an
EU nonbank SD with the EU Capital Rules and EU Financial Reporting
rules is monitored and enforced. The Commission invites public comment
on all aspects of the EU Application and on the Commission's proposed
Capital Comparability Determination discussed below.
A. Regulatory Objectives of CFTC Capital Rules and CFTC Financial
Reporting Rules and EU Capital Rules and EU Financial Reporting Rules
1. Regulatory Objectives of CFTC Capital Rules and CFTC Financial
Reporting Rules
The regulatory objectives of the CFTC Capital Rules and the CFTC
Financial Reporting Rules are to further the Congressional mandate to
ensure the safety and soundness of nonbank SDs to mitigate the greater
risk to nonbank SDs and the financial system arising from the use of
swaps that are not cleared.\136\ A primary function of the nonbank SD's
capital is to protect the solvency of the firm from decreases in the
value of firm assets, increases in the value of firm liabilities, and
from losses, including losses resulting from counterparty defaults and
margin collateral failures, by requiring the firm to maintain an
appropriate level of quality capital, including qualifying subordinated
debt, to absorb such losses without becoming insolvent. With respect to
swap positions, capital and margin perform complementary risk
mitigation functions by protecting nonbank SDs, containing the amount
of risk in the financial system as a whole, and reducing the potential
for contagion arising from uncleared swaps.
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\136\ See 7 U.S.C. 6s(e)(3)(A).
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The objective of the CFTC Financial Reporting Rules is to provide
the Commission with the means to monitor and assess a nonbank SD's
financial condition, including the nonbank SD's compliance with minimum
capital requirements. The CFTC Financial Reporting Rules are designed
to provide the Commission and NFA, which, along with the Commission,
oversees nonbank SDs' compliance with Commission regulations, with a
comprehensive view of the financial health and activities of the
nonbank SD. The Commission's rules require nonbank SDs to file
financial information, including periodic unaudited and annual audited
financial statements, specific financial position information, and
notices of certain events that may indicate a potential financial or
operational issue that may adversely impact the nonbank SD's ability to
meet its obligations to counterparties and other creditors in the swaps
market, or impact the firm's solvency.\137\
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\137\ See 17 CFR 23.105.
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2. Regulatory Objective of EU Capital Rules and EU Financial Reporting
Rules
The regulatory objective of the EU Capital Rules is to ensure the
safety and soundness of EU financial institutions, including EU nonbank
SDs.\138\ The EU Capital Rules are designed to preserve the financial
stability and solvency of an EU nonbank SD by requiring the firm to
maintain a sufficient amount of qualifying equity capital and
subordinated debt based on the EU nonbank SD's activities to absorb
decreases in the value of firm assets, increases in the value of firm
liabilities, and to cover losses from business activities, including
possible counterparty defaults and margin collateral shortfalls
associated with the firm's swap dealing activities.\139\ The EU Capital
Rules are also designed to ensure that the EU nonbank SDs have
sufficient liquidity to meet their financial obligations to
counterparties and other creditors in a distress scenario by requiring
each firm to hold an amount of sufficiently liquid assets to meet
expected payment obligations under stressed conditions for 30 days
\140\
[[Page 41786]]
and to hold a diversity of stable funding instruments sufficient to
meet long-term obligations under both normal and stressed
conditions.\141\
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\138\ EU Application, pp. 5-6.
\139\ Id.
\140\ CRR, Article 412(1). Liquid assets primarily include cash,
exposures to central banks, government-backed assets and other
highly liquid assets with high credit quality. CRR, Article 416(1).
\141\ Stable funding instruments include common equity tier 1
capital instruments, additional tier 1 capital instruments, tier 2
capital instruments, and other preferred shares and capital
instruments in excess of the tier 2 allowable amount with an
effective maturity of one year or greater. CRR, Article 427(1).
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With respect to financial reporting, the objective of the EU
Financial Reporting Rules is to enable the applicable supervisory
authorities to assess the financial condition and safety and soundness
of EU nonbank SDs. The EU Financial Reporting Rules aim to achieve this
objective by requiring an EU nonbank SD to provide financial reports
and other financial position and capital information to the applicable
supervisory authorities on a regular basis.\142\ The financial
reporting by an EU nonbank SD provides the supervisory authorities with
information necessary to effectively monitor the EU nonbank SD's
overall financial condition and its ability to meet its regulatory
obligations as a nonbank SD.
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\142\ CRR, Article 430.
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3. Commission Analysis
The Commission has reviewed the EU Application and the relevant EU
laws and regulations, and has preliminarily determined that the overall
objectives of the EU Capital Rules and CFTC Capital Rules are
comparable in that both sets of rules are intended to ensure the safety
and soundness of nonbank SDs by establishing a regulatory regime that
requires nonbank SDs to maintain a sufficient amount of qualifying
regulatory capital to absorb losses, including losses from swaps and
other trading activities, and to absorb decreases in the value of firm
assets and increases in the value of firm liabilities without the
nonbank SDs becoming insolvent. The EU Capital Rules and CFTC Capital
Rules are also based on, and consistent with, the BCBS international
bank capital framework, which is designed to ensure that banking
entities hold sufficient levels of capital to absorb losses and
decreases in the value of assets without the banks becoming insolvent.
The Commission further preliminarily believes that the EU Financial
Reporting Rules have comparable objectives with the CFTC Financial
Reporting Rules as both sets of rules require nonbank SDs to file and/
or publish, as applicable, periodic financial reports, including
unaudited financial reports and an annual audited financial report,
detailing their financial operations and demonstrating their compliance
with minimum capital requirements, with the goal of providing the EU
supervisory authorities and the CFTC staff with information necessary
to comprehensively assess the financial condition of a nonbank SD on an
ongoing basis. In addition, to achieve this objective, the financial
reports further provide the CFTC and EU authorities with information
regarding potential changes in a nonbank SD's risk profile by
disclosing changes in account balances reported over a period of time.
Such changes in account balances may indicate that the nonbank SD has
entered into new lines of business, has increased its activity in an
existing line of business relative to other activities, or has
terminated a previous line of business.
The prompt and effective monitoring of the financial condition of
nonbank SDs through the receipt and review of periodic financial
reports supports the Commission and EU supervisory authorities in
meeting their respective objectives of ensuring the safety and
soundness of nonbank SDs. In connection with these objectives, the
early identification of potential financial issues provides the
Commission and EU supervisory authorities with an opportunity to
address such issues with the nonbank SD before the issues develop to a
state where the financial condition of the firm is impaired such that
it may no longer hold a sufficient amount of qualifying regulatory
capital to absorb decreases in the value of firm assets or increases in
the value of firm liabilities, or to cover losses from the firm's
business activities, including the firm's swap dealing activities and
obligations to swap counterparties.
The Commission invites public comment on its analysis above,
including comment on the EU Application and relevant EU laws and
regulations.
B. Nonbank Swap Dealer Qualifying Capital
1. CFTC Capital Rules: Qualifying Capital Under Bank-Based Approach
The CFTC Capital Rules require a nonbank SD electing the Bank-Based
Approach to maintain regulatory capital in the form of common equity
tier 1 capital, additional tier 1 capital, and tier 2 capital in
amounts that meet certain stated minimum requirements set forth in
Commission Regulation 23.101.\143\ Common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital are composed of certain
defined forms of equity of the nonbank SD, including common stock,
retained earnings, and qualifying subordinated debt.\144\ The
Commission's requirement for a nonbank SD to maintain a minimum amount
of defined qualifying capital and subordinated debt is intended to
ensure that the firm maintains a sufficient amount of regulatory
capital to absorb decreases in the value of the firm's assets and
increases in the value of the firm's liabilities, and to cover losses
resulting from the firm's swap dealing and other activities, including
possible counterparty defaults and margin collateral shortfalls,
without the firm becoming insolvent.
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\143\ See 17 CFR 23.101(a)(1)(i).
\144\ The terms ``common equity tier 1 capital,'' ``additional
tier 1 capital,'' and ``tier 2 capital'' are defined in the bank
holding company regulations of the Federal Reserve Board. See 12 CFR
217.20.
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Common equity tier 1 capital is generally composed of an entity's
common stock instruments and any related surpluses, retained earnings,
and accumulated other comprehensive income, and is a more conservative
or permanent form of capital than additional tier 1 and tier 2
capital.\145\ Additional tier 1 capital is generally composed of equity
instruments such as preferred stock and certain hybrid securities that
may be converted to common stock if triggering events occur.\146\ Total
tier 1 capital is composed of common equity tier 1 capital and further
includes additional tier 1 capital.\147\ Tier 2 capital includes
certain types of instruments that include both debt and equity
characteristics such as qualifying subordinated debt.\148\
---------------------------------------------------------------------------
\145\ 12 CFR 217.20.
\146\ Id.
\147\ Id.
\148\ Id.
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Subordinated debt must meet certain conditions to qualify as tier 2
capital under the CFTC Capital Rules. Specifically, subordinated debt
instruments must have a term of at least one year (with the exception
of approved revolving subordinated debt agreements which may have a
maturity term that is less than one year), and contain terms that
effectively subordinate the rights of lenders to receive any payments,
including accrued interest, to other creditors of the firm.\149\
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\149\ The subordinated debt must meet the requirements set forth
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR
23.101(a)(1)(i)(B) (providing that the subordinated debt used by a
nonbank SD to meet its minimum capital requirement under the Bank-
Based Approach must satisfy the conditions for subordinated debt
under SEC Rule 18a-1d).
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[[Page 41787]]
Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are permitted to be included in a nonbank SD's regulatory
capital and used to meet the firm's minimum capital requirement due to
their characteristics of being permanent forms of capital that are
subordinate to the claims of other creditors, which ensures that a
nonbank SD will have this regulatory capital to absorb decreases in the
value of the firm's assets and increases in the value of the firm's
liabilities, and to cover losses from business activities, including
swap dealing activities, without the firm becoming insolvent.
2. EU Capital Rules: Qualifying Capital
The EU Capital Rules require an EU nonbank SD to maintain an amount
of regulatory capital (i.e., equity capital and qualifying subordinated
debt) equal to or greater than 8 percent of the EU nonbank SD's total
risk exposure, which is calculated as the sum of the firm's: (i)
capital charges for market risk; (ii) risk-weighted exposure amounts
for credit risk; (iii) capital charges for settlement risk; (iv) CVA
risk of OTC derivatives instruments; and (v) capital charges for
operational risk.\150\ The EU Capital Rules limit the composition of
regulatory capital to common equity tier 1 capital, additional tier 1
capital, and tier 2 capital in a manner consistent with the BCBS bank
capital framework.\151\ In this regard, the EU Capital Rules provide
that an EU nonbank SD's regulatory capital may be composed of: (i)
common equity tier 1 capital instruments, which generally include the
EU nonbank SD's common equity, retained earnings, and accumulated other
comprehensive income; \152\ (ii) additional tier 1 capital instruments,
which include other forms of capital instruments and certain long-term
convertible debt instruments; \153\ and (iii) tier 2 capital
instruments, which includes other reserves, hybrid capital instruments,
and certain qualifying subordinated term debt.\154\
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\150\ CRR, Article 92.
\151\ Id.
\152\ CRR, Articles 26 and 28. Capital instruments that qualify
as common equity tier 1 capital under the EU Capital Rules include
instruments that: (i) are issued directly by the EU nonbank SD; (ii)
are paid in full and not funded directly or indirectly by the EU
nonbank SD; and (iii) are perpetual. In addition, the principal
amount of the instruments may not be reduced or repaid, except in
the liquidation of the EU nonbank SD or the repurchase of shares
pursuant to the permission of the appropriate regulatory authority.
\153\ Id., Articles 50-52. To qualify as additional tier 1
capital, the instruments must meet certain conditions including: (i)
the instruments are issued directly by the EU nonbank SD and paid in
full; (ii) the instruments are not owned by the EU nonbank SD or its
subsidiaries; (iii) the purchase of the instruments is not funded
directly or indirectly by the EU nonbank SD; (iv) the instruments
rank below tier 2 instruments in the event of the insolvency of the
EU nonbank SD; (v) the instruments are not secured or guaranteed by
the EU nonbank SD or an affiliate; (vi) the instruments are
perpetual and do not include an incentive for the EU nonbank SD to
redeem them; and (vii) distributions under the instruments are
pursuant to defined terms and may be cancelled under the full
discretion of the EU nonbank SD.
\154\ Id., Articles 62-63.
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Furthermore, subordinated debt instruments must meet certain
conditions to qualify as tier 2 regulatory capital under the EU Capital
Rules, including that the: (i) loans are not granted by the EU nonbank
SD or its subsidiaries; (ii) claims on the principal amount of the
subordinated loans under the provisions governing the subordinated loan
agreement rank below any claim from eligible liabilities instruments
(i.e., certain non-capital instruments), meaning that they are
effectively subordinated to claims of all non-subordinated creditors of
the EU nonbank SD; (iii) subordinated loans are not secured, or subject
to a guarantee that enhances the seniority of the claim, by the EU
nonbank SD, its subsidiaries, or affiliates; (iv) loans have an
original maturity of at least five years; and (v) provisions governing
the loans do not include any incentive for the principal amount to be
repaid by the EU nonbank SD prior to the loans' maturity.\155\
---------------------------------------------------------------------------
\155\ Id., Article 63.
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An EU nonbank SD must also maintain a capital conservation buffer
equal to 2.5 percent of the firm's total risk exposure in addition to
the requirement to maintain qualifying regulatory capital in excess of
8 percent of its total risk exposure.\156\ The 2.5 percent capital
conservation buffer must be met with common equity tier 1 capital.\157\
Common equity tier 1 capital, as noted above, is limited to the EU
nonbank SD's common equity, retained earnings, and accumulated other
comprehensive income, and represents a more permanent form of capital
than equity instruments that qualify as additional tier 1 capital and
tier 2 capital.
---------------------------------------------------------------------------
\156\ CRD, Article 129(1). In addition, an EU nonbank SD may
also be subject to a capital countercyclical buffer which requires
the EU nonbank SD to hold an additional amount of common equity tier
1 capital equal to its total risk-weighted assets multiplied by the
weighted average of the countercyclical buffer rates that apply in
all EU countries where the relevant exposures of the EU nonbank SD
are located. CRD, Articles 130 and 140. EU nonbank SDs may also be
subject to a G-SII or an O-SII buffer if they are of systemic
importance. CRD, Article 131. In practice, however, only one of the
EU nonbank SD registered with the Commission, Citigroup Global
Markets Europe AG, is subject to an O-SII buffer (of 0.25 percent)
as of January 2023 and none of the entities is subject to a G-SII
buffer. Finally, EU nonbank SDs may be subject to a systemic risk
buffer if the EU Member State in which they are domiciled or at
least one EU Member State in which they have exposures has
implemented a systemic risk buffer. CRD, Article 133. To meet the
additional buffer requirements, if applicable, an EU nonbank SD must
maintain a level of common equity tier 1 capital that is in addition
to the common equity tier 1 capital required to meet its core
capital requirement of 4.5 percent of its risk-weighted assets and
the common equity tier 1 capital required to meet its capital
conservation buffer. See CRD, Articles 130(1), 131(4), 131(5a) and
133(1). For EU Member States that have implemented capital
countercyclical buffer rates, the rate varies between 0.5 percent
and 2.5 percent of total risk exposure. See information about EU
Member States' countercyclical capital buffer rate available here:
https://www.esrb.europa.eu/national_policy/ccb/html/index.en.html.
\157\ CRD, Article 129(1).
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The EU Capital Rules also impose different ratios for the various
components of regulatory capital that are consistent with the BCBS bank
capital framework.\158\ In this regard, the EU Capital Rules provide
that an EU nonbank SD's minimum regulatory capital must satisfy the
following requirements: (i) common equity tier 1 capital ratio of 4.5
percent of the firm's total risk exposure amount; (ii) total tier 1
capital (i.e., common equity tier 1 capital plus additional tier 1
capital) ratio of 6 percent of the firm's total risk exposure amount;
and (iii) total capital (i.e., an aggregate amount of common equity
tier 1 capital, additional tier 1 capital, and tier 2 capital) ratio of
8 percent of the firm's total risk exposure amount. As noted above, an
EU nonbank SD must also maintain a capital conservation buffer of 2.5
percent of its total risk exposure amount that must be met with common
equity tier 1 capital.\159\ With the addition of the capital
conservation buffer, each EU nonbank SD is required to maintain minimum
regulatory capital that equals or exceeds 10.5 percent of the firm's
total risk exposure amount, with common equity tier 1 capital
comprising at least 7 percent of the 10.5 percent minimum regulatory
capital requirement.\160\
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\158\ CRR, Article 92(1).
\159\ CRD, Article 129(1).
\160\ The countercyclical capital buffer, the G-SII or O-SII
buffer, and the systemic risk buffer are not included in the
analysis given their varying implementation by EU Member States and
limited applicability to the EU nonbank SDs that are currently
registered with the Commission.
---------------------------------------------------------------------------
Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are permitted to be included in an EU nonbank SD's regulatory
capital and used to meet the firm's minimum capital requirement due to
their characteristics of being permanent forms of capital that are
subordinate to the claims of other creditors, which ensures
[[Page 41788]]
that an EU nonbank SD will have this regulatory capital to absorb
decreases in the value of the firm's assets and increases in the value
of the firm's liabilities, and to cover losses from business
activities, including swap dealing activities, without the firm
becoming insolvent.
3. Commission Analysis
The Commission has reviewed the EU Application and the relevant EU
laws and regulations, and has preliminarily determined that the EU
Capital Rules are comparable in purpose and effect to the CFTC Capital
Rules with regard to the types and characteristics of a nonbank SD's
equity that qualifies as regulatory capital in meeting its minimum
requirements. The EU Capital Rules and the CFTC Capital Rules for
nonbank SDs both require a nonbank SD to maintain a quantity of high-
quality capital and permanent capital, all defined in a manner that is
consistent with the BCBS international bank capital framework, that
based on the firm's activities and on-balance sheet and off-balance
sheet exposures, is sufficient to absorb losses and decreases in the
value of the firm's assets and increases in the value of the firm's
liabilities without resulting in the firm becoming insolvent.
Specifically, equity instruments that qualify as common equity tier 1
capital and additional tier 1 capital under the EU Capital Rules and
the CFTC Capital Rules have similar characteristics (e.g., the equity
must be in the form of high-quality, committed and permanent capital)
and the equity instruments generally have no priority in distribution
of firm assets or income with respect to other shareholders or
creditors of the firm, which makes the equity available to a nonbank SD
to absorb unexpected losses, including counterparty defaults.\161\
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\161\ Compare 12 CFR 217.20(b) (defining capital instruments
that qualify as common equity tier 1 capital under the rules of the
Federal Reserve Board) and 12 CFR 217.20(c) (defining capital
instruments that qualify as additional tier 1 capital under the
rules of the Federal Reserve Board) with CRR, Articles 26 and 28
(defining items and capital instruments that qualify as common
equity tier 1 capital under the EU Capital Rules) and CRR, Article
52 (defining capital instruments that qualify as additional tier 1
capital under the EU Capital Rules).
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In addition, the Commission has preliminarily determined that the
conditions imposed on subordinated debt instruments under the EU
Capital Rules and the CFTC Capital Rules are comparable and are
designed to ensure that the subordinated debt has qualities that
support its recognition by a nonbank SD as equity for regulatory
capital purposes. Specifically, in both sets of rules, the conditions
include a requirement that the debt holders have effectively
subordinated their claims for repayment of the debt to the claims of
other creditors of the nonbank SD.\162\
---------------------------------------------------------------------------
\162\ Compare 17 CFR 240.18a-1d with CRR, Article 63(d).
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Having reviewed the EU Application and the relevant EU laws and
regulations, the Commission has made a preliminary determination that
the EU Capital Rules and CFTC Capital Rules impose comparable
requirements on EU nonbank SDs with respect to the types and
characteristics of equity capital that must be used to meet minimum
regulatory capital requirements. The Commission invites public comment
on its analysis above, including comment on the EU Application and
relevant EU laws and regulations.
C. Nonbank Swap Dealer Minimum Capital Requirement
1. CFTC Capital Rules: Nonbank SD Minimum Capital Requirement
The CFTC Capital Rules require a nonbank SD electing the Bank-Based
Approach to maintain regulatory capital that satisfies each of the
following criteria: (i) an amount of common equity tier 1 capital of at
least $20 million; (ii) an aggregate of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital in an amount equal to or
in excess of 8 percent of the nonbank SD's uncleared swap margin
amount; (iii) an aggregate amount of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital equal to or greater than
8 percent of the nonbank SD's total risk-weighted assets, provided that
common equity tier 1 capital comprises at least 6.5 percent of the 8
percent; and (iv) the amount of capital required by the NFA.\163\
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\163\ See 17 CFR 23.101(a)(1)(i). NFA has adopted the CFTC
minimum capital requirements for nonbank SDs, but has not adopted
additional capital requirements at this time.
---------------------------------------------------------------------------
Prong (i) above requires each nonbank SD electing the Bank-Based
Approach to maintain a minimum of $20 million of common equity tier 1
capital to operate as a nonbank SD. The requirement that each nonbank
SD electing the CFTC Bank-Based Approach maintain a minimum of $20
million of common equity tier 1 capital is also consistent with the
minimum capital requirement for nonbank SDs electing the NLA Approach
and the TNW Approach.\164\ The Commission adopted this minimum
requirement as it believed that the role a nonbank SD performs in the
financial markets by engaging in swap dealing activities warranted a
minimum level of capital, stated as a fixed dollar amount that does not
fluctuate with the level of the firm's dealing activities to help
ensure the safety and soundness of the nonbank SD.\165\
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\164\ Nonbank SDs electing the NLA Approach are subject to a
minimum capital requirement that includes a fixed minimum dollar
amount of net capital of $20 million. See 17 CFR
23.101(a)(1)(ii)(A)(1). Nonbank SDs electing the TNW Approach are
required to maintain levels of tangible net worth that equals or
exceeds $20 million plus the amount of the nonbank SDs' market risk
and credit risk associated with the firms' dealing activities. See
17 CFR 23.101(a)(2)(ii)(A).
\165\ See, e.g., 85 FR 57492.
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Prong (ii) above is a minimum capital requirement that is based on
the amount of uncleared margin for swap transactions entered into by
the nonbank SD and is computed on a counterparty by counterparty basis.
The requirement for a nonbank SD to maintain minimum capital equal to
or greater than 8 percent of the firm's uncleared swap margin provides
a capital floor based on a measure of the risk and volume of the swap
positions, and the number of counterparties and the complexity of
operations, of the nonbank SD. The intent of the minimum capital
requirement based on a percentage of the nonbank SD's uncleared swap
margin was to establish a minimum capital requirement that would help
ensure that the nonbank SD meets all of its obligations as a SD to
market participants, and to cover potential operational risk, legal
risk, and liquidity risk in addition to the risks associated with its
trading portfolio.\166\
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\166\ See 85 FR 57462.
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Prong (iii) above is a minimum capital requirement that is based on
the Federal Reserve Board's capital requirements for bank holding
companies and is consistent with the BCBS international capital
framework for banking institutions. As noted above, a nonbank SD under
prong (iii) must maintain an aggregate of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital in an amount equal to or
greater than 8 percent of the nonbank SD's total risk-weighted assets,
with common equity tier 1 capital comprising at least 6.5 percent of
the 8 percent. Risk-weighted assets are a nonbank SD's on-balance sheet
and off-balance sheet exposures, including proprietary swap, security-
based swap, equity, and futures positions, weighted according to risk.
The Bank-Based Approach requires each nonbank SD to maintain regulatory
capital in an amount that equals or exceeds 8 percent of the firm's
total risk-weighted assets to help ensure that the nonbank SD's level
of capital is sufficient to absorb decreases in the value of the firm's
assets and increases
[[Page 41789]]
in the value of the firm's liabilities, and to cover unexpected losses
resulting from business activities, including uncollateralized defaults
from swap counterparties, without the nonbank SD becoming insolvent.
