2023-16572
[Federal Register Volume 88, Number 151 (Tuesday, August 8, 2023)]
[Proposed Rules]
[Pages 53409-53431]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-16572]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AF36
Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants
AGENCY: Commodity Futures Trading Commission
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing to amend the margin requirements for uncleared
swaps applicable to swap dealers (``SDs'') and major swap participants
(``MSPs'') for which there is no prudential regulator. The proposed
amendment would revise the definition of ``margin affiliate'' to
provide that certain collective investment vehicles (``investment
funds'' or ``funds'') that receive all of their start-up capital, or a
portion thereof, from a sponsor entity (``seeded funds'') would be
deemed not to have any margin affiliates for the purposes of
calculating certain thresholds that trigger the requirement to exchange
initial margin (``IM'') for uncleared swaps. This proposed amendment
(``Seeded Funds Proposal'') would effectively relieve SDs and MSPs from
the requirement to post and collect IM with certain eligible seeded
funds for their uncleared swaps for a period of three years from the
date on which the eligible seeded fund's asset manager first begins
making investments on behalf of the fund (``trading inception date'').
The Commission is also proposing to eliminate a provision disqualifying
the securities issued by certain pooled investment funds (``money
market and similar funds'') that transfer their assets through
securities lending, securities borrowing, repurchase agreements,
reverse repurchase agreements, and similar arrangements from being used
as eligible IM collateral, thereby expanding the scope of assets that
qualify as eligible collateral (``Money Market Funds Proposal'').
Additionally, the Commission is proposing an amendment to the haircut
schedule set forth in a Commission Regulation to add a footnote that
was inadvertently omitted when the rule was originally promulgated.
DATES: With respect to the proposed amendments, comments must be
received on or before October 10, 2023.
ADDRESSES: You may submit comments, identified by RIN 3038-AF36, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Center, 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.
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 Sec. 145.9 of the Commission's
regulations.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to herein are
found at 17 CFR Chapter I.
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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 rulemaking 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 J. Smith, Deputy Director, 202-418-5495,
[email protected]; Warren Gorlick, Associate Director, 202-418-5195,
[email protected]; Rafael Martinez, Associate Director, 202-418-5462,
[email protected]; or Liliya Bozhanova, Special Counsel, 202-418-6232,
[email protected], Market Participants Division, Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Statutory and Regulatory Background
Section 4s(e) of the Commodity Exchange Act (``CEA'' or ``Act'')
\2\ requires the Commission to adopt rules establishing minimum initial
and variation margin requirements for all swaps \3\ that are: (i)
entered into by an SD \4\ or MSP \5\ for which there is no prudential
regulator \6\ (collectively, ``covered swap entities'' or ``CSEs'');
\7\ and (ii) not cleared by a registered derivatives clearing
organization (``uncleared swaps'').\8\ To offset the greater risk to
the SD or MSP and the financial system arising from the use of
uncleared swaps, these requirements must: (i) help ensure the safety
and soundness of the SD or MSP; and (ii) be appropriate for the risk
associated with
[[Page 53410]]
the uncleared swaps held by the SD or MSP.\9\ In 2016, the Commission
promulgated Commission Regulations 23.150 through 23.161 (``CFTC Margin
Rule'') to implement section 4s(e).\10\
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\2\ 7 U.S.C. 6s(e) (capital and margin requirements).
\3\ CEA section 1a(47), 7 U.S.C. 1a(47) (swap definition);
Commission Regulation 1.3, 17 CFR 1.3 (further definition of a
swap). A swap includes, among other things, an interest rate swap,
commodity swap, credit default swap, and currency swap.
\4\ CEA section 1a(49), 7 U.S.C. 1a(49) (swap dealer
definition); Commission Regulation 1.3 (further definition of swap
dealer).
\5\ CEA section 1a(32), 7 U.S.C. 1a(32) (major swap participant
definition); Commission Regulation 1.3 (further definition of major
swap participant).
\6\ CEA section 1a(39), 7 U.S.C. 1a(39) (defining the term
``prudential regulator'' to include the Board of Governors of the
Federal Reserve System; the Office of the Comptroller of the
Currency; the Federal Deposit Insurance Corporation; the Farm Credit
Administration; and the Federal Housing Finance Agency). The
definition of ``prudential regulator'' further specifies the
entities for which these agencies act as prudential regulators. The
prudential regulators published final margin requirements in
November 2015. See generally Margin and Capital Requirements for
Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015) (``Prudential
Regulators Margin Rule''). The Prudential Regulators Margin Rule is
substantially similar to the CFTC Margin Rule.
\7\ CEA section 4s(e)(1)(B), 7 U.S.C. 6s(e)(1)(B). SDs and MSPs
for which there is a prudential regulator must meet the margin
requirements for uncleared swaps established by the applicable
prudential regulator. CEA section 4s(e)(1)(A), 7 U.S.C. 6s(e)(1)(A).