A nonbank SD must compute its risk-weighted assets using
standardized market risk and/or credit risk charges, unless the nonbank
SD has been approved by the Commission or NFA to use internal
models.\167\ For standardized market risk charges, the Commission
incorporates by reference the standardized market risk charges set
forth in Commission Regulation 1.17 for FCMs and SEC Rule 18a-1 for
nonbank SBSDs.\168\ The standardized market risk charges under
Commission Regulation 1.17 and SEC Rule 18a-1 are calculated as a
percentage of the market value or notional value of the nonbank SD's
marketable securities and derivatives positions, with the percentages
applied to the market value or notional value increasing as the
expected or anticipated risk of the positions increases.\169\ The
resulting total market risk exposure amount is multiplied by a factor
of 12.5 to cancel the effect of the 8 percent multiplication factor
applied to all of the nonbank SD's risk-weighted assets, which
effectively requires a nonbank SD to hold qualifying regulatory capital
equal to or greater than 100 percent of the amount of its market risk
exposure.\170\
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\167\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the
term BHC equivalent risk-weighted assets in 17 CFR 23.100.
\168\ See paragraph (3) of the definition of the term BHC
equivalent risk-weighted assets in 17 CFR 23.100.
\169\ See 17 CFR 240.18a-1(c)(1).
\170\ See 17 CFR 23.100 (Definition of BHC equivalent risk-
weighted assets). As noted, a nonbank SD is required to maintain
qualifying capital (i.e., an aggregate of common equity tier 1
capital, additional tier 1 capital, and tier 2 capital) in an amount
that exceeds 8 percent of its market risk-weighted assets and
credit-risk-weighted assets. The regulations, however, require the
nonbank SD to effectively maintain qualifying capital in excess of
100 percent of its market risk-weighted assets by requiring the
nonbank SD to multiply its market-risk-weighted assets by 12.5.
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With respect to standardized credit risk charges for exposures from
non-derivatives positions, a nonbank SD computes its on-balance sheet
and off-balance sheet exposures in accordance with the standardized
credit risk charges adopted by the Federal Reserve Board and set forth
in Subpart D of 12 CFR 217 as if the SD itself were a bank holding
company subject to Subpart D.\171\ Standardized credit risk charges are
computed by multiplying the amount of the exposure by defined
counterparty credit risk factors that range from 0 percent to 150
percent.\172\ A nonbank SD with off-balance sheet exposures is required
to calculate a credit risk charge by multiplying each exposure by a
credit conversion factor that ranges from 0 percent to 100 percent,
depending on the type of exposure.\173\ In addition to the risk-
weighted assets for general credit risk, a nonbank SD calculating risk
charges under Subpart D of 12 CFR 217 must also calculate risk-weighted
assets for unsettled transactions involving securities, foreign
exchange instruments, and commodities that have a risk of delayed
settlement or delivery.
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\171\ See 17 CFR 23.101(a)(1)(i)(B) and paragraph (1) of the
definition of the term BHC equivalent risk-weighted assets in 17 CFR
23.100.
\172\ See 17 CFR 217.32. Lower credit risk factors are assigned
to entities with lower credit risk and higher credit risk factors
are assigned to entities with higher credit risk. For example, a
credit risk factor of 0% is applied to exposures to the U.S.
government, the Federal Reserve Bank, and U.S. government agencies
(see 12 CFR 217.32 (a)(1)), and a credit risk factor of 100% is
assigned to an exposure to foreign sovereigns that are not members
of the Organization of Economic Co-operation and Development (see 12
CFR 217.32(a)(2)).
\173\ See 17 CFR 217.33.
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A nonbank SD may compute standardized credit risk charges for
derivatives positions, including uncleared swaps and non-cleared
security-based swaps, using either the current exposure method
(``CEM'') or the standardized approach for measuring counterparty
credit risk (``SA-CCR'').\174\ Both CEM and SA-CCR are non-model,
rules-based, approaches to calculating counterparty credit risk
exposures for derivatives positions. Credit risk exposure under CEM is
the sum of: (i) the current exposure (i.e., the positive mark-to-
market) of the derivatives contract; and (ii) the potential future
exposure, which is calculated as the product of the notional principal
amount of the derivatives contract multiplied by a standard credit risk
conversion factor set forth in the rules of the Federal Reserve
Board.\175\ Credit risk exposure under SA-CCR is defined as the
exposure at default amount of a derivatives contract, which is computed
by multiplying a factor of 1.4 by the sum of: (i) the replacement costs
of the contract (i.e., the positive mark-to market); and (ii) the
potential future exposure of the contract.\176\
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\174\ See 17 CFR 217.34. See also, Commission Regulation 23.100
(17 CFR 23.100) defining the term BHC risk-weighted assets, which
provides that a nonbank SD that does not have model approval may use
either CEM or SA-CCR to compute its exposures for over-the-counter
derivative contracts without regard to the status of its affiliate
entities with respect to the use of a calculation approach under the
Federal Reserve Board's capital rules.
\175\ See 12 CFR 217.34.
\176\ See 12 CFR 217.132(c).
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A nonbank SD may also obtain approval from the Commission or NFA to
use internal models to compute market risk and/or credit risk charges
in lieu of the standardized charges. A nonbank SD seeking approval to
use an internal model is required to submit an application to the
Commission or NFA.\177\ The application is required to include, among
other things, a list of categories of positions that the nonbank SD
holds in its proprietary accounts and a brief description of the
methods that the nonbank SD will use to calculate market risk and/or
credit risk charges for such positions, as well as a description of the
mathematical models used to compute market risk and credit risk
charges.
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\177\ See 17 CFR 23.102(c).
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A nonbank SD approved by the Commission or NFA to use internal
models to compute market risk is required to comply with Subpart F of
the Federal Reserve Board's Part 217 regulations (``Subpart F'').\178\
Subpart F is based on models that are consistent with the BCBS Basel
2.5 capital framework.\179\ The Commission's qualitative and
quantitative requirements for internal capital models are also
comparable to the SEC's existing internal capital model requirements
for broker-dealers in securities and SBSDs,\180\ which are broadly
based on the BCBS Basel 2.5 capital framework.
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\178\ See paragraph (4) of the definition of BHC equivalent
risk-weighted assets in 17 CFR 23.100.
\179\ Compare 17 CFR 23.100 (providing for a nonbank SD that is
approved to use internal models to calculate market and credit risk
to calculate its risk-weighted assets using Subparts E and F of 12
CFR part 217), Subpart F of 12 CFR, 17 CFR 23.101(a)(1)(ii)
(providing for an SD that elects the Net Liquid Assets Approach to
calculate its net capital in accordance with Rule 18a-1), and 17 CFR
23.102(a), with Basel Committee on Banking Supervision, Revisions to
the Basel II Market Risk Framework (2011), https://www.bis.org/publ/bcbs193.pdf (describing the revised internal model approach under
Basel 2.5).
\180\ The SEC internal model requirements for SBSDs are listed
in 17 CFR 240.18a-1(d).
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A nonbank SD approved to use internal models to compute credit risk
charges is required to perform such computation in accordance with
Subpart E of the Federal Reserve Board's Part 217 regulations \181\ as
if the SD itself were a bank holding company subject to Subpart E.\182\
The internal credit risk modeling requirements are also based on the
Basel 2.5 capital framework and the Basel 3 capital framework. A
nonbank SD that computes its credit risk charges using internal models
must multiply the resulting capital requirement by a factor of
12.5.\183\
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\181\ 12 CFR 217 Subpart E.
\182\ See 85 FR 57462 at 57496.
\183\ 12 CFR 217.131(e)(1)(iii), 217.131(e)(2)(iv), and
217.132(d)(9)(iii).
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[[Page 41790]]
In adopting the final Bank-Based Approach rules, the Commission
also noted that in choosing an alternative calculation, the nonbank SD
must adopt the entirety of the alternative. As such, if the nonbank SD
is calculating its risk-weighted assets using the regulations in
Subpart E of 12 CFR 217, the nonbank SD must include charges reflecting
all categories of risk-weighted assets applicable under these
regulations, which include among other things, charges for operational
risk, CVA of OTC derivatives contracts, and unsettled transactions
involving securities, foreign exchange instruments, and commodities
that have a risk of delayed settlement or delivery.\184\ The capital
charge for operational risk and CVA of OTC derivatives contracts
calculated in accordance with Subpart E of 12 CFR 217 must also be
multiplied by a factor of 12.5.\185\
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\184\ Settlement risk for OTC derivatives contracts is addressed
as part of the counterparty-credit risk calculation methodology
described in 12 CFR 217.132.
\185\ 12 CFR 217.162(c) (operational risk) and 217.132(e)(4)
(CVA of OTC derivative contracts).
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Under the Basel 2.5 capital framework, nonbank SDs have flexibility
in developing their internal models, but must follow certain minimum
standards. Internal market risk and credit risk models must follow a
Value-at-Risk (``VaR'') structure to compute, on a daily basis, a 99th
percentile, one-tailed confidence interval for the potential losses
resulting from an instantaneous price shock equivalent to a 10-day
movement in prices (unless a different time-frame is specifically
indicated). The simulation of this price shock must be based on a
historical observation period of minimum length of one year, but there
is flexibility on the method used to render simulations, such as
variance-covariance matrices, historical simulations, or Monte Carlo.
The Commission and the Basel standards for internal models also
have requirements on the selection of appropriate risk factors as well
as on data quality and update frequency.\186\ One specific concern is
that internal models must capture the non-linear price characteristics
of options positions, including but not limited to, relevant
volatilities at different maturities.\187\
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\186\ See 17 CFR Appendix A to Subpart E of Part 23(i)(2)(iii),
and Basel Committee on Banking Supervision, Revisions to the Basel
II Market Risk Framework (2011), paragraph 718(Lxxvi)(e), available
at: https://www.bis.org/publ/bcbs193.pdf.
\187\ The Commission's requirement is set forth in paragraph
(i)(2)(iv)(A) of Appendix A to Subpart E of 17 CFR part 23. See
also, Basel Committee on Banking Supervision, Revisions to the Basel
II Market Risk Framework (2011), paragraph 718(Lxxvi)(h), available
at: https://www.bis.org/publ/bcbs193.pdf.
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In addition, BCBS standards for market risk models include a series
of additive components for risks for which the broad VaR is ill-suited
or that may need targeted calculation. These include the calculation of
a Stressed VaR measure (with the same specifications as the VaR, but
calibrated to historical data from a continuous 12-month period of
significant financial stress relevant to the firm's portfolio); a
Specific Risk measure (which includes the effect of a specific
instrument); an Incremental Risk measure (which addresses changes in
the credit rating of a specific obligor which may appear as a reference
in an asset); and a Comprehensive Risk measure (which addresses risk of
correlation trading positions).
2. EU Capital Rules: EU Nonbank Swap Dealer Minimum Capital
Requirements
The EU Capital Rules impose bank-like capital requirements on an EU
nonbank SD that, consistent with the BCBS international bank capital
framework, require the EU nonbank SD to hold a sufficient amount of
qualifying equity capital and subordinated debt based on the EU nonbank
SD's activities to absorb decreases in the value of firm assets and
increases in the value of the firm's liabilities, and to cover losses
from its business activities, including possible counterparty defaults
and margin collateral shortfalls associated with the firm's swap
dealing activities, without the firm becoming insolvent. Specifically,
the EU Capital Rules require each EU nonbank SD to maintain sufficient
levels of capital to satisfy the following capital ratios, expressed as
a percentage of the EU nonbank SD's total risk exposure amount (i.e.,
the sum of the EU nonbank SD's risk-weighted assets and exposures): (i)
a common equity tier 1 capital ratio of 4.5 percent; \188\ (ii) a tier
1 capital ratio of 6 percent; \189\ and (iii) a total capital ratio of
8 percent.\190\ The EU Capital Rules further require an EU nonbank SD
to maintain a capital conservation buffer composed of common equity
capital tier 1 capital in amount equal to 2.5 percent of the firm's
total risk exposure.\191\ The common equity tier 1 capital used to meet
the capital conservation buffer must be separate and in addition to the
4.5 percent of common equity tier 1 capital that the EU nonbank is
required to maintain in meeting its core 8 percent capital
requirement.\192\ Thus, an EU nonbank SD is required to maintain
regulatory capital equal to at least 10.5 percent of its total risk
exposure amount, with common equity tier 1 capital comprising at least
7 percent of the regulatory capital (4.5 percent of the core capital
plus the 2.5 percent capital conservation buffer).
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\188\ CRR, Article 92(1)(a).
\189\ Id., Article 92(1)(b). Tier 1 capital is the sum of the EU
nonbank SD's common equity tier 1 capital and additional tier 1
capital.
\190\ Id., Article 92(1)(c). The total capital is the sum of the
EU nonbank SD's tier 1 capital and tier 2 capital.
\191\ CRD, Article 129(1).
\192\ Id. An EU nonbank SD may also be required to maintain a
countercyclical capital buffer composed of common equity tier 1
capital equal to the firm's total risk exposure multiplied by an
entity-specific countercyclical buffer rate. The entity-specific
countercyclical capital buffer rate is determined by calculating the
weighted average of the countercyclical buffer rates that apply in
the jurisdictions in which the EU nonbank SD has relevant credit
exposures. See CRD, Article 140. In each EU Member State, the
countercyclical buffer rate is set by a designated authority on a
quarterly basis. See CRD, Article 136. In addition, an EU nonbank SD
may be subject to a G-SII or O-SII buffer, if the entity is of
systemic importance, and a systemic risk buffer if the EU Member
State in which the EU nonbank SD is domiciled or at least one EU
Member State in which the EU nonbank SD has exposures has
implemented one. See CRD, Articles 131 and 133. In practice,
however, currently only one of the EU nonbank SD registered with the
Commission, Citigroup Global Markets Europe AG, is subject to O-SII
buffer (of 0.25 percent) as of January 2023 and none of the
registered EU nonbank SDs is subject to a G-SII buffer.
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An EU nonbank SD's total risk exposure amount is calculated as the
sum of the firm's: (i) capital requirements for market risk; (ii) risk-
weighted exposure amounts for credit risk; (iii) capital requirements
for settlement risk; (iv) capital requirements for CVA risk of OTC
derivatives instruments; and (v) capital requirements for operational
risk.\193\ Capital charges for market risk and risk-weighted exposures
for credit risk are computed based on the EU nonbank SD's on-balance
sheet and off-balance sheet exposures, including proprietary swap,
security-based swap, equity, and futures positions, weighted according
to risk.\194\ Settlement risk capital charges reflect the price
difference to which an
[[Page 41791]]
EU nonbank SD is exposed if its transactions in debt instruments,
equity, foreign currency, and commodities remain unsettled after the
respective product's due delivery date.\195\ CVA is an adjustment to
the mid-market value of the portfolio of OTC derivative transactions
with a counterparty and reflects the current market value of the credit
risk of the counterparty to the EU nonbank SD.\196\ Operational risk
capital charges reflect the risk of loss resulting from inadequate or
failed internal processes, people and systems or from external events,
and includes legal risk.\197\ To compute its total risk exposure
amount, an EU nonbank SDs is also required to multiply the capital
requirements for market risk, settlement risk, CVA risk, and
operational risk, calculated in accordance with the EU Capital Rules,
by a factor of 12.5, which effectively requires an EU nonbank SD to
hold qualifying regulatory capital equal to or greater than the full
amount of the relevant risk exposures.\198\ The formulae for
calculating risk-weighted exposure amounts for credit risk also include
a 12.5 multiplication factor.\199\
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\193\ CRR, Article 92(3).
\194\ To compute capital requirements for market risk, EU
nonbank SDs are required to calculate capital charges for all
trading book positions and non-trading book positions that are
subject to foreign exchange or commodity risk. See CRR, Article 325.
The risk-weighted exposure amounts for credit risk include: (i)
risk-weighted exposure amounts for credit risk and dilution risk in
respect of all the business activities of the EU nonbank SD,
excluding risk-weighted exposure amounts from the trading book
business of the firm; and (ii) risk-weighted exposure amounts for
counterparty risk arising from the trading book business for certain
derivatives transactions, repurchase agreements, securities or
commodities lending or borrowing transactions, margin lending or
long settlement transactions. See CRR, Article 92(3)(a) and (f).
\195\ CRR, Article 378. Settlement risk is calculated as 8
percent, 50 percent, 75 percent, or 100 percent of the price
difference for transactions that are not settled within 5 to 15
business days, 16 to 30 business days, 31 to 45 business days, or 46
or more business days, respectively, from the due settlement date.
\196\ Id., Article 381.
\197\ Id., Article 4(1)(52).
\198\ Id., Article 92(4).
\199\ Id., Article 153 et seq.
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Consistent with the Commission's Bank-Based Approach and the BCBS
capital framework, the EU Capital Rules require EU nonbank SDs to
compute market risk exposures and credit risk exposures using a
standardized approach or, if approved by the relevant competent
authorities, internal risk models.\200\ In addition, EU Capital Rules,
consistent with the BCBS capital framework, require EU nonbank SDs to
compute capital charges for CVA risk and operational risk using
standardized approaches, unless approved to use internal models by
relevant competent authorities.\201\
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\200\ With the permission of the relevant competent authority,
an EU nonbank SD may use internal models to calculate market risk
(see CRR, Article 363) and credit risk (see CRR, Articles 143 and
283).
\201\ See, CRR, Articles 382-384 for CVA risk calculations; and
Article 312(2) for operational risk.
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EU nonbank SDs calculate standardized market risk charges generally
by multiplying the notional or carrying amount of net positions by
risk-weighting factors, which are based on the underlying market risk
of each asset or exposure and increase as the expected risk of the
positions increase. Market risk requirements for debt instruments and
equity instruments are calculated separately under the standardized
approach, and are each calculated as the sum of specific risk and
general risk of the positions. Securitizations are treated as debt
instruments for market risk requirements,\202\ whereas derivative
positions are generally treated as exposures on their underlying
assets,\203\ with options being delta-adjusted.\204\
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\202\ Id., Article 326. See also CRR, Articles 334-340
(provisions related to debt instruments) and 341-343 (provisions
related to equities).
\203\ Id., Articles 328-330, 358.
\204\ Id., Article 329.
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The EU Capital Rules also require EU nonbank SDs to include in
their risk-weighted assets market risk exposures to certain foreign
currency and gold positions. Specifically, an EU nonbank SD with net
positions in foreign exchange and gold that exceed 2 percent of the
firm's total capital must calculate capital requirements for foreign
exchange risk.\205\ The capital requirement for foreign exchange risk
under the standardized approach is 8 percent of the EU nonbank SD's net
positions in foreign exchange and gold.\206\
---------------------------------------------------------------------------
\205\ Id., Article 351.
\206\ Id.
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The EU Capital Rules further require EU nonbank SDs to include
exposures to commodity positions in calculating the firm's risk-
weighted assets. The standardized calculation of commodity risk
exposures may follow one of three approaches depending on type of
position or exposure. The first is the sum of a flat percentage rate
for net positions, with netting allowed among tightly defined sets,
plus another flat percentage rate for the gross position.\207\ The
other two standardized approaches are based on maturity-ladders, where
unmatched portions of each maturity band (i.e., portions that do not
net out to zero) are charged at a step-up rate in comparison to the
base charges for matched portions.\208\
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\207\ Id., Article 360.
\208\ Id., Articles 359-361.
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With respect to credit risk, the EU Capital Rules require an EU
nonbank SD to calculate its standardized credit risk exposure in a
manner aligned with the Commission's Bank-Based Approach and the BCBS
framework by taking the carrying value or notional value of each of the
EU nonbank SD's on-balance sheet and off-balance sheet exposures,
making certain additional credit risk adjustments, and then applying
specific risk-weights based on the type of counterparty and the asset's
credit quality.\209\ For instance, high quality credit exposures, such
as exposures to EU Member States' central banks, carry a zero percent
risk-weight. Exposures to EU banks, other investment firms, or other
businesses, however, may carry risk-weights between 20 percent and 150
percent depending on the credit ratings available for the entity or,
for exposures to banks and investment firms, for its central
government.\210\ If no credit rating is available, the EU nonbank SD
must generally apply a 100 percent risk-weight, meaning the total
accounting value of the exposure is used.\211\
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\209\ Id., Articles 111 and 113(1).
\210\ Id., Articles 114-122.
\211\ Id., Articles 121(2) and 122(2).
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With respect to counterparty credit risk for derivatives
transactions and certain other agreements that give rise to bilateral
credit risk, the EU Capital Rules require an EU nonbank SD that is not
approved to use credit risk models to calculate its exposure using the
standardized approach for counterparty credit risk (i.e., SA-CCR),\212\
which is one of the methods that a nonbank SD may use to calculate its
credit risk exposure under a derivatives transaction pursuant to the
Commission's Bank-Based Approach.\213\ The exposure amount under the
SA-CCR is computed, under both the EU Capital Rules and the
Commission's Bank-Based Approach, as the sum of the replacement cost of
the contract and the potential future exposure of the contract,
multiplied by a factor of 1.4.\214\
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\212\ CRR, Articles 92(3)(f) and 274-280e. EU nonbank SDs with
smaller-sized derivatives business may also use a ``simplified
standardized approach to counterparty credit risk'' (CRR, Article
281) or an ``original exposure method'' (CRR, Article 282) as
simpler methods for calculating exposure values. To use either of
these alternative methods, an entity's on-and off-balance sheet
derivatives business must be equal or less than 10 percent of the
entity's total assets and EUR 300 million or 5 percent of the
entity's total assets and EUR 100 million, respectively. CRR,
Article 273a.
\213\ 12 CFR 217.34.
\214\ CRR, Article 274(2) and 12 CFR 217.132(c).
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EU Capital Rules also require an EU nonbank SD to calculate capital
requirements for settlement risk.\215\ Consistent with the BCBS
framework, the capital charge for settlement risk for transactions
settled on a delivery-versus-payment basis is computed by multiplying
the price difference to which an EU nonbank SD is exposed as a result
of an unsettled transaction by a
[[Page 41792]]
percentage factor that varies from 8 percent to 100 percent based on
the number of working days after the due settlement date during which
the transaction remains unsettled.\216\ The CFTC's Bank-Based Approach
provides for a similar calculation methodology for risk-weighted asset
amounts for unsettled transactions involving securities, foreign
exchange instruments, and commodities.\217\
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\215\ CRR, Article 378 (indicating that if transactions in which
debt instruments, equities, foreign currencies and commodities
excluding repurchase transactions and securities or commodities
lending and securities or commodities borrowing are unsettled after
their due delivery dates, an EU nonbank SD must calculate the price
difference to which it is exposed).
\216\ Id. The price difference to which an EU nonbank SD is
exposed is the difference between the agreed settlement price for an
instrument (i.e., a debt instrument, equity, foreign currency or
commodity) and the instrument's current market value, where the
difference could involve a loss for the firm. CRR, Article 378.
\217\ 17 CFR 23.100 (definition of BHC equivalent risk-weighted
assets), 12 CFR 217.38 and 12 CFR 217.136.
---------------------------------------------------------------------------
Consistent with the BCBS framework, an EU nonbank SD is also
required to calculate capital charges for CVA risk for OTC derivative
instruments \218\ to reflect the current market value of the credit
risk of the counterparty to the EU nonbank SD.\219\ CVA can be
calculated following similar methodologies as those described in
Subpart E of the Federal Reserve Board's Part 217 regulations.\220\
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\218\ CRR, Article 382 (1). CVA risk charges need not be
calculated for credit derivatives recognized to reduce risk-weighted
exposure amounts for credit risk. Id.
\219\ Id., Article 381. CVA is defined to exclude debit
valuation adjustment.
\220\ See CRR, Articles 383-384 and 12 CFR 217.132(e)(5) and
(6). Under the CFTC's Bank-Based Approach, nonbank SDs calculating
their credit risk-weighted assets using the regulations in Subpart D
of the Federal Reserve Board's Part 217 regulations, do not
calculate CVA of OTC derivatives instruments.
---------------------------------------------------------------------------
EU nonbank SD's total risk exposure amount also includes
operational risk charges. Consistent with the BCBS framework, EU
nonbank SDs may calculate standardized operational risk charges using
either one of two approaches--the Basic Indicator Approach or the
Standardized Approach.\221\ Both the Basic Indicator Approach and the
Standardized Approach use as a calculation basis the three-year average
of the ``relevant indicator,'' which is the sum of certain items on the
statement of income/loss (i.e., the firm's net interest income and net
non-interest income). Under the Basic Indicator Approach, EU nonbank
SDs are required to multiply the relevant indicator by a factor of 15
percent. When using the Standardized Approach, firms need to allocate
the relevant indicator into eight business lines specified by
regulation (e.g., trading and sales; retail brokerage; corporate
finance) and multiply the corresponding portion by a percentage factor
ranging from 12 to 18 percent depending on the business line. The
capital requirements for operational risk are calculated as the sum of
the individual business lines' charges.
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\221\ CRR, Article 312.
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As noted above, if approved by its relevant supervisory authority,
an EU nonbank SD may use internal models to calculate its market risk
charges, credit risk charges, including counterparty credit risk
charges, CVA risk charges, and operational risk charges in lieu of
using a standardized approach.\222\ To obtain permission, an EU nonbank
SD must demonstrate to the satisfaction of the relevant authority that
it meets certain conditions for the use of models.\223\
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\222\ Id., Articles 143 (credit risk), 283 (counterparty credit
risk), 312 (operational risk), 363 (market risk) and 383 (CVA risk).
EU nonbank SDs are not permitted, however, to calculated
counterparty credit risk charges using internal models when
calculating large exposures. CRR, Article 390(4).
\223\ Id., Articles 143, 283, 312(2) and 363(1).
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With respect to market risk, the relevant supervisory authority may
grant an EU nonbank SD permission to use internal models to calculate
one or more of the following risk categories: (i) general risk of
equity instruments, (ii) specific risk of equity instruments, (iii)
general risk of debt instruments, (iv) specific risk of debt
instruments, (v) foreign exchange risk, or (vi) commodities risk,\224\
along with interest rate risk on derivatives.\225\ To obtain approval
to use a market risk model, an EU nonbank SD must meet conditions
related to specified model elements and controls including risk and
stressed risk calculations,\226\ back-testing and multiplication
factors,\227\ risk measurement requirements,\228\ governance and
qualitative requirements,\229\ internal validation,\230\ and specific
requirements by risk categories.\231\ An EU nonbank SD approved to use
models must also obtain approval from the relevant authority to
implement a material change to the model or make a material extension
to the use of the model.\232\ The EU Capital Rules' market risk model-
based methodology is based on the Basel 2.5 standard \233\ and
incorporates relevant aspects of the BCBS framework in terms of
requiring EU nonbank SDs with model approval to use a VaR model with a
99 percent, one-tailed confidence level with (i) price changes
equivalent to a 10-business day movement in rates and prices, (ii)
effective historical observation periods of at least one year, and
(iii) at least monthly data set updates.\234\ EU Capital Rules also
include a framework for governance that includes requirements related
to the implementation of independent risk management,\235\ senior
management's involvement in the risk-control process,\236\
establishment of procedures for monitoring and ensuring compliance with
a documented set of internal policies and controls,\237\ and the
conducting of independent review of the models as part of the internal
audit process.\238\
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\224\ Id., Article 363(1).
\225\ Id., Article 331(1), using sensitivity models.
\226\ Id., Articles 364-365.
\227\ Id., Article 366.
\228\ Id., Article 367.
\229\ Id., Article 368.
\230\ Id., Article 369.
\231\ Id., Articles 364-377.
\232\ Id., Article 363(3).
\233\ Compare CRR, Articles 362-377 with Revisions to the Basel
II Market Risk Framework.
\234\ Id., Article 365(1).
\235\ Id., Articles 368 (1)(b).
\236\ Id., Articles 368 (1)(c).
\237\ Id., Articles 368 (1)(e).
\238\ Id., Articles 368 (1)(h).
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With regulatory permission, EU nonbank SDs may also use models to
calculate credit risk exposures.\239\ Credit risk models may include
internal ratings based on the estimation of default probabilities and
loss given default, consistent with the BCBS framework and subject to
similar model risk management guidelines.\240\ To obtain approval for
the use of internal ratings-based models, an EU nonbank SD must meet
requirements related to, among other things, the structure of its
rating systems and its criteria for assigning exposures to grades and
pools within a rating system, the parameters of risk quantification,
the validation of internal estimates, and the internal governance and
oversight of the rating systems and estimation processes.\241\
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\239\ Id., Article 143.
\240\ Id.
\241\ Id., Articles 170-177 (rating systems), 178-184 (risk
quantification), 185 (validation of internal estimates), and 189-191
(internal governance and oversight).
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In addition, subject to regulatory approval, EU nonbank SDs may use
internal models to calculate counterparty credit risk exposures for
derivatives, securities financing, and long settlement
transactions.\242\ The prerequisites for approval for such models
include requirements related to the establishment and maintenance of a
counterparty credit risk management framework, stress testing, the
integrity of the modelling process, the risk
[[Page 41793]]
management system, and validation.\243\ The EU Capital Rules' internal
counterparty credit risk model-based methodology is also based on the
Basel 2.5 standard.\244\ The EU Capital Rules allow for the estimation
of expected exposure as a measure of the average of the distribution of
exposures at a particular future date,\245\ with adjustments to the
period of risk, as appropriate to the asset and counterparty.
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\242\ Id., Article 283. As noted above, however, EU nonbank SDs
are not permitted to calculate counterparty credit risk charges
using internal models when calculating large exposures. CRR, Article
390(4).
\243\ Id., Articles 283-294.
\244\ Compare CRR, Article 362-377 with Revisions to the Basel
II Market Risk Framework.
\245\ CRR, Article 272(19), 283-285.
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EU nonbank SDs may also obtain regulatory permission to use
``advanced measurement approaches'' based on their own operational risk
measurement systems, to calculate capital charges for operational risk.
To obtain such permission, EU nonbank SDs must meet qualitative and
quantitative standards, as well as general risk management standards
set forth in the EU Capital Rules.\246\ Specifically, among other
qualitative standards, EU nonbank SDs must meet requirements related to
the governance and documentation of their operational risk management
processes and measurement systems.\247\ In addition, EU nonbank SDs
must meet quantitative standards related to process, data, scenario
analysis, business environment and internal control factors laid down
in the EU Capital Rules.\248\
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\246\ CRR, Article 312(1), cross-referencing CRR, Articles 321
and 322 and CRD, Articles 74 and 85.
\247\ CRR, Article 321.
\248\ Id., Article 322.
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As an additional element to the capital requirements, the EU
Capital Rules further impose a 3 percent leverage ratio floor on EU
nonbank SDs.\249\ Specifically, each EU nonbank SD is required to
maintain an aggregate amount of common equity tier 1 capital and
additional tier 1 capital equal to or in excess of 3 percent of the
firm's total on-balance sheet and off-balance sheet exposures,
including exposures on uncleared swaps, without regard to any risk-
weighting.\250\ The leverage ratio is a non-risk based minimum capital
requirement that is intended to prevent an EU nonbank SD from engaging
in excessive leverage, and complements the risk-based minimum capital
requirement that is based on the EU nonbank SD's risk-weighted assets.
---------------------------------------------------------------------------
\249\ Id., Article 92(1)(d).
\250\ Total exposures are required to be computed in accordance
with CRR, Article 429.
---------------------------------------------------------------------------
Furthermore, the EU Capital Rules also impose separate liquidity
requirements on an EU nonbank SD to address liquidity risk. The
liquidity requirements are composed of three main obligations. First,
an EU nonbank SD is required to hold an amount of sufficiently liquid
assets to meet the firm's expected payment obligations under stressed
conditions for 30 days.\251\ Second, an EU nonbank SD is subject to a
stable funding requirement whereby the firm must hold a diversity of
stable funding instruments \252\ sufficient to meet long-term
obligations under both normal and stressed conditions.\253\ Third, to
ensure that an EU nonbank SD continues to meet its liquidity
requirements, the firm is required to maintain robust strategies,
policies, processes, and systems for the identification of liquidity
risk over an appropriate set of time horizons, including intra-
day.\254\ The EU Capital Rules' liquidity requirements are intended to
help ensure that EU nonbank SDs can continue to fund their operations
over various time horizons, including the timely making of payments to
customers and counterparties.
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\251\ CRR, Article 412(1) provides that an EU nonbank SD shall
hold liquid assets in amount sufficient to cover the liquidity
outflows less the liquidity inflows under stressed conditions so as
to ensure the firm maintains levels of liquidity buffers that are
adequate to address any possible imbalance between liquidity inflows
and outflows under stressed conditions over a period of 30 days.
Liquid assets primarily include cash, deposits with central banks
(to the extent that the deposits can be withdrawn at any times in
periods of stress), government-backed assets and other highly liquid
assets with high credit quality. Id., Article 416(1).
\252\ Stable funding instruments include common equity tier 1
capital instruments, additional tier 1 capital instruments, tier 2
capital instruments, and other preferred shares and capital
instruments in excess of the tier 2 allowable amount with an
effective maturity of one year or greater. CRR, Article 427(1).
\253\ CRR, Article 413(1).
\254\ CRD, Article 86 provides that EU Member States' competent
authorities must ensure that institutions, including EU nonbank SDs,
have robust strategies, policies, processes and systems for the
identification, measurement, management and monitoring of liquidity
risk over an appropriate set of time horizons, including intra-day,
so as to ensure that entities maintain adequate levels of liquidity
buffers. The strategies, policies, processes, and systems must be
tailored to business lines, currencies, branches, and legal entities
and must include adequate allocation mechanisms of liquidity costs,
benefits, and risks. CRD, Article 86 was implemented into French law
by MFC, Articles L.511-41-1-B and L.511-41-1-C for credit
institutions and L.533-2-1 for investment firms subject to the CRR/
CRD framework, as well as the Articles 148 to 186 of the Ministerial
Order on Internal Control. Article 86 was implemented into German
law by Bundesanstalt f[uuml]r Finanzdienstleistungsaufsicht's
(``BaFin'') Minimum Requirements for Risk Management (``MaRisk'')
Circular.
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The EU Capital Rules also require EU nonbank SDs to comply with a
minimum initial capital requirement of EUR 5 million in order to become
and remain licensed as a credit institution.\255\ The initial capital
requirement must be met with common equity tier 1 capital.\256\
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\255\ CRD, Article 12(1).
\256\ Id., Article 12(2).
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3. Commission Analysis
The Commission has reviewed the EU Application and the relevant EU
laws and regulations, and has preliminarily determined that the EU
Capital Rules are comparable in purpose and effect to the CFTC Capital
Rules with regard to the establishment of the nonbank SD's minimum
capital requirement and the calculation of the nonbank SD's amount of
regulatory capital to meet that requirement.\257\ Although there are
differences between the EU Capital Rules and the CFTC Capital Rules, as
discussed below, the Commission preliminarily believes that the EU
Capital Rules and the CFTC Capital Rules are designed to ensure the
safety and soundness of a nonbank SD and, subject to the proposed
conditions discussed below, will achieve comparable outcomes by
requiring the firm to maintain a minimum level of qualifying regulatory
capital, including subordinated debt, to absorb losses from the firm's
business activities, including swap dealing activities, and decreases
in the value of the firm's assets and increases in the value of the
firm's liabilities, without the nonbank SD becoming insolvent. The
Commission's preliminary finding of comparability is based on a
comparative analysis of the three minimum capital requirements
thresholds of the CFTC Capital Rules' Bank-Based Approach (i.e., the
three prongs recited in Section III.C.1 above) and the respective
elements of the EU Capital Rules' requirements, as discussed below.
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\257\ The Commission notes that pursuant to Article 7 of CRR,
the competent authority may exempt an entity subject to CRR from the
applicable capital requirements, provided certain conditions are
met. In such case, the relevant requirements would apply to the
entity's parent entity, on a consolidated basis. The Commission's
assessment does not cover the application of Article 7 of CRR and
therefore an entity that benefits from an exemption under Article 7
of CRR would not qualify for substituted compliance under the
Capital Comparability Determination Order.
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a. Fixed Amount Minimum Capital Requirement
CFTC Capital Rules and the EU Capital Rules both require nonbank
SDs to hold a minimum amount of regulatory capital that is not based on
the risk-weighted assets of the firms. Prong (i) of the CFTC Capital
Rules requires each nonbank SD electing the Bank-Based Approach to
maintain a minimum of $20 million of common
[[Page 41794]]
equity tier 1 capital. The CFTC's $20 million fixed-dollar minimum
capital requirement is intended to ensure that each nonbank SD
maintains a level of regulatory capital, without regard to the level of
the firm's dealing and other activities, sufficient to meet its
obligations to swap market participants given the firm's status as a
CFTC-registered nonbank SD and to help ensure the safety and soundness
of the nonbank SD.\258\ The EU Capital Rules also contain a requirement
that an EU nonbank SD maintain a fixed amount of minimum initial
capital of EUR 5 million of common equity tier 1 capital in order to
become and remain authorized as a credit institution.\259\
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\258\ 85 FR 57492.
\259\ CRD, Article 12.
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The Commission recognizes that the $20 million fixed-dollar minimum
capital required under the CFTC Capital Rules is substantially higher
than the EUR 5 million minimum initial capital required under the EU
Capital Rules and the Commission preliminarily believes that the $20
million represents a more appropriate level of minimum capital to help
ensure the safety and soundness of the nonbank SD that is engaging in
uncleared swap transactions. Accordingly, the Commission is proposing
to condition the Capital Comparability Determination Order to require
each EU nonbank SD to maintain, at all times, a minimum level of $20
million regulatory capital in the form of common equity tier 1 items as
defined in Article 26 of CRR.\260\ The proposed condition would require
each EU nonbank SD to maintain an amount of common equity tier 1
capital denominated in euro that is equivalent to the $20 million in
U.S. dollars.\261\ The Commission is also proposing that an EU nonbank
SD may convert the euro-denominated common equity tier 1 capital amount
to the U.S. dollar equivalent based on a commercially reasonable and
observable exchange rate.
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\260\ The Commission notes that the proposed requirement that EU
nonbank SDs maintain a minimum level of $20 million of common equity
tier 1 capital is consistent with conditions set forth in the
proposed Capital Comparability Determination Orders for Japan and
Mexico, respectively. See, Notice of Proposed Order and Request for
Comment on an Application for a Capital Comparability Determination
from the Financial Services Agency of Japan, 87 FR 48092 (Aug. 8,
2022) (``Proposed Japan Order''); Notice of Proposed Order and
Request for Comment on an Application for a Capital Comparability
Determination Submitted on behalf of Nonbank Swap Dealers subject to
Regulation by the Mexican Comision Nacional Bancaria y de Valores,
87 FR 76374 (Dec. 13, 2022) (``Proposed Mexico Order'').
\261\ Each of the four current EU nonbank SDs currently
maintains common equity tier 1 capital in excess of $20 million
based on financial filings made with the Commission. Therefore, the
Commission does not anticipate that the proposed condition would
have any material impact on the EU nonbank SDs currently registered
with the Commission. Nonetheless, the Commission requests comment on
the proposed condition.
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b. Minimum Capital Requirement Based on Risk-Weighted Assets
Prong (iii) of the CFTC Capital Rules requires each nonbank SD to
maintain an aggregate of common equity tier 1 capital, additional tier
1 capital, and tier 2 capital in an amount equal to or greater than 8
percent of the nonbank SD's total risk-weighted assets, with common
equity tier 1 capital comprising at least 6.5 percent of the 8
percent.\262\ Risk-weighted assets are a nonbank SD's on-balance sheet
and off-balance sheet market risk and credit risk exposures, including
exposures associated with proprietary swap, security-based swap,
equity, and futures positions, weighted according to risk. The
requirements and capital ratios set forth in prong (iii) are based on
the Federal Reserve Board's capital requirements for bank holding
companies and are consistent with the BCBS international bank capital
adequacy framework. The requirement for each nonbank SD to maintain
regulatory capital in an amount that equals or exceeds 8 percent of the
firm's total risk-weighted assets is intended to help ensure that the
nonbank SD's level of capital is sufficient to absorb decreases in the
value of the firm's assets and increases in the value of the firm's
liabilities, and to cover unexpected losses resulting from the firm's
business activities, including losses resulting from uncollateralized
defaults from swap counterparties, without the nonbank SD becoming
insolvent.
---------------------------------------------------------------------------
\262\ 17 CFR 23.101(a)(1)(B).
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The EU Capital Rules contain capital requirements for EU nonbank
SDs that the Commission preliminarily believes are comparable to the
requirements contained in prong (iii) of the CFTC Capital Rules.
Specifically, the EU Capital Rules require an EU nonbank SD to
maintain: (i) common equity tier 1 capital equal to at least 4.5
percent of the EU nonbank SD's total risk exposure amount; (ii) total
tier 1 capital (i.e., common equity tier 1 capital plus additional tier
1 capital) equal to at least 6 percent of the EU nonbank SD's total
risk exposure amount; and (iii) total capital (i.e., an aggregate
amount of common equity tier 1 capital, additional tier 1 capital, and
tier 2 capital) equal to at least 8 percent of the EU nonbanks SD's
total risk exposure amount.\263\ In addition, the EU Capital Rules
further require each EU nonbank SD to maintain an additional capital
conservation buffer equal to 2.5 percent of the EU nonbank SD's total
risk exposure amount, which must be met with common equity tier 1
capital.\264\ Thus, an EU nonbank SD is effectively required to
maintain total qualifying regulatory capital in an amount equal to or
in excess of 10.5 percent of the market risk, credit risk, CVA risk,
settlement risk and operational risk of the firm (i.e., total capital
requirement of 8 percent of risk-weighted assets and an additional 2.5
percent of risk-weighted assets as a capital conservation buffer),
which is higher than the 8 percent required of nonbank SDs under prong
(iii) of the CFTC Capital Rules.\265\
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\263\ CRR, Article 92(1).
\264\ CRD, Article 129(1).
\265\ CRR, Article 92(1) and CRD, Article 129(1).
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The Commission also preliminarily believes that the EU Capital
Rules and the CFTC Capital Rules are comparable with respect to the
calculation of capital charges for market risk and credit risk
(including as it relates to aspects of settlement risk and CVA risk),
in determining the nonbank SD's risk-weighted assets. More
specifically, with respect to the calculation of market risk charges
and general credit risk charges, both regimes require a nonbank SD to
use standardized approaches to compute market and credit risk, unless
the firms are approved to use internal models. The standardized
approaches follow the same structure that is now the common global
standard: (i) allocating assets to categories according to risk and
assigning each a risk-weight; (ii) allocating counterparties according
to risk assessments and assigning each a risk factor; (iii) calculating
gross exposures based on valuation of assets; (iv) calculating a net
exposure allowing offsets following well defined procedures and subject
to clear limitations; (v) adjusting the net exposure by the market
risk-weights; and (vi) finally, for credit risk exposures, multiplying
the sum of net exposures to each counterparty by their corresponding
risk factor.
Internal market risk and credit risk models under the EU Capital
Rules and the CFTC Capital Rules are based on the BCBS framework and
contain comparable quantitative and qualitative requirements, covering
the same risks, though with slightly different categorization, and
including comparable model risk management requirements. As both rule
sets address the same types of risk, with similar allowed methodologies
and under similar controls, the Commission
[[Page 41795]]
preliminarily believes that these requirements are comparable.
The Commission also preliminarily believes that the EU Capital
Rules and CFTC Capital Rules are comparable in that nonbank SDs are
required to account for operational risk in computing their minimum
capital requirements. In this connection, the EU Capital Rules require
an EU nonbank SD to calculate an operational risk exposure as a
component of the firm's total risk exposure amount.\266\ EU nonbank SDs
may use either a standardized approach or, if the EU nonbank SD has
obtained regulatory permission, an internal approach based on the
firm's own measurement systems, to calculate their capital charges for
operational risk. The CFTC Capital Rules address operational risk both
as a stand-alone, separate minimum capital requirement that a nonbank
SD is required to meet under prong (ii) of the Bank-Based Approach
\267\ and as a component of the calculation of risk-weighted assets for
nonbank SDs that use Subpart E of the Federal Reserve Board's Part 217
regulations to calculate their credit risk-weighted assets via internal
models.\268\
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\266\ CRR, Article 92(3).
\267\ Specifically, as further discussed below, prong (ii) of
the CFTC Capital Rules' Bank-Based Approach requires a nonbank SD to
maintain regulatory capital in an amount equal to or greater than 8
percent of the firm's total uncleared swaps margin amount associated
with its uncleared swap transactions to address potential
operational, legal, and liquidity risks. 17 CFR 101(a)(i)(C). The
term ``uncleared swap margin'' is defined by Commission Regulation
23.100 as the amount of initial margin, computed in accordance with
the Commission's margin rules for uncleared swaps, that a nonbank SD
would be required to collect from each counterparty for each
outstanding swap position of the nonbank SD. 17 CFR 23.100 and
23.154. A nonbank SD must include all swap positions in the
calculation of the uncleared swap margin amount, including swaps
that are exempt or excluded from the scope of the Commission's
margin regulations for uncleared swaps pursuant to Commission
Regulation 23.150, exempt foreign exchange swaps or foreign exchange
forwards, or netting set of swaps or foreign exchange swaps, for
each counterparty, as if that counterparty was an unaffiliated swap
dealer. 17 CFR 23.100 and 23.150. Furthermore, in computing the
uncleared swap margin amount, a nonbank SD may not exclude any de
minis thresholds contained in Commission Regulation 23.151. 17 CFR
23.100 and 23.151.
\268\ 17 CFR 23.101(a)(1)(i) and 17 CFR 23.100 (definition of
BHC equivalent risk-weighted assets).
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c. Minimum Capital Requirement Based on the Uncleared Swap Margin
Amount
As noted above, prong (ii) of the CFTC Capital Rules' Bank-Based
Approach requires a nonbank SD to maintain regulatory capital in an
amount equal to or greater than 8 percent of the firm's total uncleared
swaps margin amount associated with its uncleared swap transactions to
address potential operational, legal, and liquidity risks.
The EU Capital Rules differ from the CFTC Capital Rules in that
they do not impose a capital requirement on EU nonbank SDs based on a
percentage of the margin for uncleared swap transactions. The
Commission notes, however, that the EU Capital Rules impose capital and
liquidity requirements that may compensate for the lack of direct
analogue to the 8 percent uncleared swap margin requirement.
Specifically, as discussed above, under the EU Capital Rules, the total
risk exposure amount is computed as the sum of the EU nonbank SD's
capital charges for market risk, credit risk, settlement risk, CVA risk
of OTC derivatives instruments, and operational risk.\269\ Notably, the
EU Capital Rules require that EU nonbank SDs, including firms that do
not use internal models, calculate capital charges for operational risk
as a separate component of the total risk exposure amount. The EU
Capital Rules also impose separate liquidity requirements designed to
ensure that the EU nonbank SDs can meet both short- and long-term
obligations, in addition to the general requirement to maintain
processes and systems for the identification of liquidity risk.\270\ In
comparison, the Commission requires nonbank SDs to maintain a risk
management program covering liquidity risk, among other risk
categories, but does not have a distinct liquidity requirement.\271\
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\269\ CRR, Article 92(3).
\270\ More specifically, the EU Capital Rules impose separate
liquidity buffers and ``stable funding'' requirements designed to
ensure that EU nonbank SDs can cover both long-term obligations and
short-term payment obligations under stressed conditions for 30
days. CRR, Article 412-413. In addition, EU nonbank SDs are required
to maintain robust strategies, policies, processes, and systems for
the identification of liquidity risk over an appropriate set of time
horizons, including intra-day. CRD, Article 86.
\271\ Specifically, CFTC Regulation 23.600(b) requires each SD
to establish, document, maintain, and enforce a system of risk
management policies and procedures designed to monitor and manage
the risks related to swaps, and any products used to hedge swaps,
including futures, options, swaps, security-based swaps, debt or
equity securities, foreign currency, physical commodities, and other
derivatives. The elements of the SD's risk management program are
required to include the identification of risks and risk tolerance
limits with respect to applicable risks, including operational,
liquidity, and legal risk, together with a description of the risk
tolerance limits set by the SD and the underlying methodology in
written policies and procedures. 17 CFR 23.600.
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As such, the Commission preliminarily believes the inclusion of an
operational risk charge in the EU nonbank SD's total risk exposure
amount in all circumstances, and the existence of separate liquidity
requirements, will achieve a comparable outcome to the Commission's
requirement for nonbank SDs to hold regulatory capital in excess of 8
percent of its uncleared swap margin amount. In that regard, the
Commission, in establishing the requirement that a nonbank SD must
maintain a level of regulatory capital in excess of 8 percent of the
uncleared swap margin amount associated with the firm's swap
transactions, stated that the intent of the requirement was to
establish a method of developing a minimum amount of required capital
for a nonbank SD to meet its obligations as an SD to market
participants, and to cover potential operational, legal, and liquidity
risks.\272\
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\272\ See 85 FR 57462 at 57485.
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d. Preliminary Finding of Comparability
Based on a principles-based, holistic assessment, the Commission
has preliminarily determined, subject to the proposed condition below,
and further subject to its consideration of public comments to the
proposed Capital Comparability Determination and Order, that the
purpose and effect of the EU Capital Rules and the CFTC Capital Rules
are comparable. In this regard, the EU Capital Rules and the CFTC
Capital Rules are both designed to require a nonbank SD to maintain a
sufficient amount of qualifying regulatory capital and subordinated
debt to absorb losses resulting from the firm's business activities,
and decreases in the value of firm assets, without the nonbank SD
becoming insolvent.
The Commission invites comment on the EU Application, the EU laws
and regulations, and the Commission's analysis above regarding its
preliminary determination that, subject to the $20 million minimum
capital requirement, the EU Capital Rules and the CFTC Capital Rules
are comparable in purpose and effect and achieve comparable outcomes
with respect to the minimum regulatory capital requirements and the
calculation of regulatory capital for nonbank SDs. The Commission also
specifically seeks public comment on the question of whether the
requirements under the EU Capital Rules that EU nonbank SDs calculate
an operational risk exposure as part of the firm's total risk exposure
amount and meet separate liquidity requirements are sufficiently
comparable in purpose and effect to the Commission's requirement for a
nonbank SD to hold regulatory capital equal to or greater than 8
percent of its uncleared swap margin amount.
[[Page 41796]]
D. Nonbank Swap Dealer Financial Reporting Requirements
1. CFTC Financial Recordkeeping and Reporting Rules for Nonbank Swap
Dealers
The CFTC Financial Reporting Rules impose financial recordkeeping
and reporting requirements on nonbank SDs. The CFTC Financial Reporting
Rules require each nonbank SD to prepare and keep current ledgers or
similar records summarizing each transaction affecting the nonbank SD's
asset, liability, income, expense, and capital accounts.\273\ The
nonbank SD's ledgers and similar records must be prepared in accordance
with generally accepted accounting principles as adopted in the United
States (``U.S. GAAP''), except that if the nonbank SD is not otherwise
required to prepare financial statements in accordance with U.S. GAAP,
the nonbank SD may prepare and maintain its accounting records in
accordance with International Financial Reporting Standards (``IFRS'')
issued by the International Accounting Standards Board.\274\
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\273\ 17 CFR 23.105(b).
\274\ Id.
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The CFTC Financial Reporting Rules also require each nonbank SD to
prepare and file with the Commission and with NFA periodic unaudited
and annual audited financial statements.\275\ A nonbank SD that elects
the TNW Approach is required to file unaudited financial statements
within 17 business days of the close of each quarter, and its annual
audited financial statements within 90 days of its fiscal year-
end.\276\ A nonbank SD that elects the NLA Approach or the Bank-Based
Approach is required to file unaudited financial statements within 17
business days of the end of each month, and to file its annual audited
financial statements within 60 days of its fiscal year-end.\277\
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\275\ 17 CFR 23.105(d) and (e).
\276\ 17 CFR 23.105(d)(1) and (e)(1).
\277\ Id.
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The CFTC Financial Reporting Rules provide that a nonbank SD's
unaudited financial statements must include: (i) a statement of
financial condition; (ii) a statement of income/loss; (iii) a statement
of changes in liabilities subordinated to claims of general creditors;
(iv) a statement of changes in ownership equity; (v) a statement
demonstrating compliance with and calculation of the applicable
regulatory requirement; and (vi) such further material information
necessary to make the required statements not misleading.\278\ The
annual audited financial statements must include: (i) a statement of
financial condition; (ii) a statement of income/loss; (iii) a statement
of cash flows; (iv) a statement of changes in liabilities subordinated
to claims of general creditors; (v) a statement of changes in ownership
equity; (vi) a statement demonstrating compliance with and calculation
of the applicable regulatory capital requirement; (vii) appropriate
footnote disclosures; and (viii) a reconciliation of any material
differences from the unaudited financial report prepared as of the
nonbank SD's year-end date.\279\
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\278\ 17 CFR 23.105(d)(2).
\279\ 17 CFR 23.105(e)(4).
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A nonbank SD that has obtained approval from the Commission or NFA
to use internal capital models also must submit certain model metrics,
such as aggregate VaR and counterparty credit risk information, each
month to the Commission and NFA.\280\ A nonbank SD also is required to
provide the Commission and NFA with a detailed list of financial
positions reported at fair market value as part of its monthly
unaudited financial statements.\281\ Each nonbank SD is also required
to provide information to the Commission and NFA regarding its
counterparty credit concentration for the 15 largest exposures in
derivatives, a summary of its derivatives exposures by internal credit
ratings, and the geographical distribution of derivatives exposures for
the 10 largest countries.\282\
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\280\ 17 CFR 23.105(k) and (l) and Appendix B to Subpart E of
Part 23.
\281\ 17 CFR 23.105(l) and Appendix B to Subpart E of Part 23.
\282\ 17 CFR 23.105(l) and Appendix B to Subpart E of Part 23,
Schedules 2, 3, and 4.
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CFTC Financial Reporting Rules also require a nonbank SD to attach
to each unaudited and audited financial report an oath or affirmation
that to the best knowledge and belief of the individual making the
affirmation the information contained in the financial report is true
and correct.\283\ The individual making the oath or affirmation must be
a duly authorized officer if the nonbank SD is a corporation, or one of
the persons specified in the regulation for business organizations that
are not corporations.\284\
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\283\ 17 CFR 23.105(f).
\284\ Id.
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The CFTC Financial Reporting Rules further require a nonbank SD to
make certain financial information publicly available by posting the
information on its public website.\285\ Specifically, a nonbank SD must
post on its website a statement of financial condition and a statement
detailing the amount of the nonbank SD's regulatory capital and the
minimum regulatory capital requirement based on its audited financial
statements and based on its unaudited financial statements that are as
of a date that is six months after the nonbank SD's audited financial
statements.\286\ Such public disclosure is required to be made within
10 business days of the filing of the audited financial statements with
the Commission, and within 30 calendar days of the filing of the
unaudited financial statements required with the Commission.\287\ A
nonbank SD also must obtain written approval from NFA to change the
date of its fiscal year-end for financial reporting.\288\
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\285\ 17 CFR 23.105(i).
\286\ Id.
\287\ Id.
\288\ 17 CFR 23.105(g).
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The CFTC Financial Reporting Rules also require a nonbank SD to
provide the Commission and NFA with information regarding the
custodianship of margin for uncleared swap transactions (``Margin
Report'').\289\ The Margin Report must contain: (i) the name and
address of each custodian holding initial margin or variation margin
that is required for uncleared swaps subject to the CFTC margin rules
(``uncleared margin rules''), on behalf of the nonbank SD or its swap
counterparties; (ii) the amount of initial and variation margin
required by the uncleared margin rules held by each custodian on behalf
of the nonbank SD and on behalf its swap counterparties; and (iii) the
aggregate amount of initial margin that the nonbank SD is required to
collect from, or post with, swap counterparties for uncleared swap
transactions subject to the uncleared margin rules.\290\ The Commission
requires this information in order to monitor the use of custodians by
nonbank SDs and their swap counterparties. Such information assists the
Commission in monitoring the safety and soundness of a nonbank SD by
verifying whether the firm is current with its swap counterparties with
respect to the posting and collecting of margin required by the
uncleared margin rules. By requiring the nonbank SD to report the
required amount of margin to be posted and collected, and the amount of
margin that is actually posted and collected, the Commission could
identify potential issues with the margin practices and compliance by
nonbank SDs that may hinder the ability of the firm to meet its
obligations to market participants. The Margin Report also allows the
Commission to identify custodians used by nonbank SDs and
[[Page 41797]]
their counterparties, which may permit the Commission to assess
potential market issues, including a concentration of custodial
services by a limited number of banks.
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\289\ 17 CFR 23.105(m).
\290\ Id.
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2. EU Nonbank Swap Dealer Financial Reporting Requirements
The EU Financial Reporting Rules impose financial reporting
requirements on an EU nonbank SD that are designed to provide relevant
EU competent authorities with a comprehensive view of the financial
information and capital position of the firm. Specifically, Article 430
of CRR requires an EU nonbank SD to report information to the relevant
competent authorities concerning its capital and financial condition
sufficient to provide a comprehensive view of the firm's risk profile,
including information on the firm's capital requirements, leverage
ratio, large exposures, and liquidity requirements.\291\
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\291\ CRR, Article 430(1). CRR also establishes reporting
requirements for reporting on stable funding (Articles 427-428) and
TLAC (Articles 92a and 430).
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Article 430 of CRR does not mandate the specific individual
financial statements that an EU nonbank SD is required to provide to
its applicable competent authorities in view of differing local
conventions in EU Member States. Instead, the relevant competent
authorities specify the financial statements to be submitted. To ensure
a level of consistency, the European Banking Authority (``EBA'')
developed implementing technical standards to specify uniform reporting
templates and to determine the frequency of reporting by EU nonbank
SDs.\292\
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\292\ The EBA is a regulatory agency of the EU that is tasked
with establishing a single regulatory and supervisory framework for
the banking sector in EU Member States. CRR, Article 430(7) provides
that the EBA shall develop draft implementing technical standards to
specify the uniform reporting formats and templates, the
instructions and methodology on how to use the templates, the
frequency and dates of reporting, and the definitions.
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The implementing technical standards under Article 430 of CRR
(``CRR Reporting ITS'') \293\ require an EU nonbank SD subject to the
standards, including the EU nonbank SDs currently registered with the
Commission, to prepare and deliver to its competent authorities common
reporting (``COREP'') on a quarterly basis. COREP requires, among other
things, calculations in relation to the EU nonbank SD's capital and
capital requirements,\294\ capital ratios and capital levels,\295\ and
market risk (the listed items are collectively referred to hereinafter
as ``COREP Reports'').\296\
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\293\ See Commission Implementing Regulation (EU) 2021/451 of 17
December 2020 laying down implementing technical standards for the
application of Regulation (EU) No 575/2013 of the European
Parliament and of the Council with regard to supervisory reporting
of institutions and repealing Implementing Regulation (EU) No 680/
2014.
\294\ CRR, Article 430; Annex I, Template Numbers 1 and 2 CRR
Reporting ITS.
\295\ CRR, Article 430; Annex I, Template Number 3 CRR Reporting
ITS.
\296\ CRR, Article 430; Annex I, Template Numbers 18-25 (as
applicable) CRR Reporting ITS.
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The CRR Reporting ITS also specify the contents of the required
financial reports (``FINREP'') for certain EU nonbank SDs that report
financial information on a consolidated basis.\297\ To further ensure
comparability of the financial information reported by EU nonbank SDs,
the ECB has adopted a regulation setting forth a common minimum set of
financial information that must be reported by credit institutions
subject to CRR to their relevant competent authorities on the basis of
the CRR Reporting ITS (``ECB FINREP Regulation'').\298\ More
specifically, the ECB FINREP Regulation complements the CRR Reporting
ITS by imposing financial reporting requirements applying on an
individual basis to entities subject to CRR, including EU nonbank SDs,
whereas CRR, Article 430 and the CRR Reporting ITS impose financial
reporting requirements on a consolidated basis.\299\ In addition to
those requirements, each national competent authority has discretion to
require institutions subject to CRR to report additional supervisory
information on the basis of CRR and the CRR Reporting ITS or of
national law.\300\
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\297\ See CRR, Article 430(3), (4), and (9); CRR Reporting ITS,
Articles 11 and 12 (requiring EU nonbank SDs subject to CRR to
submit FINREP reports on a consolidated basis if they are any of the
following: (i) an entity that prepares its consolidated accounts in
accordance with IFRS; (ii) an entity that determines its capital
requirements on a consolidated basis in accordance with IFRS and has
been required by the competent authority to submit FINREP reports on
a consolidated basis; and (iii) an entity subject to a national
accounting framework that is not already reporting on a consolidated
basis, to which the competent authority has decided to extend the
requirement to submit FINREP reports on a consolidated basis).
\298\ See Regulation (EU) 2015/534 of the European Central Bank
of March 17, 2015 on reporting of supervisory financial information.
\299\ ECB FINREP Regulation, Articles 6, 7, 13, and 14.
\300\ In France, the Autorit[eacute] de Contr[ocirc]le
Prudentiel et de R[eacute]solution (``ACPR''), the French regulatory
authority with prudential supervision authority over French
financial firms, including EU nonbank SDs domiciled in France,
requires the submission of several statistical financial reports and
may request additional information during examinations pursuant to
French MFC, Articles L.612-1 and L.612-24. In Germany, BaFin, the
German financial sector regulatory authority, may request
information on all business matters pursuant to German KWG, Section
44. See Responses to Staff Questions of May 15, 2023.
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Pursuant to the CRR Reporting ITS, as complemented by the ECB
FINREP Regulation, an EU nonbank SD is required to provide, among other
items, the following statements or reports to its relevant competent
authorities: (i) on a quarterly basis, a balance sheet statement (or
statement of financial position) that reflects the EU nonbank SD's
financial condition; \301\ (ii) on a quarterly basis, a statement of
profit or loss; \302\ (iii) on a quarterly basis, a breakdown of
financial liabilities by product and by counterparty sector; \303\ (iv)
on a quarterly basis, a listing of subordinated financial liabilities;
\304\ and (v) on an annual basis, a statement of changes in
equity.\305\ Under the FINREP requirements, an EU nonbank SD subject to
the CRR Reporting ITS is also required to provide its competent
authorities with additional financial information, including a
breakdown of its loans and advances by product and type of
counterparty,\306\ as well as detailed information regarding its
[[Page 41798]]
derivatives trading activities,\307\ collateral and guarantees.\308\
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\301\ CRR, Article 430; Annex III, Template Numbers 1.1, 1.2,
and 1.3 (for reporting according to IFRS) and Annex IV, Template
Numbers 1.1., 1.2, and 1.3 (for reporting according to national
accounting frameworks), CRR Reporting ITS; and ECB FINREP
Regulation, Articles 6, 7 and 13 (referring to Annex III and Annex
IV of the CRR Reporting ITS, as applicable).
\302\ CRR, Article 430; Annex III, Template Number 2 (for
reporting according to IFRS) and Annex IV, Template Number 2 (for
reporting according to national accounting frameworks), CRR
Reporting ITS; and ECB FINREP Regulation, Articles 6, 7 and 13
(referring to Annex III and Annex IV of the CRR Reporting ITS, as
applicable).
\303\ CRR, Article 430; Annex III, Template Number 8.1 (for
reporting according to IFRS) and Annex IV, Template Number 8.1(for
reporting according to national accounting frameworks), CRR
Reporting ITS; and ECB FINREP Regulation, Articles 6, 7 and 13
(referring to Annex III and Annex IV of the CRR Reporting ITS, as
applicable).
\304\ CRR, Article 430, Annex III, Template Number 8.2 (for
reporting according to IFRS) and Annex IV, Template Number 8.3 (for
reporting according to national accounting frameworks), CRR
Reporting ITS; and ECB FINREP Regulation, Articles 6, 7 and 13
(referring to Annex III and Annex IV of the CRR Reporting ITS, as
applicable).
\305\ CRR, Article 430; Annex III, Template Number 46 (for
reporting according to IFRS) and Annex IV, Template Number 46 (for
reporting according to national accounting frameworks), CRR
Reporting ITS; and ECB FINREP Regulation, Articles 6, 7 and 13
(referring to Annex III and Annex IV of the CRR Reporting ITS, as
applicable).
\306\ CRR, Article 430; Annex III, Template Numbers 5.1 and 6.1
(for reporting according to IFRS) and Annex IV, Template Numbers 5.1
and 6.1, CRR Reporting ITS; and ECB FINREP Regulation, Articles 6, 7
and 13 (referring to Annex III and Annex IV of the CRR Reporting
ITS, as applicable).
\307\ CRR, Article 430; Annex III, Template Number 10 (for
reporting according to IFRS) and Annex IV, Template Number 10 (for
reporting according to national accounting frameworks), CRR
Reporting ITS; and ECB FINREP Regulation, Articles 6, 7 and 13
(referring to Annex III and Annex IV of the CRR Reporting ITS, as
applicable).
\308\ CRR, Article 430; Annex III, Template Number 13 (for
reporting according to IFRS) and Annex IV, Template Number 13 (for
reporting according to national accounting frameworks), CRR
Reporting ITS; and ECB FINREP Regulation, Articles 6, 7 and 13
(referring to Annex III and Annex IV of the CRR Reporting ITS, as
applicable).
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Furthermore, with the exception of certain ``small'' entities, EU
nonbank SDs are required to prepare annual audited financial statements
and a management report (together, ``annual audited financial report'')
pursuant to Article 430 of CRR and the Accounting Directive.\309\ The
audit of the financial statements and management report is required to
be performed by one or more statutory auditors or auditors approved by
EU Member States to conduct audits of EU nonbank SDs.\310\ The annual
audited financial report, together with the opinion and statements of
the auditor, must be published.\311\
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\309\ Accounting Directive, Articles 4, 19 and 34; French MFC,
Articles L.511-35 to L.511-38; German Commercial Code
(Handelsgesetzbuch, ``HGB''), Section 316 et seq. The Accounting
Directive provides that the audit requirement is not applicable to
``small'' entities defined as firms meeting the following
requirements: (1) the firm's balance sheet is not more than EUR 4
million; (2) the firm's net turnover does not exceed more than EUR 8
million; or (3) the firm did not employ more than 50 employees
during the financial year. See Article 3(2) and Article 34 of the
Accounting Directive. The Applicants represent that the four EU
nonbank SDs currently registered with the Commission do not meet the
criteria to be classified as ``small'' entities and, therefore, are
required to prepare audited annual financial reports. See EU
Application, p. 5.
\310\ Accounting Directive, Article 34(1).
\311\ Id., Article 30.
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The annual audited financial statements must comprise, at a
minimum, a balance sheet, a profit and loss statement, and notes to the
financial statements.\312\ The auditor's audit report must include: (i)
a specification of the financial statements subject to the audit and
the financial reporting framework that was applied in their
preparation; (ii) a description of the scope of the audit, which must
specify the auditing standards used to conduct the audit; (iii) an
audit opinion stating whether the financial statements give a true and
fair view in accordance with the relevant financial reporting
framework; and (iv) a reference to any matters emphasized by the
auditor that did not qualify the audit opinion.\313\
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\312\ Id., Article 4(1).
\313\ Id., Article 35.
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The management report is required to include a review of the
development and performance of the EU nonbank SD's business and of its
position, with a description of the principal risks and uncertainties
that the firm faces.\314\ The auditors are required to express an
opinion on whether the management report is consistent with the
financial statements for the same financial year, and whether the
management report has been prepared in accordance with applicable legal
requirements.\315\ The opinion also must state whether the auditor has
identified material misstatements in the management report and, if so,
describe the misstatement.\316\
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\314\ Id., Article 19.
\315\ Id.
\316\ Id.
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In addition, the SEC's French and German Orders granting
substituted compliance for financial reporting to EU nonbank SBSDs, as
supplemented by the SEC Order on Manner and Format of Filing Unaudited
Financial and Operational Information, require an EU nonbank SBSD to
file an unaudited SEC Form X-17A-5 Part II (``FOCUS Report'') with the
SEC on a monthly basis.\317\ The FOCUS Report is required to include,
among other statements and schedules: (i) a statement of financial
condition; (ii) a statement of the EU nonbank SBSD's capital
computation in accordance with home country Basel-Based requirements;
(iii) a statement of income/loss; and (iv) a statement of capital
withdrawals.\318\ An EU nonbank SBDS is required to file its FOCUS
Report with the SEC within 35 calendar days of the month end.\319\
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\317\ See, French Order and German Order. See also, SEC Order on
Manner and Format of Filing Unaudited Financial and Operational
Information.
\318\ See, SEC Order on Manner and Format of Filing Unaudited
Financial and Operational Information.
\319\ Id.
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3. Commission Analysis
The Commission has reviewed the EU Application and the relevant EU
laws and regulations, and has preliminarily determined that, subject to
the proposed conditions described below, the financial reporting
requirements of the EU Financial Reporting Rules are comparable to CFTC
Financial Reporting Rules in purpose and effect as they are intended to
provide the relevant EU competent authorities and the Commission,
respectively, with financial information to monitor and assess the
financial condition of nonbank SDs and their ability to absorb
decreases in firm assets and increases in firm liabilities, and to
cover losses from business activities, including swap dealing
activities, without the firm becoming insolvent.
The EU Financial Reporting Rules require EU nonbank SDs to prepare
and submit to the competent authorities on a quarterly basis unaudited
financial information that includes: (i) a statement of financial
condition; (ii) a statement of profit or loss; and (iii) a schedule of
the breakdown of financial liabilities by product and by counterparty
sector. The EU Financial Reporting Rules also require EU nonbank SDs to
prepare and submit to the competent authorities on an annual basis an
unaudited statement of changes in equity. Under the FINREP reporting
requirements, an EU nonbank SD is also required to provide its
competent authorities with additional financial information, including
a breakdown of its loans and advances by product and type of
counterparty, as well as detailed information regarding its derivatives
trading activities, collateral, and guarantees. In addition, under the
COREP reporting requirement, an EU nonbank SD is required to provide
its competent authorities on a quarterly basis with calculations in
relation to the EU nonbank SD's capital requirements and capital
ratios, among other items.
The EU Financial Reporting Rules further require an EU nonbank SD
to prepare and publish an annual audited financial report. The annual
audited financial report is required to include a statement of
financial condition and a statement of profit or loss, and must also
include relevant notes to the financial statements.\320\
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\320\ Accounting Directive, Articles 4(1), 30, and 34.
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The Commission preliminarily finds that the EU Financial Reporting
Rules impose reporting requirements that are comparable with respect to
overall form and content to the CFTC Financial Reporting Rules, which
require each nonbank SD to file, among other items, periodic unaudited
financial reports with the Commission and NFA that contain: (i) a
statement of financial condition; (ii) a statement of profit or loss;
(iii) a statement of changes in liabilities subordinated to the claims
of general creditors; (iv) a statement of changes in ownership equity;
and (v) a statement demonstrating compliance with the capital
requirements. Accordingly, the Commission has preliminarily determined
that an EU nonbank SD may comply with the financial reporting
requirements contained in Commission Regulation 23.105 by complying
with the corresponding EU Financial Reporting
[[Page 41799]]
Rules, subject to the conditions set forth below.\321\
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\321\ An EU nonbank SD that qualifies and elects to seek
substituted compliance with the EU Capital Rules must also seek
substituted compliance with the EU Financial Reporting Rules.
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The Commission is proposing to condition the Capital Comparability
Determination Order on an EU nonbank SD providing the Commission and
NFA with copies of the relevant templates of the FINREP reports and
COREP reports that correspond to the EU nonbank SD's statement of
financial condition, statement of income/loss, and statement of
regulatory capital, total risk exposure, and capital ratios. These
templates consist of FINREP templates 1.1 (Balance Sheet Statement:
assets), 1.2 (Balance Sheet Statement: liabilities), 1.3 (Balance Sheet
Statement: equity), 2 (Statement of profit or loss), and 10
(Derivatives--Trading and economic hedges), and COREP templates 1 (Own
Funds), 2 (Own Funds Requirements) and 3 (Capital Ratios). The
Commission also notes that EU nonbank SDs submit FINREP and COREP
templates in addition to the ones listed above to their competent
authorities. These templates generally provide supporting detail to the
core financial templates that the Commission is proposing to require
from each EU nonbank SD. The Commission is not proposing to require an
EU nonbank SD to file these additional FINREP and COREP templates as a
condition to the Capital Comparability Order, and alternatively would
exercise its authority under Commission Regulation 23.105(h) to direct
EU nonbank SDs to provide such additional information to the Commission
and NFA on an ad hoc basis as necessary to oversee the financial
condition of the firms.\322\
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\322\ Commission Regulation 23.105(h) provides that the
Commission or NFA may, by written notice, require any nonbank SD to
file financial or operational information as may be specified by the
Commission or NFA. 17 CFR 23.105(h).
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As noted in Section D.2. of this Determination, EU Financial
Reporting Rules require EU nonbank SDs to submit the unaudited FINREP
and COREP templates to their competent authorities on a quarterly
basis. The CFTC Financial Reporting Rules contain a more frequent
reporting requirement by requiring nonbank SDs that elect the Bank-
Based Approach to file unaudited financial information with the
Commission and NFA, on a monthly basis.\323\ The financial statement
reporting requirements are an integral part of the Commission's and
NFA's oversight programs to effectively and timely monitor nonbank SDs'
compliance with capital and other financial requirements, and for
Commission and NFA staff to assess the overall financial condition and
business operations of nonbank SDs. The Commission has extensive
experience with monitoring the financial condition of registrants
through the receipt of financial statements, including FCMs and, more
recently, nonbank SDs. Both FCMs and nonbank SDs that elect the Bank-
Based Approach or NLA Approach file financial statements with the
Commission and NFA on a monthly basis. The Commission preliminarily
believes that receiving financial information from EU nonbank SDs on a
quarterly basis is not comparable with the CFTC Financial Reporting
Rules and would impede the Commission's and NFA's ability to
effectively and timely monitor the financial condition of EU nonbank
SDs for the purposes of assessing their safety and soundness, as well
as their ability to meet obligations to creditors and counterparties
without becoming insolvent. Therefore, the Commission is preliminarily
proposing to include a condition in the Capital Comparability
Determination Order to require EU nonbank SDs to file the applicable
templates of the FINREP reports and COREP reports with the Commission
and NFA on a monthly basis. The Commission also is proposing to
condition the Capital Comparability Determination Order on the EU
nonbank SD filing the above-listed templates of the FINREP reports and
COREP reports with the Commission and NFA within 35 calendar days of
the end of each month.\324\
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\323\ Commission Regulation 23.105(d) (17 CFR 23.105(d)).
\324\ The proposed condition for EU nonbank SDs to file monthly
unaudited financial information with the Commission and NFA is
consistent with proposed conditions contained in the Commission's
proposed Capital Comparability Determinations for Japanese nonbank
SDs and Mexican nonbank SDs. See Proposed Japan Order and Proposed
Mexico Order.
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The Commission is further proposing that in lieu of filing such
FINREP and COREP reports, EU nonbank SDs that are registered with the
SEC as EU nonbank SBSDs could satisfy this condition by filing with the
CFTC and NFA, on a monthly basis, copies of the unaudited FOCUS Reports
that the EU nonbank SDs are required to file with the SEC pursuant to
the SEC French Order or SEC German Order, as supplemented by the SEC
Order on Manner and Format of Filing Unaudited Financial and
Operational Information. The FOCUS Report is required to include, among
other statements and schedules: (i) a statement of financial condition;
(ii) a statement of the EU nonbank SBSD's capital computation in
accordance with home country Basel-Based requirements; (iii) a
statement of income/loss; and (iv) a statement of capital
withdrawals.\325\
---------------------------------------------------------------------------
\325\ See, SEC Order on Manner and Format of Filing Unaudited
Financial and Operational Information.
---------------------------------------------------------------------------
The filing of a FOCUS Report would be at the election of the EU
nonbank SD as an alternative to the filing of unaudited FINREP and
COREP templates that such firms would otherwise be required to file
with the Commission and NFA pursuant to the proposed Order. Three of
the EU nonbank SDs currently registered with the SEC as EU nonbank
SBSDs would be eligible to file copies of their monthly FOCUS Report
with the Commission and NFA in lieu of the FINREP and COREP templates
and Schedule 1. An EU nonbank SD electing to file copies of its monthly
FOCUS Reports would be required to submit the reports to the Commission
and NFA within 35 calendar days of the end of each month.
In addition, the Commission is proposing to condition the Capital
Comparability Determination Order on an EU nonbank SD submitting to the
Commission and NFA copies of the EU nonbank SD's annual audited
financial report that is required to be prepared pursuant to provisions
implementing the Accounting Directive.\326\ EU nonbank SDs would be
required to file the annual audited financial report with the
Commission and NFA on the earliest of the date the report is filed with
the competent authority, the date the report is published, or the date
the report is required to be filed with the competent authority or the
date the report is required to be published pursuant to the EU
Financial Reporting Rules.
---------------------------------------------------------------------------
\326\ Accounting Directive, Articles 4, 19, and 34; French MFC,
Articles L.511-35 to L.511-38; German HGB, Section 316 et seq.
---------------------------------------------------------------------------
The Commission is also proposing to condition the Capital
Comparability Determination Order on the EU nonbank SD translating the
reports and statements into the English language with balances
converted to U.S. dollars.\327\ The Commission, however, recognizes
that the requirement to translate accounts denominated in euro to U.S.
dollars on the annual audited financial report may impact the opinion
provided by the independent auditor. The Commission is therefore
proposing
[[Page 41800]]
to accept the annual audited financial report denominated in euro,
provided that the report is translated into the English language.
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\327\ The translation of audited financial statements into the
English language and the conversion of account balances from euro to
U.S. dollars is not required to be subject to the audit of the
independent auditor. An EU nonbank SD must report the exchange rate
that it used to convert balances from euro to U.S. dollars to the
Commission and NFA as part of the financial reporting.
---------------------------------------------------------------------------
The Commission is proposing to impose these conditions as they are
necessary to ensuring that the CFTC Financial Reporting Rules and EU
Financial Reporting Rules, supplemented by the proposed conditions, are
comparable and provide the Commission and NFA with appropriate
financial information to effectively monitor the financial condition of
EU nonbank SDs. Frequent financial reporting is a central component of
the Commission's and NFA's programs for monitoring and assessing the
safety and soundness of nonbank SDs as required under Section 4s(e) of
the CEA. Although, as further discussed in Section D.2. below, the
Commission preliminarily believes that the competent authorities have
the necessary powers to supervise and enforce compliance by EU nonbank
SDs with applicable capital and financial reporting requirements, the
Commission is proposing the conditions to facilitate the timely access
to information allowing the Commission and NFA to effectively monitor
and assess the ongoing financial condition of all nonbank SDs,
including EU nonbank SDs, to help ensure their safety and soundness and
their ability to meet their financial obligations to customers,
counterparties, and creditors.
The Commission preliminarily considers that its approach of
requiring EU nonbank SDs to provide the Commission and NFA with the
selected FINREP and COREP templates and the annual audited financial
report that the firms currently file with the relevant competent
authorities strikes an appropriate balance of ensuring that the
Commission receives the financial reporting necessary for the effective
monitoring of the financial condition of the nonbank SDs, while also
recognizing the existing regulatory structure of the EU Financial
Reporting Rules. Under the proposed conditions, the EU nonbank SD would
not be required to prepare different financial reports and statements
for filing with the Commission, but would be required to prepare
selected reports and statements in the content and format used for
submissions to the relevant competent authority and translate the
reports and financial statements into the English language with
balances converted to U.S. dollars so that Commission staff may
properly understand and efficiently analyze the financial information.
Although the Commission is proposing to require submission of certain
reports (i.e., selected FINREP and COREP templates) on a more frequent
basis (monthly instead of quarterly as required by the EU Financial
Reporting Rules), the proposed conditions provide the EU nonbank SDs
with 35 calendar days from the end of each month to translate the
documents into English and to convert balances to U.S. dollars. In
addition, EU nonbank SDs that are registered as SBSDs with the SEC
would have the option of filing a copy of the FOCUS Report they submit
to the SEC in lieu of the FINREP and COREP templates. The Commission
preliminarily believes that by requiring that EU nonbank SDs file
unaudited financial reports on a monthly basis instead of quarterly,
the Commission would help ensure that the CFTC Financial Reporting
Rules and the EU Financial Reporting Rules achieve a comparable
outcome.
The Commission is also proposing to condition the Capital
Comparability Determination Order on EU nonbank SDs filing with the
Commission and NFA, on a monthly basis, the aggregate securities,
commodities, and swap positions information set forth in Schedule 1 of
Appendix B to Subpart E of Part 23.\328\ The Commission is proposing to
require that Schedule 1 be filed with the Commission and NFA as part of
the EU nonbank SD's monthly submission of selected FINREP and COREP
templates or FOCUS Report, as applicable. Schedule 1 provides the
Commission and NFA with detailed information regarding the financial
positions that a nonbank SD holds as of the end of each month,
including the firm's swap positions, which will allow the Commission
and NFA to monitor the types of investments and other activities that
the firm engages in and will enhance the Commission's and NFA's ability
to monitor the safety and soundness of the firm.
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\328\ Schedule 1 of Appendix B to Subpart E of Part 23 includes
a nonbank SD's holding of U.S Treasury securities, U.S. government
agency debt securities, foreign debt and equity securities, money
market instruments, corporate obligations, spot commodities, cleared
and uncleared swaps, cleared and non-cleared security-based swaps,
and cleared and uncleared mixed swaps in addition to other position
information.
---------------------------------------------------------------------------
The Commission is also proposing to condition the Capital
Comparability Determination Order on an EU nonbank SD submitting with
each set of selected FINREP and COREP templates, annual audited
financial report, and the applicable Schedule 1 a statement by an
authorized representative or representatives of the EU nonbank SD that
to the best knowledge and belief of the person(s) the information
contained in the respective reports and statements is true and correct,
including the translation of the reports and statements into the
English language and conversion of balances in the statements to U.S.
dollars, as applicable. The statement by the authorized representative
or representatives of the EU nonbank SD is in lieu of the oath or
affirmation required of nonbank SDs under Commission Regulation
23.105(f), and is intended to ensure that reports and statements filed
with the Commission and NFA are prepared and submitted by firm
personnel with knowledge of the financial reporting of the firm who can
attest to the accuracy of the reporting and translation.
The Commission is further proposing to condition the Capital
Comparability Determination Order on an EU nonbank SD filing the Margin
Report specified in Commission Regulation 23.105(m) with the Commission
and NFA. The Margin Report contains: (i) the name and address of each
custodian holding initial margin or variation margin on behalf of the
nonbank SD or its swap counterparties; (ii) the amount of initial and
variation margin held by each custodian on behalf of the nonbank SD and
on behalf its swap counterparties; and (iii) the aggregate amount of
initial margin that the nonbank SD is required to collect from, or post
with, swap counterparties for uncleared swap transactions.\329\
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\329\ 17 CFR 23.105(m).
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The Commission preliminarily believes that receiving this margin
information from EU nonbank SDs will assist in the Commission's
assessment of the safety and soundness of the EU nonbank SDs.
Specifically, the Margin Report would provide the Commission with
information regarding an EU nonbank SD's swap book, the extent to which
it has uncollateralized exposures to counterparties or has not met its
financial obligations to counterparties. This information, along with
the list of custodians holding both the firms' and counterparties'
collateral for swap transactions, is expected to assist the Commission
in assessing and monitoring potential financial impacts to the nonbank
SD resulting from defaults on its swap transactions. The Commission is
further proposing to require an EU nonbank SD to file the Margin Report
with the Commission and NFA within 35 calendar days of the end of each
month, which corresponds with the proposed timeframe for the EU nonbank
SD to file the selected FINREP and COREP templates or FOCUS Report, as
applicable, and proposing to require the Margin Report to be prepared
in the
[[Page 41801]]
English language with balances reported in U.S. dollars.
The Commission notes that the proposed conditions in the EU Capital
Comparability Determination Order are consistent with the proposed
conditions set forth in the proposed Capital Comparability
Determination Orders for Japan and Mexico,\330\ and reflects the
Commission's approach of preliminarily determining that non-U.S.
nonbank SDs could meet their financial statement reporting obligations
to the Commission by filing financial reports currently prepared for
home country regulators, albeit in the case of certain financial
reports under a more frequent submission schedule, provided such
reports are translated into English language and, in certain
circumstances, balances expressed in U.S. dollars. The Commission's
proposed conditions also include certain financial information and
notices that the Commission believes are necessary for effective
monitoring of EU nonbank SDs that are not currently part of the
relevant EU authorities' supervision regimes.
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\330\ See Proposed Japan Order and Proposed Mexico Order.
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The Commission is not proposing to require that an EU nonbank SD
that has been approved by the relevant competent authority to use
capital models files with the Commission or NFA the monthly model
metric information contained in Commission Regulation 23.105(k) \331\
or that an EU nonbank SD files with the Commission or NFA the monthly
counterparty credit exposure information specified in Commission
Regulation 23.105(l) and Schedules 2, 3, and 4 of Appendix B to Subpart
E of Part 23.\332\
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\331\ Commission Regulation 23.105(k) requires a nonbank SD that
has obtained approval from the Commission or NFA to use internal
capital models to submit to the Commission and NFA each month
information regarding its risk exposures, including VaR and credit
risk exposure information when applicable. The model metrics are
intended to provide the Commission and NFA with information that
would assist with the ongoing oversight and assessment of internal
market risk and credit risk models that have been approved for use
by a nonbank SD. 17 CFR 23.105(k).
\332\ Commission Regulation 23.105(l) requires each nonbank SD
to provide information to the Commission and NFA regarding its
counterparty credit concentration for the 15 largest exposures in
derivatives, a summary of its derivatives exposures by internal
credit ratings, and the geographic distribution of derivatives
exposures for the 10 largest countries in Schedules 2, 3, and 4,
respectively. 17 CFR 23.105(l).
---------------------------------------------------------------------------
The Commission, in making the preliminary determination to not
require an EU nonbank SD to file the model metrics and counterparty
exposures required by Commission Regulations 23.105(k) and (l),
respectively, recognizes that NFA's current risk monitoring program
requires each bank SD and each nonbank SD, including each EU nonbank
SD, to file risk metrics addressing market risk and credit risk with
NFA on a monthly basis. NFA's monthly risk metric information includes:
(i) VaR for interest rates, credit, foreign exchange, equities,
commodities, and total VaR; (ii) total stressed VaR; (iii) interest
rate, credit spread, foreign exchange market, and commodity
sensitivities; (iv) total swaps current exposure both before and after
offsetting against collateral held by the firm; and (v) a list of the
15 largest swaps counterparty current exposures before collateral and
net of collateral.\333\
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\333\ See NFA Financial Requirements, Section 17--Swap Dealer
and Major Swap Participant Reporting Requirements, and Notice to
Members--Monthly Risk Data Reporting for Swap Dealers (May 30,
2017).
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Although there are differences in the information required under
Commission Regulations 23.105(k) and (l), the NFA risk metrics provide
a level of information that allows NFA to identify SDs that may pose
heightened risk and to allocate appropriate NFA regulatory oversight
resources. The Commission preliminarily believes that the proposed
financial statement reporting set forth in the proposed Capital
Comparability Determination Order, and the risk metric and counterparty
exposure information currently reported by nonbank SDs (including EU
nonbank SDs) under NFA rules, provide the appropriate balance of
recognizing the comparability of the EU Financial Reporting Rules to
the CFTC Financial Reporting Rules while also ensuring that the
Commission and NFA receive sufficient data to monitor and assess the
overall financial condition of EU nonbank SDs. The Commission has
access to the monthly risk metric filings collected by NFA. In
addition, the Commission retains authority to request EU nonbank SDs to
provide information regarding their model metrics and counterparty
exposures on an ad hoc basis.
Furthermore, the Commission notes that although the EU Financial
Reporting Rules do not contain an analogue to the CFTC's requirements
for nonbank SDs to file monthly model metric information and
counterparty exposures information, the competent authorities have
access to comparable information. More specifically, under the EU
Financial Reporting Rules, the competent authorities have broad powers
to request any information necessary for the exercise of their
functions.\334\ As such, the competent authorities have access to
information allowing them to assess the ongoing performance of risk
models and to monitor the EU nonbank SD's credit exposures, which may
be comprised of credit exposures to primarily other EU counterparties.
In addition, the COREP reports, which EU nonbank SDs are required to
file with the competent authority on a quarterly basis, include
information regarding the EU nonbank SD's risk exposure amounts,
including risk-weighted exposure amounts for credit risk.\335\
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\334\ See CRD, Article 65(3)(a), French MFC, Article L.612-24,
and SSM Regulation, Article 10 (indicating that competent
authorities have broad information gathering powers).
\335\ See CRR Reporting ITS, Annex I.
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The Commission invites public comment on its analysis above,
including comment on the EU Application and relevant EU Financial
Reporting Rules. The Commission also invites comment on the proposed
conditions listed above and on the Commission's proposal to exclude EU
nonbank SDs from certain reporting requirements outlined above.
Specifically, the Commission requests comment on its preliminary
determination to not require EU nonbank SDs to submit the information
set forth in Commission Regulations 23.105(k) and (l). Are there
specific elements of the data required under Commission Regulations
23.105(k) and (l) that the Commission should require of EU nonbank SDs
for purposes of monitoring model performance?
The Commission requests comment on the proposed filing dates for
the reports and information specified above. Specifically, do the
proposed filing dates provide sufficient time for EU nonbank SDs to
prepare the reports, translate the reports into English, and, where
required, convert balances into U.S. dollars? If not, what period of
time should the Commission consider imposing on one or more of the
reports?
The Commission also requests specific comment regarding the setting
of compliance dates for any new reporting obligations that the proposed
Capital Comparability Determination Order would impose on EU nonbank
SDs. In this connection, if the Commission were to require EU nonbank
SDs to file the Margin Report discussed above and included in the
proposed Order below, how much time would EU nonbank SDs need to
develop new systems or processes to capture information that is
required? Would EU nonbank SDs need a period of time to develop any
systems or processes to
[[Page 41802]]
meet any other reporting obligations in the proposed Capital
Comparability Determination Order? If so, what would be an appropriate
amount of time for an EU nonbank SD to develop and implement such
systems or processes?
E. Notice Requirements
1. CFTC Nonbank SD Notice Reporting Requirements
The CFTC Financial Reporting Rules require nonbank SDs to provide
the Commission and NFA with written notice of certain defined
events.\336\ The notice provisions are intended to provide the
Commission and NFA with an opportunity to assess whether the
information contained in the notices indicates the existence of actual
or potential financial and/or operational issues at a nonbank SD, and,
when necessary, allows the Commission and NFA to engage the nonbank SD
in an effort to minimize potential adverse impacts on swap
counterparties and the larger swaps market. The notice provisions are
part of the Commission's overall program for helping to ensure the
safety and soundness of nonbank SDs and the swaps markets in general.
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\336\ 17 CFR 23.105(c).
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The CFTC Financial Reporting Rules require a nonbank SD to provide
written notice within specified timeframes if the firm is: (i)
undercapitalized; (ii) fails to maintain capital at a level that is in
excess of 120 percent of its minimum capital requirement; or (iii)
fails to maintain current books and records.\337\ A nonbank SD is also
required to provide written notice if the firm experiences a 30 percent
or more decrease in excess regulatory capital from its most recent
financial report filed with the Commission.\338\ A nonbank SD also is
required to provide notice if the firm fails to post or collect initial
margin for uncleared swap and non-cleared security-based swap
transactions or exchange variation margin for uncleared swap and non-
cleared security-based swap transactions as required by the
Commission's uncleared swaps margin rules or the SEC's non-cleared
security-based swaps margin rules, respectively, if the aggregate is
equal to or greater than: (i) 25 percent of the nonbank SD's required
capital under Commission Regulation 23.101 calculated for a single
counterparty or group of counterparties that are under common ownership
or control; or (ii) 50 percent of the nonbank SD's required capital
under Commission Regulation 23.101 calculated for all of the firm's
counterparties.\339\
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\337\ 17 CFR 23.105(c)(1), (2), and (3).
\338\ 17 CFR 23.105(c)(4).
\339\ 17 CFR 23.105(c)(7).
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The CFTC Financial Reporting Rules further require a nonbank SD to
provide notice two business days prior to a withdrawal of capital by an
equity holder that would exceed 30 percent of the firm's excess
regulatory capital.\340\ Finally, a nonbank SD that is dually-
registered with the SEC as an SBSD or major security based swap
participant (``MSBSP'') must file a copy of any notice with the
Commission and NFA that the SBSD or MSBSP is required to file with the
SEC under SEC Rule 18a-8 (17 CFR 240.18a-8).\341\ SEC Rule 18a-8
requires SBSDs and MSBSPs to provide written notice to the SEC for
comparable reporting events as in the CFTC Capital Rule in Commission
Regulation 23.105(c), including if a SBSD or MSBSP is undercapitalized
or fails to maintain current books and records.
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\340\ 17 CFR 23.105(c)(5).
\341\ 17 CFR 23.105(c)(6).
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2. EU Nonbank Swap Dealer Notice Requirements
The EU capital and resolution frameworks require EU nonbank SDs to
provide certain notices to competent authorities concerning the firm's
compliance with relevant laws and regulations. The EU Financial
Reporting Rules require an EU nonbank SD to provide notice within five
business days to the competent authority \342\ if the firm fails to
meet its combined buffer requirement, which at a minimum consists of a
capital conservation buffer of 2.5 percent of the EU nonbank SD's total
risk exposure amount.\343\ As noted earlier, to meet its capital buffer
requirements, an EU nonbank SDs must hold common equity tier 1 capital
in addition to the minimum common equity tier 1 ratio requirement of
4.5 percent of the firm's core capital requirement of 8 percent of the
firm's total risk exposure amount. The notice to the competent
authority must be accompanied by a capital conservation plan that sets
out how the EU nonbank SD will restore its capital levels.\344\ The
capital conservation plan is required to include: (i) estimates of
income and expenditures and a forecast balance sheet; (ii) measures to
increase the capital ratios of the EU nonbank SD; (iii) a plan and
timeframe for the increase in the capital of the EU nonbank SD with the
objective of meeting fully the combined buffer requirement; and (iv)
any other information that the competent authority considers to be
necessary to assess the capital conservation plan.\345\
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\342\ As further discussed in Section F.2. below, the relevant
prudential competent authority may either be the national competent
authority with jurisdiction to oversee compliance with the EU
Capital Rules and the EU Financial Reporting Rules or, for EU
nonbank SDs that are authorized as credit institutions and qualify
as ``significant supervised entities,'' the ECB. See generally SSM
Regulation and SSM Framework Regulation.
\343\ CRD, Article 142; French MFC, Article L.511-41-1-A; French
Ministerial Order on Capital Buffers, Articles 61 to 64; German KWG,
Sections 10i(2) to (9). The combined capital buffer requirement is
the total common equity tier 1 capital required to meet the
requirement for the capital conservation buffer required by Article
129 of CRD, extended to include, as applicable, an institution-
specific countercyclical buffer required by Article 130 of CRD, a G-
SII buffer required by Article 131(4) of CRD, an O-SII buffer
required by Article 131(5) of CRD, and a systemic risk buffer
required by Article 133 of CRD. CRD, Article 128.
\344\ Id., Article 142(1); French Ministerial Order on Capital
Buffers, Article 61; German KWG, Section 10i(6). The competent
authority may extend the filing deadline, and require the EU nonbank
SD to file the capital conservation plan within 10 days of the firm
identifying that it failed to meet the applicable buffer
requirements.
\345\ Id., Article 142(2); French Ministerial Order on Capital
Buffers, Article 62; German KWG, Section 10i(6).
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The relevant competent authority is required to assess the capital
conservation plan, and may approve the plan only if it considers that
the plan would be reasonably likely to conserve or raise sufficient
capital to enable the EU nonbank SD to meet its combined capital buffer
requirement within a timeframe that the competent authority considers
to be appropriate.\346\ If the relevant competent authority does not
approve the capital conservation plan, the competent authority may
impose requirements for the EU nonbank SD to increase its capital to
specified levels within a specified time or the competent authority may
impose more restrictions on distributions.\347\
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\346\ Id., Article 142(3); French MFC, Article L.511-41-1-1;
French Ministerial Order on Capital Buffers, Article 63; German KWG,
Section 10i(7).
\347\ Id., Article 142(4); French MFC, Article L.511-41-1-A;
French Ministerial Order on Capital Buffers, Article 64 and French
Ministerial Order on Distribution Restrictions, Articles 2 to 9;
German KWG, Section 10i(8).
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In addition, an EU nonbank SD must immediately notify its relevant
resolution authority in situations where the firm meets the combined
buffer requirement, but fails to meet the combined buffer requirement
when considered in addition to the applicable MREL requirements.\348\
The EU nonbank SD must also notify the relevant resolution authority if
it
[[Page 41803]]
considers the firm to be failing or likely to fail.\349\
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\348\ BRRD, Article 16a; French MFC, Article L.613-56 III and
French Ministerial Order on Distribution Restrictions, Articles 7
and 8; German SAG, Article 58a.
\349\ BRRD, Article 81(1); French MFC, Article L.613-49; German
SAG, Section 138(1).
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Furthermore, if an EU nonbank SD breaches its liquidity or MREL
requirements, the EU authorities possess wide-ranging tools to deal
with the firm's financial deterioration. Specifically, the competent
authority may impose administrative penalties or other administrative
measures, including prudential capital charges, if an EU nonbank SD's
liquidity position repeatedly or persistently falls below the liquidity
and stable funding requirements established at the national or EU
level.\350\
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\350\ CRD, Articles 67(1)(j) and 105; French MFC, Articles
L.511-41-3 and L.612-40; German KWG, Section 45(1), (2) and (3),
36(1) and (3).
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In addition, if MREL is breached, the EU nonbank SD's resolution
authority may take early measures to intervene, such as requiring
management to take certain actions, order members of management to be
removed or replaced, or require changes to the firm's business strategy
or legal or operational structure, among other measures.\351\ If
additional requirements are met, it is also possible that resolution
authorities may assess the EU nonbank SD as ``failing or likely to
fail,'' triggering a resolution action, which could occur even before
the firm actually breached its minimum capital requirements.\352\ A
breach of the EU nonbank SD's MREL requirements may also trigger
restrictions on the firm's ability to make certain distributions (e.g.,
paying certain dividends or employee bonuses).\353\
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\351\ BRRD, Article 27(1); French MFC, Article L.511-41-5;
German SAG, Section 36(1).
\352\ BRRD, Article 32(1)(a); French MFC, Article L.613-49;
German SAG, Section 62(2).
\353\ BRRD, Article 16a; French MFC, Article L.613-56 III and
French Ministerial Order on Distribution Restrictions, Articles 7
and 8; German SAG, Article 58a.
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3. Commission Analysis
The Commission has reviewed the EU Application and the relevant EU
laws and regulations, and has preliminarily determined that the EU
Financial Reporting Rules related to notice provisions, subject to the
conditions specified below, are comparable to the notice provisions of
the CFTC Financial Reporting Rules. The Commission is therefore
proposing to issue a Capital Comparability Determination Order
providing that an EU nonbank SD may comply with the notice provisions
required under EU laws and regulations in lieu of certain notice
provisions required of nonbank SDs under Commission Regulation
23.105(c),\354\ subject to the conditions set forth below.
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\354\ 17 CFR 23.105(c).
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The notice provisions contained in Commission Regulation 23.105(c)
are intended to provide the Commission and NFA with information in a
prompt manner regarding actual or potential financial or operational
issues that may adversely impact the safety and soundness of a nonbank
SD by impairing the firm's ability to meet its obligations to
counterparties, creditors, and the general swaps market. Upon the
receipt of a notice from a nonbank SD under Commission Regulation
23.105(c), the Commission and NFA initiate reviews of the facts and
circumstances that resulted in the notice being filed including, as
appropriate, communicating with personnel of the nonbank SD. The review
of the facts and the interaction with the personnel of the nonbank SD
provide the Commission and NFA with information to develop an
assessment of whether it is necessary for the nonbank SD to take
remedial action to address potential financial or operational issues,
and whether the remedial actions instituted by the nonbank SD properly
address the issues that are the root cause of the operational or
financial issues. Such actions may include the infusion of additional
capital into the firm, or the development and implementation of
additional internal controls to address operational issues. The notice
filings further allow the Commission and NFA to monitor the firm's
performance after the implementation of remedial actions to assess the
effectiveness of such actions.
The EU Financial Reporting Rules require an EU nonbank SD to
provide notice to competent authorities if the firm fails to maintain a
minimum capital ratio of common equity tier 1 capital to risk-weighted
assets equal or greater than 7 percent (4.5 percent of the core capital
requirement plus the 2.5 percent capital conservation buffer
requirement, assuming no other capital buffer requirements apply). The
EU nonbank SD is also required to file a capital conservation plan with
its notice to the competent authority. The capital conservation plan is
required to contain information regarding actions that the EU nonbank
SD will take to ensure proper capital adequacy.
The Commission has preliminarily determined that the requirement
for an EU nonbank SD to provide notice of a breach of its capital
buffer requirements to its competent authority is not sufficiently
comparable in purpose and effect to the CFTC notice provisions
contained in Commission Regulation 23.105(c)(1) and (2),\355\ which
require a nonbank SD to provide notice to the Commission and to NFA if
the firm fails to meet its minimum capital requirement or if the firm's
regulatory capital falls below 120 percent of its minimum capital
requirement (``Early Warning Level''). The requirement for an EU
nonbank SD to provide notice of a breach of its capital buffer
requirements does not achieve a comparable outcome to the CFTC's Early
Warning Level requirement due to the difference in the thresholds
triggering a notice requirement in the respective rule sets.
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\355\ 17 CFR 23.105(c)(1) and (2).
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The requirement for a nonbank SD to file notice with the Commission
and NFA if the firm becomes undercapitalized or if the firm experiences
a decrease of excess regulatory capital below defined levels is a
central component of the Commission's and NFA's oversight program for
nonbank SDs.\356\ Therefore, the Commission preliminarily believes that
it is necessary for the Commission and NFA to receive copies of notices
filed under Article 142 of CRD by EU nonbank SDs alerting competent
authorities of a breach of the EU nonbank SD's combined capital buffer.
The notice must be filed by the EU nonbank SD within 24 hours of the
filing of the notice with the relevant competent authority, and the
Commission expects that, upon the receipt of a notice, Commission staff
and NFA staff will engage with staff of the EU nonbank SD to obtain an
understanding of the facts that led to the filing of the notice and
will discuss with the EU nonbank SD the firm's capital conservation
plan. The proposed condition would not require the EU nonbank SD to
file copies of its capital conservation plan with the Commission or
NFA. To the extent Commission staff needs further information from the
EU nonbank SD, the Commission expects to request such information as
part of its assessment of the notice and its communications with the EU
nonbank SD.
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\356\ See Commission Regulation 23.105(c)(4), which requires a
nonbank SD to file notice with the Commission and NFA if it
experiences decrease in excess capital of 30 percent or more from
the excess capital reported in its last financial filing with the
Commission. 17 CFR 23.105(c)(4).
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In addition, due to the lack of a sufficiently comparable analogue
to the CFTC Financial Reporting Rules' Early Warning Level requirement,
the Commission is proposing to condition the Capital Comparability
Determination Order to require an EU nonbank SD to file a notice with
the
[[Page 41804]]
Commission and NFA if the firm's capital ratio does not equal or exceed
12.6 percent.\357\ The proposed condition would further require the EU
nonbank SD to file the notice with the Commission and NFA within 24
hours of when the firm knows or should have known that its regulatory
capital was below 120 percent of its minimum capital requirement. The
timing requirement for the filing of the proposed notice with the
Commission and NFA is consistent with the Commission's requirements for
an FCM or a nonbank SD, which are both required to file an Early
Warning Level notice with the Commission and NFA when the firm knows or
should have known that its regulatory capital is below specified
reporting levels.\358\ The requirement for a firm to file a notice with
the Commission when it knows or should have known that its capital is
below the reporting level is designed to prevent a situation where a
firm's deficient recordkeeping leads to an inadequate monitoring of the
Early Warning Level threshold. More generally, the ``should have
known'' part of the timing standard for the filing of the proposed
notice is intended to cover facts and circumstances that should
reasonably lead the firm to believe that its regulatory capital is
below 120 percent of the minimum requirement.\359\ In practice, even if
the EU nonbank SD's books and records do not reflect a decrease of
regulatory capital below 120 percent of the minimum requirement or if
the computations that may reveal a decrease of regulatory capital below
120 percent have not been made yet, the firm would be expected to
provide notice if it became aware of deficiencies in its recordkeeping
processes that could result in inaccurate recording of the firm's
capital levels or if it had other reasons to believe its regulatory
capital is below the Early Warning Level threshold.\360\
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\357\ The Commission's proposed reporting level of 12.6 percent
reflects the aggregate of the EU nonbank SD's core capital
requirement of 8 percent and capital conservation buffer requirement
of 2.5 percent, multiplied by a factor of 1.20. For purposes of the
calculation, the Commission proposes that the 20 percent capital
increase must be comprised of common equity tier 1 capital (i.e.,
common equity tier 1 capital must comprise a minimum of 8.4 percent,
which reflects the aggregate of the 4.5 percent core common equity
tier 1 capital requirement and the 2.5 percent capital conservation
buffer requirement, multiplied by a factor of 1.20).
\358\ 17 CFR 1.12 and 17 CFR 23.105(c)(ii)(2).
\359\ This interpretation is consistent with the Commission's
discussion of the timing standard in the preamble to the 1998 final
rule adopting amendments to Commission Regulation 1.12, where the
Commission noted that the part of the standard requiring an FCM to
report when it ``should know'' of a problem may be defined as the
point at which a party, in the exercise of reasonable diligence,
should become aware of an event. See 63 FR 45711 at 45713.
\360\ To that point, in discussing the standard applicable to
the timing requirement for the filing of a notice by an FCM to
report an undersegregated or undersecured condition (i.e., situation
where the FCM has insufficient funds in accounts segregated for the
benefit of customers trading on U.S. contract markets or has
insufficient funds set aside for customers trading on non-U.S.
markets to meet the FCM's obligations to its customers), the
Commission noted that an obligation to file a notice could arise
even before the required computations that would reveal deficiencies
must be made. See id.
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As noted above, a purpose of the proposed Early Warning Level
notice provision is to allow the Commission and NFA to initiate
conversations and fact finding with a registrant that may be
experiencing operational or financial issues that may adversely impact
the firm's ability to meet its obligations to market participants,
including customers or swap counterparties. The notice filing is a
central component of the Commission's and NFA's oversight program, and
the Commission believes that a firm that is experiencing operational
challenges that prevent the firm from definitively computing its
capital level during a period when it recognizes from the facts and
circumstances that the firm's capital level may be below the reporting
threshold should file the notice with the Commission and NFA.
Therefore, the Commission preliminarily deems it appropriate to include
a similar early warning notice condition in the Capital Comparability
Determination Order.
The EU Financial Reporting Rules also do not contain an explicit
requirement for an EU nonbank SD to notify its competent authority if
the firm fails to maintain current books and records, experiences a
decrease in regulatory capital over levels previously reported, or
fails to collect or post initial margin with uncleared swap
counterparties that exceed certain threshold levels.\361\ The EU
Financial Reporting Rules also do not require an EU nonbank SD to
provide the relevant competent authority with advance notice of equity
withdrawals initiated by equity holders that exceed defined amounts or
percentages of the firm's excess regulatory capital.\362\
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\361\ 17 CFR 23.105(c)(3), (4), and (7).
\362\ Commission Regulation 23.105(c)(5) requires a nonbank SD
to provide written notice to the Commission and NFA two business
days prior to the withdrawal of capital by action of the equity
holders if the amount of the withdrawal exceeds 30 percent of the
nonbank SD's excess regulatory capital. 17 CFR 23.105(c)(5).
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To ensure that the Commission and NFA receive prompt information
concerning potential operational or financial issues that may adversely
impact the safety and soundness of an EU nonbank SD, the Commission is
proposing to condition the Capital Comparability Determination Order to
require EU nonbank SDs to file certain notices required under the CFTC
Financial Reporting Rules with the Commission and NFA. In this
connection, the Commission is proposing to condition the Capital
Comparability Determination Order on an EU nonbank SD providing the
Commission and NFA with notice if the firm fails to maintain current
books and records with respect to its financial condition and financial
reporting requirements. For avoidance of doubt, in this context the
Commission believes that books and records would include current
ledgers or other similar records which show or summarize, with
appropriate references to supporting documents, each transaction
affecting the EU nonbank SD's asset, liability, income, expense and
capital accounts in accordance with the accounting principles accepted
by the relevant competent authorities.\363\ The Commission
preliminarily believes that the maintenance of current books and
records is a fundamental and essential component of operating as a
registered nonbank SD and that the failure to comply with such a
requirement may indicate an inability of the firm to promptly and
accurately record transactions and to ensure compliance with regulatory
requirements, including regulatory capital requirements. Therefore, the
proposed Order would require an EU nonbank SD to provide the Commission
and NFA with a written notice within 24 hours if the firm fails to
maintain books and records on a current basis.
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\363\ For comparison, see Commission Regulation 23.105(b), which
similarly defines the term ``current books and records'' as used in
the context of the Commission's requirements. 17 CFR 23.105(b).
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The proposed Capital Comparability Determination Order would also
require an EU nonbank SD to file notice with the Commission and NFA if:
(i) a single counterparty, or group of counterparties under common
ownership or control, fails to post required initial margin or pay
required variation margin on uncleared swap and security-based swap
positions that, in the aggregate, exceeds 25 percent of the EU nonbank
SD's minimum capital requirement; (ii) counterparties fail to post
required initial margin or pay required variation margin to the EU
nonbank SD for uncleared swap and security-based swap positions that,
in the aggregate, exceeds 50 percent of the EU nonbank
[[Page 41805]]
SD's minimum capital requirement; (iii) an EU nonbank SD fails to post
required initial margin or pay required variation margin for uncleared
swap and security-based swap positions to a single counterparty or
group of counterparties under common ownership and control that, in the
aggregate, exceeds 25 percent of the EU nonbank SD's minimum capital
requirement; and (iv) an EU nonbank SD fails to post required initial
margin or pay required variation margin to counterparties for uncleared
swap and security-based swap positions that, in the aggregate, exceeds
50 percent of the EU nonbank SD's minimum capital requirement. The
Commission is proposing to require this notice so that it and the NFA
may commence communication with the EU nonbank SD and the relevant
competent authority in order to obtain an understanding of the facts
that have led to the failure to exchange material amounts of initial
margin and variation margin in accordance with the applicable margin
rules, and to assess whether there is a concern regarding the financial
condition of the firm that may impair its ability to meet its financial
obligations to customers, counterparties, creditors, and general market
participants, or otherwise adversely impact the firm's safety and
soundness.
The proposed Capital Determination Order would not require an EU
nonbank SD to file notices with the Commission and NFA concerning
withdrawals of capital or changes in capital levels as such information
will be reflected in the financial statement reporting filed with the
Commission and NFA as conditions of the Order, and because the EU
nonbank SD's capital levels are monitored by the relevant competent
authority, which the Commission preliminarily believes renders the
separate reporting to the Commission superfluous.
The proposed Capital Comparability Determination Order would
require an EU nonbank SD to file any notices required under the Order
with the Commission and NFA in English and, where applicable, to
reflect any balances in U.S. dollars. Each notice required by the
proposed Capital Comparability Determination Order must be filed in
accordance with instructions issued by the Commission or NFA.\364\
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\364\ The proposed conditions for EU nonbank SDs to file a
notice with the Commission and NFA if the firm fails to maintain
current books and records or fails to collect or post margin with
uncleared swap counterparties that exceed the above-referenced
threshold levels are consistent with the proposed conditions in the
proposed Capital Comparability Determination Orders for Japan and
Mexico. See Proposed Japan Order and Proposed Mexico Order.
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The Commission invites public comment on its analysis above,
including comment on the EU Application and relevant EU Financial
Reporting Rules. The Commission also invites comment on the proposed
conditions to the Capital Comparability Determination Order that are
listed above.
The Commission requests comment on the timeframes set forth in the
proposed conditions for EU nonbank SDs to file notices with the
Commission and NFA. In this regard, the proposed conditions would
require EU nonbank SDs to file certain written notices with the
Commission within 24 hours of the occurrence of a reportable event or
of being alerted to a reportable event by the relevant competent
authority. These notices would have to be translated into English prior
to being filed with the Commission and NFA. The Commission requests
comment on the issues EU nonbank SDs may face meeting the filing
requirements given time-zone difference, translation, and governance
issues, as applicable. The Commission also requests specific comment
regarding the setting of compliance dates for the notice reporting
conditions that the proposed Capital Comparability Determination Order
would impose on EU nonbank SDs.
F. Supervision and Enforcement
1. Commission and NFA Supervision and Enforcement of Nonbank SDs
The Commission and NFA conduct ongoing supervision of nonbank SDs
to assess their compliance with the CEA, Commission regulations, and
NFA rules by reviewing financial reports, notices, risk exposure
reports, and other filings that nonbank SDs are required to file with
the Commission and NFA. The Commission and/or NFA also conduct periodic
examinations as part of the supervision of nonbank SDs, including
routine onsite examinations of nonbank SDs' books, records, and
operations to ensure compliance with CFTC and NFA requirements.\365\
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\365\ Section 17(p)(2) of the CEA requires NFA as a registered
futures association to establish minimum capital and financial
requirements for non-bank SDs and to implement a program to audit
and enforce compliance with such requirements. 7 U.S.C. 21(p)(2).
Section 17(p)(2) further provides that NFA's capital and financial
requirements may not be less stringent than the capital and
financial requirements imposed by the Commission.
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As noted in Section D.1. above, financial reports filed by a
nonbank SD provide the Commission and NFA with information necessary to
ensure the firm's compliance with minimum capital requirements and to
assess the firm's overall safety and soundness and its ability to meet
its financial obligations to customers, counterparties, and creditors.
A nonbank SD is also required to provide written notice to the
Commission and NFA if certain defined events occur, including that the
firm is undercapitalized or maintains a level of capital that is less
than 120 percent of the firm's minimum capital requirements.\366\ The
notice provisions, as stated in Section E.1. above, are intended to
provide the Commission and NFA with information of potential issues at
a nonbank SD that may impact the firm's ability to maintain compliance
with the CEA and Commission regulations. The Commission and NFA also
have the authority to require a nonbank SD to provide any additional
financial and/or operational information on a daily basis or at such
other times as the Commission or NFA may specify to monitor the safety
and soundness of the firm.\367\
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\366\ See 17 CFR 23.105(c).
\367\ See 17 CFR 23.105(h).
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The Commission also has authority to take disciplinary actions
against a nonbank SD for failing to comply with the CEA and Commission
regulations. Section 4b-1(a) of the CEA \368\ provides the Commission
with exclusive authority to enforce the capital requirements imposed on
nonbank SDs adopted under Section 4s(e) of the CEA.\369\
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\368\ 7 U.S.C. 6b-1(a).
\369\ 7 U.S.C. 6s(e).
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2. EU Authorities' Supervision and Enforcement of EU Nonbank SDs
Supervision of EU nonbank SDs' compliance with the EU Capital Rules
and the EU Financial Reporting Rules is conducted by the ECB and the
relevant national competent authorities in the EU Member States. EU
nonbank SDs that are registered as credit institutions and that qualify
as ``significant supervised entities'' fall under the direct authority
of the ECB and are supervised within the ``Single Supervisory
Mechanism'' (``SSM'').\370\ Within the SSM, the ECB supervises firms
for compliance with the EU Capital Rules and the EU Financial Reporting
Rules through joint supervisory teams (``JSTs''), comprised of ECB
staff and staff of the national competent
[[Page 41806]]
authorities.\371\ EU nonbank SDs that are registered as credit
institutions and that qualify as ``less significant supervised
entities,'' \372\ or EU nonbank SDs registered as investment firms that
remain subject to the CRR/CRD framework regime, fall under the direct
authority of the applicable national competent authorities.\373\
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\370\ See generally SSM Regulation and SSM Framework Regulation.
The criteria for determining whether credit institutions are
considered ``significant supervised entities'' include size,
economic importance for the specific EU Member State or the EU
economy, significance of cross-border activities, and request for or
receipt of direct public financial assistance. See SSM Regulation,
Article 6 and SSM Framework Regulation, Articles 39-44 and 50-62.
\371\ SSM Framework Regulation, Article 3.
\372\ SSM Regulation, Article 6. Entities that qualify as ``less
significant supervised entities'' are supervised by their national
competent authorities in close cooperation with the ECB. With
respect to the prudential supervision of these entities, the ECB has
the power to issue regulations, guidelines or general instructions
to the national competent authorities. SSM Regulation, Article
6(5)(a). At any time, the ECB can also decide to directly supervise
any one of these less significant supervised entities to ensure that
high supervisory standards are applied consistently. SSM Regulation,
Article 6(5)(b).
\373\ Three of the four EU nonbank SDs currently registered with
the Commission (BofA Securities Europe S.A.; Citigroup Global
Markets Europe AG; and Morgan Stanley Europe SE) are registered as
credit institutions and qualify as ``significant supervised
entities'' subject to the direct supervision of the ECB. One entity
(Goldman Sachs Paris Inc. et Cie) is registered as an investment
firm, but has a pending application for authorization as a credit
institution. The Applicants represented that Goldman Sachs Paris Inc
et Cie would likely be a categorized as a ``less significant
supervised entity'' and subject to direct supervision by the French
ACPR. According to the Applicants, however, the ECB is still
considering whether it may exercise direct supervisory authority
over the entity, pursuant to SSM Regulation, Article 6. See
Responses to Staff Questions of May 15, 2023.
Accordingly, this Section describes the supervisory powers of
the ECB and the French ACPR and refers to provisions establishing
those powers. Therefore, if a future EU nonbank SD applicant that is
subject to supervision by a national competent authority in an EU
Member State other than France, seeks substituted compliance for
some or all of the CFTC Capital Rules and CFTC Financial Reporting
Rules, the EU nonbank SD applicant must submit an application to the
Commission in accordance with Commission Regulation 23.106 (17 CFR
23.106) and provide, among other information, a description of the
ability of the relevant EU Member State regulatory authority to
supervise and enforce compliance with the relevant EU Member State's
capital adequacy and financial reporting requirements.
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The ECB and the ACPR have supervision, audit, and investigation
powers with respect to EU nonbank SDs, which include the power to
require EU nonbank SDs to provide all necessary information in order
for the authorities to carry out their supervisory tasks; \374\ examine
the books and records of EU nonbank SDs; obtain written and oral
explanations from the EU nonbank SD's management, staff, and other
persons; \375\ and conduct all necessary inspections at the business
premises of EU nonbank SDs and other group entities.\376\
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\374\ CRD, Article 65(3)(a); French MFC, Article L.612-24; and
SSM Regulation, Article 10.
\375\ CRD, Article 65(3)(b); French MFC, Article L.612-24; and
SSM Regulation, Article 11.
\376\ CRD, Article 65(3)(c); French MFC, Articles L.612-23 and
L.612-26; and SSM Regulation, Article 12.
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The competent authorities also monitor the capital adequacy of EU
nonbank SDs through supervisory measures on an ongoing basis. The
monitoring includes assessing the notices and the capital conservation
plan discussed in Section E.2. above. In addition to the tools
described in Section E.2., the relevant competent authorities are
empowered with a variety of measures to address an EU nonbank SD's
financial deterioration. Specifically, if an EU nonbank SD fails to
meet its capital or liquidity thresholds or if the competent authority
has evidence that the EU nonbank SD is likely to breach its capital or
liquidity thresholds in the next 12 months, the competent authority may
order an EU nonbank SD to comply with additional requirements,
including: (i) maintaining additional capital in excess of the minimum
requirements, if certain conditions are met; (ii) requiring that the EU
nonbank SD submit a plan to restore compliance with applicable capital
or liquidity thresholds; (iii) imposing restrictions on the business or
operations of the EU nonbank SD; (iv) imposing restrictions or
prohibitions on distributions or interest payments to shareholders or
holders of additional tier 1 capital instruments; (v) requiring
additional or more frequent reporting requirements; and (vi) imposing
additional specific liquidity requirements.\377\ The competent
authority may also withdraw an EU nonbank SD's authorization if the
firm no longer meets its minimum capital requirements.\378\
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\377\ CRD, Articles 102(1) and 104(1); French MFC, Articles
L.511-41-3 and L.612-31 to L.612-33; SSM Regulation, Article 16.
\378\ CRD Article 18; MiFID, Article 8c; French MFC, Articles
L.532-6 and L.612-40; SSM Regulation, Article 14.
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Although the relevant competent authorities generally have broad
discretion as to what powers they may exercise, the EU Capital Rules
and the EU Financial Reporting Rules specifically mandate that the
competent authorities require EU nonbank SDs to hold increased capital
when: (i) risks or elements of risks are not covered by the capital
requirements imposed by the EU Capital Rules; (ii) the EU nonbank SD
lacks robust governance arrangements, appropriate resolution and
recovery plans, processes to manage large exposures or effective
processes to maintain on an ongoing basis the amounts, types and
distribution of capital needed to cover the nature and level of risks
to which they might be exposed and it is unlikely that other
supervisory measures would be sufficient to ensure that those
requirements can be met within an appropriate timeframe; (iii) the EU
nonbank SD repeatedly fails to establish or maintain an adequate level
of additional capital to cover the guidance communicated by the
relevant competent authorities; or (iv) other entity-specific
situations deemed by the relevant competent authority to raise material
supervisory concerns.\379\
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\379\ CRD, Article 104 and 104a; French MFC, Article L.511-41-3;
German KWG, Section 6c(1); and SSM Regulation, Articles 9
(indicating that the ECB shall have all the powers and obligations
that national authorities have under EU law, unless otherwise
provided in the SSM Regulation, and that the ECB may require, by way
of instructions, that national competent authorities make use of
their powers, where the SSM Regulation does not confer such powers
to the ECB) and 16 (describing ECB's supervisory powers, including
the power to require entities subject to its authority to hold
capital in excess of the capital requirements imposed by relevant EU
law).
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The national competent authorities can also issue administrative
penalties and other administrative measures if an EU nonbank SD (or its
management) does not fully comply with its reporting requirements.\380\
These penalties and measures include: (i) public statements identifying
a firm or one or more of its managers as responsible for the breach;
(ii) cease-and-desist orders; (iii) temporary bans against a member of
the firm's management body or other manager; (iv) administrative
monetary penalties against the firm of up to 10 percent of the total
annual net turnover of the preceding year; (v) administrative monetary
penalties of up to twice the amount of the profits gained or losses
avoided because of the breach; or (vi) withdrawal of the firm's
authorization.\381\
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\380\ CRD, Articles 65, 67(1)(e) to (i) and 67(2); French MFC,
Article L.612-39 and L.612-40; German KWG, Sections 56(6) and (7),
60b(1) and (3).
\381\ Id.
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The ECB has the same powers to impose administrative monetary
penalties for breaches of directly applicable EU laws and
regulations.\382\ In addition, the ECB can instruct the national
competent authorities to open proceedings that may lead to the
imposition of non-monetary penalties for breaches of directly
applicable EU law and regulations, monetary and non-monetary penalties
for breaches of EU Member State laws implementing relevant directives,
and monetary and non-monetary penalties against natural
[[Page 41807]]
persons for breaches of relevant EU laws and regulations.\383\
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\382\ SSM Regulation, Article 18.
\383\ SSM Regulation, Article 9.
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3. Commission Analysis
Based on the above, the Commission preliminarily finds that the
competent authorities have the necessary powers to supervise,
investigate, and discipline EU nonbank SDs for compliance with the
applicable capital and financial reporting requirements, and to detect
and deter violations of, and ensure compliance with, the applicable
capital and financial reporting requirements in the EU.\384\
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\384\ The Commission, the French Autorit[eacute] des
March[eacute]s Financiers (``AMF'') (the French market conduct
regulatory authority with which the ACPR shares supervision
authority over French financial firms, including EU nonbank SDs
domiciled in France, as it regards business conduct matters), and
the German BaFin (the German financial sector regulatory authority
whose staff participates in the SSM's JSTs that conduct prudential
supervision of the two EU nonbank SDs domiciled in Germany) are
signatories to the IOSCO Multilateral Memorandum of Understanding
Concerning Consultation and Cooperation and the Exchange of
Information (revised May 2012), which covers primarily information
sharing in the context of enforcement matters.
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The Commission would expect to communicate and consult, to the
fullest extent permissible under applicable law, with the relevant
competent authorities regarding the supervision of the financial and
operational condition of the EU nonbank SDs. An appropriate MOU or
similar arrangement with the relevant competent authorities would
facilitate cooperation and information sharing in the context of
supervising the EU nonbank SDs. Such an arrangement would enhance
communication with respect to entities within the arrangement's scope
(``Covered Firms''), as appropriate, regarding: (i) general supervisory
issues, including regulatory, oversight, or other related developments;
(ii) issues relevant to the operations, activities, and regulation of
Covered Firms; and (iii) any other areas of mutual supervisory
interest, and would anticipate periodic meetings to discuss relevant
functions and regulatory oversight programs. The arrangement would
provide for the Commission and the relevant competent authority to
inform each other of certain events, including any material events that
could adversely impact the financial or operational stability of a
Covered Firm, and would provide a procedure for any on-site
examinations of Covered Firms.
In the absence of an MOU or similar information sharing
arrangement, the Commission is proposing to condition the Capital
Comparability Determination Order on an EU nonbank SD providing notice
to the Commission and NFA if its competent authority has required an EU
nonbank SD to: (i) maintain additional capital in excess of the minimum
requirements; (ii) require that the EU nonbank SD submit a plan to
restore compliance with applicable capital or liquidity thresholds;
(iii) impose restrictions on the business or operations of the EU
nonbank SD; (iv) impose restrictions or prohibitions on distributions
or interest payments to shareholders or holders of additional tier 1
capital instruments; (v) require additional or more frequent reporting
requirements; or (vi) impose additional specific liquidity
requirements.\385\ Upon receipt of such notice, the Commission and NFA
would communicate with the EU nonbank SD to obtain further information
regarding the underlying issues that prompted the competent authority
to direct the EU nonbank SD to take such actions and would obtain
information regarding how the EU nonbank SD would address the
underlying issues.
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\385\ The authority for the competent authorities to impose such
conditions or requirements is set forth in CRD, Articles 102(1) and
104(1); French MFC, Articles L.511-41-3 and L.612-31 to L.612-33;
SSM Regulation, Article 16.
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The Commission invites public comment on the EU Application, the EU
laws and regulations, and the Commission's analysis above regarding its
preliminary determination that the competent authorities in the EU and
the CFTC have supervision programs and enforcement authority that are
comparable in that the purpose of the relevant programs and authority
is to ensure that nonbank SDs maintain compliance with applicable
capital and financial reporting requirements.
IV. Proposed Capital Comparability Determination Order
A. Commission's Proposed Comparability Determination
The Commission's preliminary view, based on the EU Application and
the Commission's review of applicable EU laws and regulations, is that
the EU Capital Rules and the EU Financial Reporting Rules, subject to
the conditions set forth in the proposed Capital Comparability
Determination Order below, achieve comparable outcomes and are
comparable in purpose and effect to the CFTC Capital Rules and CFTC
Financial Reporting Rules. In reaching this preliminary conclusion, the
Commission recognizes that there are certain differences between the EU
Capital Rules and CFTC Capital Rules and certain differences between
the EU Financial Reporting Rules and the CFTC Financial Reporting
Rules. The proposed Capital Comparability Determination Order is
subject to proposed conditions that are preliminarily deemed necessary
to promote consistency in regulatory outcomes, or to reflect the scope
of substituted compliance that would be available notwithstanding
certain differences. In the Commission's preliminary view, the
differences between the two rules sets would not be inconsistent with
providing a substituted compliance framework for EU nonbank SDs subject
to the conditions specified in the proposed Order below.
Furthermore, the proposed Capital Comparability Determination Order
is limited to the comparison of the EU Capital Rules to the Bank-Based
Approach contained within the CFTC Capital Rules. As noted previously,
the Applicants have not requested, and the Commission has not
performed, a comparison of the EU Capital Rules to the Commission's NAL
Approach or TNW Approach. In addition, as discussed in Section I.C.
above, the Applicants have not requested, and the Commission has not
performed, a comparison of the capital rules for smaller EU investment
firms under IFR to the Commission's Bank-Based Approach, NAL Approach,
or TNW Approach.
B. Proposed Capital Comparability Determination Order
The Commission invites comments on all aspects of the EU
Application, relevant EU laws and regulations, the Commission's
preliminary views expressed above, the question of whether requirements
under the EU Capital Rules are comparable in purpose and effect to the
Commission's requirement for a nonbank SD to hold regulatory capital
equal to or greater than 8 percent of its uncleared swap margin amount,
and the Commission's proposed Capital Comparability Determination
Order, including the proposed conditions included in the proposed
Order, set forth below.
C. Proposed Order Providing Conditional Capital Comparability
Determination for Certain EU Nonbank Swap Dealers
It is hereby determined and ordered, pursuant to Commodity Futures
Trading Commission (``CFTC'' or ``Commission'') Regulation 23.106 (17
CFR 23.106) under the Commodity Exchange Act (``CEA'') (7 U.S.C. 1 et
seq.) that a swap dealer (``SD'') organized and domiciled in the French
Republic (``France'') or the Federal
[[Page 41808]]
Republic of Germany (``Germany'') and subject to the Commission's
capital and financial reporting requirements under Sections 4s(e) and
(f) of the CEA (7 U.S.C. 6s(e) and (f)) may satisfy the capital
requirements under Section 4s(e) of the CEA and Commission Regulation
23.101(a)(1)(i) (17 CFR 23.101(a)(1)(i)) (``CFTC Capital Rules''), and
the financial reporting rules under Section 4s(f) of the CEA and
Commission Regulation 23.105 (17 CFR 23.105) (``CFTC Financial
Reporting Rules''), by complying with certain specified requirements of
the European Union (``EU'') laws and regulations cited below and
otherwise complying with the following conditions, as amended or
superseded from time to time:
(1) The SD is not subject to regulation by a prudential regulator
defined in Section 1a(39) of the CEA (7 U.S.C. 1a(39));
(2) The SD is organized under the laws of France or Germany (``EU
Member State'') and is domiciled in France or Germany, respectively
(``EU nonbank SD'');
(3) The EU nonbank SD is licensed as a credit institution or an
investment firm in an EU Member State and is treated for the purposes
of the EU capital and financial reporting rules as an ``institution,''
as defined in Regulation (EU) No 575/2013 of the European Parliament
and of the Council of 26 June 2013 on prudential requirements for
credit institutions and amending Regulation (EU) No 648/2012 (``Capital
Requirements Regulation'' or ``CRR''), Article 4(1)(3), and Directive
2013/36/EU of the European Parliament and of the Council of 26 June
2013 on access to the activity of credit institutions and the
prudential supervision of credit institutions, amending Directive 2002/
87/EC and repealing Directives 2006/48/EC and 2006/49/EC (``Capital
Requirements Directive'' or ``CRD''), Article 3(1)(3);
(4) The EU nonbank SD is subject to and complies with: CRR and CRD
as implemented in the national laws of France and Germany
(collectively, ``EU Capital Rules'');
(5) The EU nonbank SD satisfies at all times applicable capital
ratio and leverage ratio requirements set forth in Article 92 of CRR,
the capital conservation buffer requirements set forth in Article 129
of CRD, and applicable liquidity requirements set forth in Articles 412
and 413 of CRR, and otherwise complies with the requirements to
maintain a liquidity risk management program as required under Article
86 of CRD;
(6) The EU nonbank SD is subject to and complies with: Commission
Implementing Regulation (EU) 2021/451 of 17 December 2020 laying down
implementing technical standards for the application of Regulation (EU)
No 575/2013 of the European Parliament and of the Council with regard
to supervisory reporting of institutions and repealing Implementing
Regulation (EU) No 680/2014 (``CRR Reporting ITS''); Regulation (EU)
2015/534 of the European Central Bank of 17 March 2015 on reporting of
supervisory financial information (``ECB FINREP Regulation''); and
Directive 2013/34/EU of the European Parliament and of the Council of
26 June 2013 on the annual financial statements, consolidated financial
statements and related reports of certain types of undertakings,
amending Directive 2006/43/EC of the European Parliament and of the
Council and repealing Council Directives 78/660/EEC and 83/349/EEC
(``Accounting Directive'') as implemented in the national laws of
France and Germany (collectively and together with CRR and CRD as
implemented in the national laws of France and Germany, ``EU Financial
Reporting Rules'');
(7) The EU nonbank SD is subject to prudential supervision by an EU
Member State supervisory authority with jurisdiction to enforce the
requirements set forth by the EU Capital Rules and the EU Financial
Reporting Rules or the European Central Bank (``ECB''), as applicable
(``competent authority'');
(8) The EU nonbank SD maintains at all times an amount of
regulatory capital in the form of common equity tier 1 capital as
defined in Article 26 of CRR, equal to or in excess of the equivalent
of $20 million in United States dollars (``U.S. dollars''). The EU
nonbank SD shall use a commercially reasonable and observable euro/U.S.
dollar exchange rate to convert the value of the euro-denominated
common equity tier 1 capital to U.S. dollars;
(9) The EU nonbank SD has filed with the Commission a notice
stating its intention to comply with the EU Capital Rules and the EU
Financial Reporting Rules in lieu of the CFTC Capital Rules and the
CFTC Financial Reporting Rules. The notice of intent must include the
EU nonbank SD's representation that the firm is organized and domiciled
in an EU Member State, is a licensed investment firm or a credit
institution in an EU Member State, and is subject to, and complies
with, the EU Capital Rules and EU Financial Reporting Rules. An EU
nonbank SD may not rely on this Capital Comparability Determination
Order until it receives confirmation from Commission staff, acting
pursuant to authority delegated by the Commission, that the EU nonbank
SD may comply with the applicable EU Capital Rules and EU Financial
Reporting Rules in lieu of the CFTC Capital Rules and CFTC Reporting
Rules. Each notice filed pursuant to this condition must be prepared in
the English language and submitted to the Commission via email to the
following address: [email protected];
(10) The EU nonbank SD prepares and keeps current ledgers and other
similar records in accordance with accounting principles required by
the relevant competent authority;
(11) The EU nonbank SD files with the Commission and with the
National Futures Association (``NFA'') a copy of templates 1.1 (Balance
Sheet Statement: assets), 1.2 (Balance Sheet Statement: liabilities),
1.3 (Balance Sheet Statement: equity), 2 (Statement of profit or loss),
and 10 (Derivatives--Trading and economic hedges) of the financial
reports (``FINREP'') that EU nonbank SDs are required to submit
pursuant to CRR Reporting ITS, Annex III or IV, or the ECB FINREP
Regulation, as applicable, and templates 1 (Own Funds), 2 (Own Funds
Requirements) and 3 (Capital Ratios) of the common reports (``COREP'')
that EU nonbank SDs are required to submit pursuant to CRR Reporting
ITS, Annex I. The FINREP and COREP templates must be translated into
the English language and balances must be converted to U.S. dollars.
The FINREP and COREP templates must be filed with the Commission and
NFA within 35 calendar days of the end of each month. EU nonbank SDs
that are registered as security-based swap dealers (``SBSDs'') with the
U.S. Securities and Exchange Commission (``SEC'') may comply with this
condition by filing with the Commission and NFA a copy of Form X-17A-5
(``FOCUS Report'') that the EU nonbank SD is required to file with the
SEC or its designee pursuant to an order granting conditional
substituted compliance with respect to Securities Exchange Act of 1934
Rule 18a-7. The copy of the FOCUS Report must be filed with the
Commission and NFA within 35 calendar days after the end of each month
in the manner, format and conditions specified by the SEC in Order
Specifying the Manner and Format of Filing Unaudited Financial and
Operational Information by Security-Based Swap Dealers and Major
Security-Based Swap Participants that are not U.S. Persons and are
Relying on Substituted Compliance with Respect to Rule 18a-7, 86 FR
59208 (Oct. 26, 2021);
(12) The EU nonbank SD files with the Commission and with NFA a
copy
[[Page 41809]]
of its annual audited financial statements and management report
(together, ``annual audited financial report'') that are required to be
prepared and published pursuant to Articles 4, 19, 30 and 34 of the
Accounting Directive as implemented in the national laws of France and
Germany. The annual audited financial report must be translated into
the English language and balances may be reported in euro. The annual
audited financial report must be filed with the Commission and NFA on
the earliest of the date the report is filed with the competent
authority, the date the report is published, or the date the report is
required to be filed with the competent authority or the date the
report is required to be published pursuant to the EU Financial
Reporting Rules;
(13) The EU nonbank SD files Schedule 1 of Appendix B to Subpart E
of Part 23 of the CFTC's regulations (17 CFR 23 Subpart E--Appendix B)
with the Commission and NFA on a monthly basis. Schedule 1 must be
prepared in the English language with balances reported in U.S. dollars
and must be filed with the Commission and NFA within 35 calendar days
of the end of each month;
(14) The EU nonbank SD submits with each set of FINREP and COREP
templates, annual audited financial report, and Schedule 1 of Appendix
B to Subpart E of Part 23 of the CFTC's regulations a statement by an
authorized representative or representatives of the EU nonbank SD that
to the best knowledge and belief of the representative or
representatives the information contained in the reports, including the
translation of the reports into English and conversion of balances in
the reports to U.S. dollars, is true and correct. The statement must be
prepared in the English language;
(15) The EU nonbank SD files a margin report containing the
information specified in Commission Regulation 23.105(m) (17 CFR
23.105(m)) with the Commission and with NFA within 35 calendar days of
the end of each month. The margin report must be in the English
language and balances reported in U.S. dollars;
(16) The EU nonbank SD files a notice with the Commission and NFA
within 24 hours of being informed by a competent authority that the
firm is not in compliance with any component of the EU Capital Rules or
EU Financial Reporting Rules. The notice must be prepared in the
English language;
(17) The EU nonbank SD files a notice within 24 hours with the
Commission and NFA if it fails to maintain regulatory capital in the
form of common equity tier 1 capital as defined in Article 26 of CRR,
equal to or in excess of the U.S. dollar equivalent of $20 million
using a commercially reasonable and observable euro/U.S. dollar
exchange rate. The notice must be prepared in the English language;
(18) The EU nonbank SD provides the Commission and NFA with notice
within 24 hours of filing a capital conservation plan with the relevant
competent authority pursuant to the relevant EU Member State's
provisions implementing Article 143 of CRD, indicating that the firm
has breached its combined capital buffer requirement. The notice filed
with the Commission and NFA must be prepared in the English language;
(19) The EU nonbank SD provides the Commission and NFA with notice
within 24 hours if it is required by its competent authority to
maintain additional capital or additional liquidity requirements, or to
restrict its business operations, or to comply with other requirements
pursuant to Articles 102(1) and 104(1) of CRD as implemented in the
national laws of France or to Article 16 of Council Regulation (EU) No
1024/2013 of 15 October 2013 conferring specific tasks on the European
Central Bank concerning policies relating to the prudential supervision
of credit institutions. The notice filed with the Commission and NFA
must be prepared in the English language;
(20) The EU nonbank SD files a notice with the Commission and NFA
within 24 hours if it fails to maintain its minimum requirement for own
funds and eligible liabilities (``MREL''), if such requirement is
applicable to the EU nonbank SD pursuant to Directive 2014/59/EU of the
European Parliament and of the Council of 15 May 2014 establishing a
framework for the recovery and resolution of credit institutions and
investment firms and amending Council Directive 82/891/EEC, and
Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC,
2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/
2010 and (EU) No 648/2012, of the European Parliament and of the
Council as implemented in the national laws of France and Germany. The
notice filed with the Commission and NFA must be prepared in the
English language;
(21) The EU nonbank SD files a notice with the Commission and NFA
within 24 hours of when the firm knew or should have known that its
regulatory capital fell below 120 percent of its minimum capital
requirement, comprised of the firm's core capital requirements and any
applicable capital buffer requirements. For purposes of the
calculation, the 20 percent excess capital must be in the form of
common equity tier 1 capital. The notice filed with Commission and NFA
must be prepared in the English language;
(22) The EU nonbank SD files a notice with the Commission and NFA
within 24 hours if it fails to make or keep current the financial books
and records. The notice must be prepared in the English language;
(23) The EU nonbank SD files a notice with the Commission and NFA
within 24 hours of the occurrence of any of the following: (i) a single
counterparty, or group of counterparties under common ownership or
control, fails to post required initial margin or pay required
variation margin on uncleared swap and non-cleared security-based swap
positions that, in the aggregate, exceeds 25 percent of the EU nonbank
SD's minimum capital requirement; (ii) counterparties fail to post
required initial margin or pay required variation margin to the EU
nonbank SD for uncleared swap and non-cleared security-based swap
positions that, in the aggregate, exceeds 50 percent of the EU nonbank
SD's minimum capital requirement; (iii) the EU nonbank SD fails to post
required initial margin or pay required variation margin for uncleared
swap and non-cleared security-based swap positions to a single
counterparty or group of counterparties under common ownership and
control that, in the aggregate, exceeds 25 percent of the EU nonbank
SD's minimum capital requirement; or (iv) the EU nonbank SD fails to
post required initial margin or pay required variation margin to
counterparties for uncleared swap and non-cleared security-based swap
positions that, in the aggregate, exceeds 50 percent of the EU nonbank
SD's minimum capital requirement. The notice must be prepared in the
English language;
(24) The EU nonbank SD files a notice with the Commission and NFA
of a change in its fiscal year-end approved or permitted to go into
effect by the relevant competent authority. The notice required by this
paragraph will satisfy the requirement for a nonbank SD to obtain the
approval of NFA for a change in fiscal year-end under Commission
Regulation 23.105(g) (17 CFR 23.105(g)). The notice of change in fiscal
year-end must be prepared in the English language and filed with the
Commission and NFA at least 15 business days prior to the effective
date of the EU nonbank SD's change in fiscal year-end;
(25) The EU nonbank SD or an entity acting on its behalf notifies
the
[[Page 41810]]
Commission of any material changes to the information submitted in the
application for capital comparability determination, including, but not
limited to, material changes to the EU Capital Rules or EU Financial
Reporting Rules imposed on EU nonbank SDs, the ECB or relevant EU
Member State authority's supervisory authority or supervisory regime
over EU nonbank SDs, and proposed or final material changes to the EU
Capital Rules or EU Financial Reporting Rules as they apply to EU
nonbank SDs; and
(26) Unless otherwise noted in the conditions above, the reports,
notices, and other statements required to be filed by the EU nonbank SD
with the Commission and NFA pursuant to the conditions of this Capital
Comparability Determination Order must be submitted electronically to
the Commission and NFA in accordance with instructions provided by the
Commission or NFA.
Issued in Washington, DC, on June 20, 2023, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Notice of Proposed Order and Request for Comment on an
Application for a Capital Comparability Determination Submitted on
Behalf of Nonbank Swap Dealers Domiciled in the French Republic and
Federal Republic of Germany and Subject to Capital and Financial
Reporting Requirements of the European Union--Voting Summary and
Commissioners' Statements
Appendix 1--Voting Summary
On this matter, Chairman Behnam and Commissioners Johnson,
Goldsmith Romero, Mersinger, and Pham voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Chairman Rostin Behnam in Support of the
Notice of Proposed Order and Request for Comment on the Capital
Comparability Determination Submitted on Behalf of Nonbank Swap Dealers
Domiciled in the French Republic and Federal Republic of Germany and
Subject to Capital and Financial Reporting Requirements of the European
Union
I support the Commission's proposed order and request for
comment on an application for a preliminary capital comparability
determination on behalf of four nonbank swap dealers that are
domiciled in France or Germany. All four of these EU nonbank SDs are
subject to, and comply with, the EU capital and financial reporting
rules as implemented by the national laws of France or Germany,
which the Commission has preliminarily determined are comparable to
certain capital and financial reporting requirements under the
Commodity Exchange Act and the Commission's regulations, subject to
certain conditions. This preliminary capital comparability
determination for these EU nonbank SDs is the third proposed order
and request for comment to come before the Commission since it
adopted its substituted compliance framework for non-U.S. domiciled
nonbank swap dealers in July 2020.
Appendix 3--Statement of Commissioner Kristin N. Johnson in Support of
Notice and Order on EU Capital Comparability Determination
I support the Commission's issuance of the proposed capital
comparability order for comment (Proposed Order).\1\ The Proposed
Order, if approved, will allow registered nonbank swap dealers (SDs)
organized and domiciled in France and Germany to satisfy certain
capital and financial reporting requirements under the Commodity
Exchange Act (CEA) by being subject to and complying with comparable
capital and financial reporting requirements under the European
Union (EU) laws and regulations applicable in those countries. Since
July 2020, this is the third proposed capital comparability
determination approved for comment.\2\
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\1\ The application here is by three trade associations (the
Institute of International Bankers, the International Swaps and
Derivatives Association, and the Securities Industry and Financial
Markets Association), and there are currently four nonbank swap
dealers who would be eligible to take advantage of a comparability
determination if made (France: BofA Securities Europe SA and Goldman
Sachs Paris Inc. et Cie; Germany: Citigroup Global Markets Europe AG
and Morgan Stanley Europe SE). See Letter dated Sept. 24, 2021, from
Stephanie Webster, General Counsel, Institute of International
Bankers, Steven Kennedy, Global Head of Public Policy, International
Swaps and Derivatives Association, and Kyle Brandon, Managing
Director, Head of Derivatives Policy, Securities Industry and
Financial Markets Association, https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm. There are no other nonbank SDs
registered with the Commission and organized and domiciled within
the EU.
\2\ The Commission approved a Notice of Proposed Order and
Request for Comment on an Application for a Capital Comparability
Determination from the Financial Services Agency of Japan at its
July 27, 2022 open meeting. See 87 FR 48,092 (Aug. 8, 2022); see
also Statement of Commissioner Kristin N. Johnson in Support of
Proposed Order on Japanese Capital Comparability Determination, July
27, 2022, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement072722c.
The Commission approved a Notice of Proposed Order and Request
for Comment on an Application for a Capital Comparability
Determination Submitted on Behalf of Nonbank Swap Dealers Subject to
Regulation by the Mexican Comisi[oacute]n Nacional Bancaria y de
Valores at its November 10, 2022 open meeting. See 87 FR 76374 (Dec.
13, 2022); see also Statement of Commissioner Kristin N. Johnson in
Support of Proposed Order and Request for Comment on Mexican Capital
Comparability Determination, Nov. 10, 2022, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement111022c.
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As I previously noted in the context of another recent proposed
capital comparability determination,\3\ the Commission vigilantly
monitors and surveils risk management activities by our market
participants. Capital requirements play a critical role in fostering
the safety and soundness of financial markets. Our efforts to
coordinate and harmonize regulation with regulators around the world
reinforce the adoption, implementation, and enforcement of sound
prudential and capital requirements. These requirements aim to
ensure the integrity of entities operating in these markets, to
ensure rapid identification and remediation of liquidity crises, and
to mitigate the threat of systemic risks that may threaten the
stability of domestic and global financial markets.
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\3\ See Statement of Commissioner Kristin N. Johnson in Support
of Proposed Order and Request for Comment on Mexican Capital
Comparability Determination, Nov. 10, 2022, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement111022c; see also
Statement of Commissioner Kristin N. Johnson in Support of Proposed
Order on Japanese Capital Comparability Determination, July 27,
2022, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement072722c.
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Section 4s(e) of the CEA directs the Commission to impose
capital requirements on all SDs registered with the Commission.\4\
Section 4s(f) of the CEA directs the Commission to adopt rules
imposing financial condition reporting obligations on all SDs.\5\
The Commission's capital and financial reporting requirements
adopted pursuant to these sections of the CEA are critical to
ensuring the safety and soundness of our markets by addressing and
managing risks that arise from a firm's operation as an SD.\6\
Ensuring necessary levels of capital, as well as accurate and timely
reporting about financial conditions, helps to protect swap dealers
and the broader financial markets ecosystem from shocks, thereby
ensuring solvency and resiliency. This, in turn, protects the
financial system as a whole, reducing the risk of contagion that
could arise from uncleared swaps. Financial reporting requirements
work with the capital requirements by allowing the Commission to
monitor and assess an SD's financial condition, including compliance
with minimum capital requirements. The Commission uses the
information it receives pursuant to these requirements to detect
potential risks before they materialize.
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\4\ 7 U.S.C. 6s(e).
\5\ 7 U.S.C. 6s(f).
\6\ See 7 U.S.C. 6s(e); 17 CFR subpart E.
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I support acknowledging market participants' compliance with the
regulations of foreign jurisdictions when the requirements lead to
an outcome that is comparable to the outcome of complying with the
CFTC's corresponding requirements. Moreover, notwithstanding our
issuance of the Proposed Order, the covered swap dealers domiciled
in France and Germany would remain subject to the Commission's
examination and enforcement authority. Capital adequacy and
financial reporting are pillars of risk management oversight for any
business, and, for firms operating in our markets, it is of the
utmost importance that rules governing these risk management tools
[[Page 41811]]
are effectively calibrated, continuously assessed, and fit for
purpose. The Commission's efforts in considering the Proposed Order
reflect careful and thoughtful evaluation of the comparability of
relevant standards and an attempt to coordinate our efforts to bring
transparency to the swaps market and reduce its risks to the public.
I look forward to reviewing the comments that the Commission will
receive in response to the Proposed Order.
I commend the work of staff in the Market Participants Division
and their careful consideration of this application. I commend the
staff of the Market Participants Division: Amanda Olear, Tom Smith,
Rafael Martinez, Liliya Bozhanova, Joo Hong, and Justin McPhee, as
well as the members of the Office of International Affairs for their
careful review of the capital and financial reporting requirements
for SDs organized and domiciled in France and Germany.
I also want to thank my fellow Commissioners for their support
in advancing this matter before the Commission. Successfully
implementing comparability determinations requires collaboration
between the CFTC and its partner regulators in other countries. The
EU is one of our closest partners internationally, and increased
collaboration can only be beneficial in achieving our key goals of
customer protection and market integrity.
Appendix 4--Statement of Commissioner Christy Goldsmith Romero on the
CFTC's Proposed Comparability Determination for European Swap Dealer
Capital Requirements
Today, the Commission considers efforts to safeguard the
resilience of four swap dealers in the European Union (``EU'').\1\
The proposal is part of the Commission's ``substituted compliance''
framework--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. We must ensure that our comparability assessments are sound
and do not increase risk to U.S. markets.
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\1\ The four swap dealers in the European Union are located in
France and Germany--BofA Securities Europe SA (France), Citigroup
Global Markets Europe AG (Germany), Morgan Stanley Europe SE
(Germany), and Goldman Sachs Paris Inc. et Cie (France).
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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 SD . . . and
the financial system arising from the use of swaps that are not
cleared'' \2\ and ``help ensure the safety and soundness of the
SD.'' \3\ The Commission's capital requirements, adopted in 2020,\4\
are intended to do exactly that.
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\2\ 7 U.S.C. 6s(e)(3)(A).
\3\ 7 U.S.C. 6s(e)(3)(A)(i). The capital requirements also must
``be appropriate to the risk associated with non-cleared swaps.'' 7
U.S.C. 6s(e)(3)(A)(ii).
\4\ See Commodity Futures Trading Commission, Capital
Requirements of Swap Dealers and Major Swap Participants, 85 FR
57462 (Sept. 15, 2020).
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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.
Substituted compliance must leave U.S. markets at no greater
risk than full compliance with our rules. The Commission has to
proceed cautiously given the importance of capital to financial
stability, the complexity of capital frameworks, the interconnected
nature of global derivatives markets, and the speed of contagion in
the global financial system.
First, we have to ensure that our substituted compliance
framework recognizes only those frameworks that are comparable with
respect to the most fundamental outcome--the amount of capital
required to support a swap dealer's activities. The substituted
compliance framework must result in the application of capital rules
that are legitimately a substitute for the capital protections
provided by U.S. law.
Second, the fact that a foreign regulator may have comparable
capital rules will not be enough. 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.
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. I served as the Special Inspector General for the Troubled
Asset Relief Program (``SIGTARP'') for more than a decade, providing
oversight over the U.S. Government's unprecedented taxpayer-funded
injections of hundreds of billions of dollars in capital into Wall
Street as a response to the 2008 financial crisis. I have testified
before Congress and reported to Congress about how inadequate
capitalization at the largest banks contributed to the financial
crisis, how the significant interconnections between financial
institutions posed systemic risk, and the painful toll the crisis
took on hardworking America families and small businesses.
All four swap dealers who would be able to avail themselves of
our determination today are affiliated with the largest TARP
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 two prior capital comparability
proposals,\5\ 10 of 106 registered swap dealers would be eligible to
rely on substituted compliance.\6\
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\5\ See Commodity Futures Trading Commission, Notice of Proposed
Order and Request for Comment on an Application for a Capital
Comparability Determination from the Financial Services Agency of
Japan, 87 FR 48092 (Aug. 8, 2022); See also Commodity Futures
Trading Commission, Notice of Proposed Order and Request for Comment
on an Application for a Capital Comparability Determination
Submitted on behalf of Nonbank Swap dealers subject to Regulation by
the Mexican Comision Nacional Bancaria y de Valores, 87 FR 76374
(Dec. 13, 2022).
\6\ 55 of the 107 swap dealers are subject to U.S. prudential
regulatory capital requirements.
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Strong capital requirements and areas where the Commission would
particularly benefit from public comment.
Three of the four EU swap dealers are dually-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 French and German requirements.\7\
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\7\ See Amended and Restated Order Granting Conditional
Substituted Compliance in Connection with Certain Requirements
Applicable to Non-U.S. Security-Based Swap Dealers and Major
Security-Based Swap Participants Subject to Regulation in the
Federal Republic of Germany; Amended Orders Addressing Non-U.S.
Security-Based Swap Entities Subject to Regulation in the French
Republic or the United Kingdom; and Order Extending the Time to Meet
Certain Conditions Relating to Capital and Margin, 86 FR 59797 (Oct.
28, 2021); Order Granting Conditional Substituted Compliance in
Connection with Certain Requirements Applicable to Non-U.S.
Security-Based Swap Dealers and Major Security-Based Swap
Participants Subject to Regulation in the French Republic, 86 FR
41612 (Aug. 8, 2021); and Order Specifying the Manner and Format of
Filing Unaudited Financial and Operational Information by Security-
Based Swap Dealers and Major Security-Based Swap Participants that
are not U.S. Persons and are Relying on Substituted Compliance with
Respect to Rule 18a-7, 86 FR 59208 (Oct. 26, 2021).
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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 24 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 and Mexico,\8\ one of the
most important
[[Page 41812]]
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.\9\ 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.
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\8\ See CFTC Commissioner Christy Goldsmith Romero, Proposal for
Strong Capital Requirements and Financial Reporting for Swap Dealers
in Japan, (July 27, 2022) Statement of Commissioner Christy
Goldsmith Romero Regarding the Proposal for Strong Capital
Requirements and Financial Reporting for Swap Dealers in Japan
available at https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatement072722b. See also CFTC Commissioner Christy Goldsmith
Romero, Promoting the Resilience of Swap Dealers in Mexico Through
Strong Capital Requirements and Financial Reporting, (Nov. 10, 2022)
Statement of Commissioner Christy Goldsmith Romero on a Proposed
Comparability Determination for Capital available at https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatment111022b.
\9\ This CFTC capital rule substantially exceeds the EUR 5
million minimum capital required under EU capital rules.
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Today, the Commission preliminarily finds that EU 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. For
example, the Commission proposes to permit compliance with EU
capital rules that are not necessarily anchored by a threshold
percentage of uncleared swap margin as the CFTC requires. I note
that EU 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.
In these areas, and others, public comments will be tremendously
beneficial. I approve.
Appendix 5--Statement of Commissioner Caroline D. Pham in Support of
Proposed Order and Request for Comment on Comparability Determination
for EU Nonbank Swap Dealer Capital and Financial Reporting Requirements
In order to implement Title VII of the Dodd-Frank Act and create
a comprehensive regulatory framework for over-the-counter (OTC)
derivatives markets, the Commodity Futures Trading Commission
(Commission or CFTC) promulgated rules for the registration of swap
dealers in 2012.\1\ Since that time, the Commission has issued
dozens of rules for the oversight of swap dealers and their
activities.\2\ Because swaps markets are global and involve cross-
border transactions, and both U.S. and non-U.S. swap dealers must
register with the CFTC, the Commission has also made 12
comparability determinations in order to provide for substituted
compliance for non-U.S. swap dealers with home jurisdiction
regulations that are comparable and comprehensive.\3\
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\1\ See Registration of Swap Dealers and Major Swap Participants
(Final Rule), 77 FR 2613 (Jan. 19, 2012), https://www.cftc.gov/sites/default/files/idc/groups/public/@lrfederalregister/documents/file/2012-792a.pdf.
\2\ These rules range from business conduct standards to
thresholds for registration with the CFTC. See, e.g., Business
Conduct Standards for Swap Dealers and Major Swap Participants with
Counterparties (Final Rule), 77 FR 9734 (Feb. 17, 2012).
\3\ See generally, 7 U.S.C. 2(i). The Commission created the
comparable and comprehensive standard for substituted compliance
determinations. See Cross-Border Application of Certain Swaps
Provisions of the Commodity Exchange Act (Proposed Rule), 77 FR
41214, 41230 (July 12, 2012). The comparable standard is now in CFTC
regulations 23.23 for swap dealer registration, 23.160 for margin,
and 23.106 for capital. See 17 CFR 23.23, 23.160, and 23.106. The
CFTC maintains its list of comparability determinations for
substituted compliance purposes at https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
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I support the Commission's proposed order and request for
comment on a comparability determination for European Union (EU)
nonbank swap dealer capital and financial reporting requirements. I
would like to first deeply thank the staff of the Market
Participants Division (MPD) for their hard work on these incredibly
technical and detailed requirements, involving many hours of
engagement with the European Central Bank (ECB), Autorit[eacute] de
contr[ocirc]le prudentiel et de resolution (ACPR), and CFTC
registrants. This proposal is the staff's third proposed capital
adequacy and financial reporting comparability determination in the
past year, after Japan \4\ and Mexico,\5\ with the UK to be
addressed next.
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\4\ Commissioner Pham ``Concurring Statement of Commissioner
Caroline D. Pham Regarding Proposed Swap Dealer Capital and
Financial Reporting Comparability Determination'' (July 27, 2022).
\5\ Commissioner Pham ``Concurring Statement of Commissioner
Caroline D. Pham Regarding Proposed Order and Request for Comment on
an Application for a Capital Comparability Determination'' (Nov. 10,
2022).
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I want to remind you that this decidedly unglamorous work by
CFTC staff creates the underpinnings of global markets that enable
governments, central banks and commercial banks, asset managers and
investors, and companies to manage the risks inherent in
international flows of capital that fuel economic growth and
prosperity in both developed and developing economies. I commend
these MPD staff members for their dedication and work on this
proposal: Amanda Olear, Tom Smith, Rafael Martinez, Liliya
Bozhanova, Joo Hong, and Justin McPhee.
Conditions for Notice Requirements
I especially thank the staff for addressing my comments on the
prior capital and financial reporting comparability determination
proposals, by providing more clarity on the conditions for notice
requirements for certain defined events such as undercapitalization
or breaches of capital levels. Generally, the proposal states that
written notice to the CFTC and the National Futures Association
(NFA) is required within 24 hours of when the firm ``knows or should
have known'' of the defined event.
I am pleased that this proposal solves the guessing game and now
makes clear that the ``should have known'' part of the timing
standard for the filing of the proposed notice is ``intended to
cover facts and circumstances that should reasonably lead the firm
to believe'' that the defined event has occurred. This additional
clarity will allow EU nonbank swap dealers to implement reasonably
designed notification processes to comply with the proposed
conditions.
In addition, I thank the staff for providing more clarity in
response to my feedback on conditions for written notice within 24
hours to the CFTC and NFA if an EU nonbank swap dealer fails to
maintain current books and records. I am pleased that this proposal
now makes clear that the proposed notice requirement applies to
books and records with respect to the EU nonbank swap dealer's
financial condition and financial reporting requirements, such as
``current ledgers or other similar records'' regarding asset,
liability, income, expense, and capital accounts ``in accordance
with the accounting principles accepted by the relevant competent
authorities.''
Without this substantive clarification, the proposed notice
requirement could have been so overbroad as to require 24 hours'
written notice to the CFTC and NFA for any failure to maintain books
and records. The Commission could have been inundated by a nonstop
deluge of written notices for recordkeeping lapses, no matter how
immaterial.
Market Fragmentation and Good Practices for Cross-Border Regulation
The importance of substituted compliance and these comparability
determinations for global swaps markets cannot be overstated. As
noted by the International Organization of Securities Commissions
(IOSCO) in its 2019 report on Market Fragmentation and Cross-Border
Regulation \6\ under the Japanese Presidency of the G20, unintended
market fragmentation \7\ can be harmful to wholesale securities and
derivatives markets.
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\6\ IOSCO Report ``Market Fragmentation & Cross Border
Regulation'' (June 2019), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD629.pdf.
\7\ Both the Financial Stability Board and IOSCO have defined
``market fragmentation'' as ``global markets that break into
segments, either geographically or by type of products or
participants.'' Id. at 6-9.
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Despite its flaws and inauspicious beginnings,\8\ the CFTC's
2013 Cross-Border Guidance is the foundation for today's $600
trillion notional swaps markets \9\ that spans
[[Page 41813]]
the globe from one financial markets trading hub to another--New
York, to London, Paris, Frankfurt, Tokyo, Hong Kong, Singapore, and
beyond. The Commission and its staff have labored for the past 10
years to improve upon the Cross-Border Guidance and promote
international regulatory harmonization through substituted
compliance comparability determinations, rulemakings, guidance,
advisories, and no-action letters. These efforts have helped to
address features and indicators of market fragmentation set forth in
the IOSCO 2019 report:
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\8\ Commissioner O'Malia ``Statement of Dissent by Commissioner
Scott D. O'Malia, Interpretive Guidance and Policy Statement
Regarding Compliance with Certain Swap Regulations and Related
Exemptive Order'' (July 12, 2013), https://www.cftc.gov/PressRoom/SpeechesTestimony/omaliastatement071213b.
\9\ See Bank for International Settlements ``OTC derivatives
statistics at end-June 2022'' (Nov. 30, 2022), https://www.bis.org/publ/otc_hy2211.pdf.
Multiple liquidity pools in market sectors or for
instruments of the same economic value which reduces depth and may
reduce firms' abilities to diversify or hedge their risks and result
in similar assets quoted at significantly different prices
Reduction in cross-border flows that would otherwise occur
to meet demand
Increased costs to firms in both risks and fees
Potential scope for regulatory arbitrage or hindrance of
effective market oversight
I am pleased that the Commission is finishing what it started
back in 2012 by taking these steps to complete comparability
determinations necessary to providing a substituted compliance
regime over the whole of the CFTC's swaps regulation. As I have
stated before, global collaboration and coordination are critical to
promoting regulatory cohesion and financial stability, and
mitigating market fragmentation and systemic risk.\10\
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\10\ Commissioner Pham ``Opening Statement of Commissioner
Caroline D. Pham before the Global Markets Advisory Committee''
(Feb. 13, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement021323.
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I continue to believe that the CFTC should take an outcomes-
based approach to substituted compliance that promotes efficient
global markets and preserves access for U.S. persons to other
markets. In particular, I encourage the Commission, its staff, and
our regulatory counterparts around the world to adhere to the
recommendations in IOSCO's 2020 report on Good Practices on
Processes for Deference, which was developed to provide solutions to
the challenges and drivers of market fragmentation.\11\
---------------------------------------------------------------------------
\11\ IOSCO Report, ``Good Practices on Processes for Deference''
(June 2020), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD659.pdf.
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As set forth in the IOSCO 2020 report, such processes for
deference \12\ are typically outcomes-based; risk-sensitive;
transparent; cooperative; and sufficiently flexible.
---------------------------------------------------------------------------
\12\ IOSCO uses ``deference'' as an ``overarching concept to
describe the reliance that authorities place on one another when
carrying out regulation or supervision of participants operating
cross-border.'' Id. at 1. The CFTC's use of substituted compliance
for swaps regulation is an example of regulatory deference
mechanisms.
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Conclusion
When used appropriately, substituted compliance can take a
balanced approach to achieving these key objectives: (1)
facilitating market access to foreign market participants seeking to
conduct business on a cross-border basis; (2) maintaining
appropriate levels of market participant protection; and (3)
managing systemic risks.\13\ I commend the staff for striking the
appropriate balance in this proposed order and request for comment
on a comparability determination for EU nonbank swap dealer capital
and financial reporting requirements. I encourage the public to
comment on this, and to especially note any areas where the proposed
conditions may be unnecessarily burdensome, create operational
complexity, or present implementation challenges.
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\13\ These considerations for regulatory authorities were
recognized by IOSCO in its 2015 Report on Cross-Border Regulation.
See IOSCO Report, ``IOSCO Task Force on Cross-Border Regulation
Final Report'' (Sept. 2015), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD507.pdf.
[FR Doc. 2023-13446 Filed 6-26-23; 8:45 am]
BILLING CODE 6351-01-P