\8\ CEA section 4s(e)(2)(B)(ii), 7 U.S.C. 6s(e)(2)(B)(ii). In
Commission Regulation 23.151, the Commission further defined this
statutory language to mean all swaps that are not cleared by a
registered derivatives clearing organization or a derivatives
clearing organization that the Commission has exempted from
registration as provided under the CEA. 17 CFR 23.151.
\9\ CEA section 4s(e)(3)(A), 7 U.S.C. 6s(e)(3)(A).
\10\ See generally Margin Requirements for Uncleared Swaps for
Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016)
(``Final Margin Rule'') (adopting the CFTC Margin Rule). The CFTC
Margin Rule became effective April 1, 2016 and is codified in part
23 of the Commission's regulations. 17 CFR 23.150-23.159, 23.161. In
May 2016, the Commission amended the CFTC Margin Rule to add
Commission Regulation 23.160, 17 CFR 23.160, providing rules on its
cross-border application. See generally Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants--Cross-
Border Application of the Margin Requirements, 81 FR 34818 (May 31,
2016).
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The CFTC Margin Rule imposes IM requirements on uncleared swaps
entered into by CSEs and certain specified counterparties. More
specifically, Commission Regulation 23.152 requires CSEs to collect and
post IM \11\ with each counterparty that is an SD, MSP or financial end
user (``FEU'') with material swaps exposure (``MSE'').\12\ Commission
Regulation 23.151 defines the term FEU by listing entities, persons,
and arrangements whose business is financial in nature, including
certain funds.\13\
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\11\ IM (or initial margin) is the collateral (calculated as
provided by Commission Regulation 23.154) that is collected or
posted in connection with one or more uncleared swaps pursuant to
Commission Regulation 23.152. IM is intended to secure potential
future exposure following default of a counterparty (i.e., adverse
changes in the value of an uncleared swap that may arise during the
period of time when it is being closed out). See CFTC Margin Rule,
81 FR at 683.
\12\ See 17 CFR 23.152. Commission Regulation 23.151 provides
that MSE for an entity means that the entity and its margin
affiliates have an average month-end aggregate notional amount of
uncleared swaps, uncleared security-based swaps, foreign exchange
forwards, and foreign exchange swaps with all counterparties for
March, April, or May of the current calendar year that exceeds $8
billion, where such amount is calculated only for the last day of
the month. 17 CFR 23.151.
\13\ See 17 CFR 23.151 for a full list of entities subject to
the FEU definition as well as a list of entities excluded from the
definition. Among other entities, persons, and arrangements, whose
business is financial in nature, the definition of FEU includes
counterparties that are not an SD or MSP and are: (i) investment
companies registered with the Securities and Exchange Commission
under the Investment Company Act of 1940; (ii) private funds as
defined in section 202(a) of the Investment Advisers Act of 1940;
entities that would be investment companies under section 3 of the
Investment Company Act of 1940; or entities that are deemed not to
be investment companies under section 3 of the Investment Company
Act of 1940 pursuant to Investment Company Act Rule 3a-7 of the
Securities and Exchange Commission; (iii) commodity pools; and (iv)
entities, persons, or arrangements that are, or hold themselves out
as being, entities, persons, or arrangements that raise money from
investors, accept money from clients, or use their own money
primarily for investing, or trading, or facilitating the investing
or trading, in loans, securities, swaps, funds, or other assets.
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Commission Regulation 23.161 sets forth a phase-in schedule for
compliance with the CFTC Margin Rule.\14\ Under the schedule, which
commenced on September 1, 2016 and concluded on September 1, 2022,
entities have been required to comply with the IM requirements with
respect to their uncleared swaps in staggered phases, starting with
entities with higher average aggregate notional amount of uncleared
swaps and certain other financial products (``AANA''), and then
successively those with lesser AANA.\15\ The AANA is calculated at a
group level (i.e., taking into consideration the AANA of the CSE
combined with its margin affiliates,\16\ and the AANA of the
counterparty combined with its margin affiliates). During the last
phase of compliance, which started on September 1, 2022, CSEs and
eligible covered counterparties \17\ that had not come into the scope
of the IM requirements in prior phases of the phase-in schedule,
including FEUs with MSE of more than $8 billion, became subject to the
IM requirements.
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\14\ 17 CFR 23.161.
\15\ Id.
\16\ Commission Regulation 23.151 provides that a company is a
``margin affiliate'' of another company if: (i) either company
consolidates the other on a financial statement prepared in
accordance with U.S. Generally Accepted Accounting Principles
(``U.S. GAAP''), the International Financial Reporting Standards
(``IFRS''), or other similar standards; (ii) both companies are
consolidated with a third company on a financial statement prepared
in accordance with such principles or standards; or (iii) for a
company that is not subject to such principles or standards, if
consolidation as described in paragraph (1) or (2) of this
definition would have occurred if such principles or standards had
applied. 17 CFR 23.151.
\17\ The term ``covered counterparty'' is defined in Commission
Regulation 23.151 as FEU with MSE or a swap entity, including an SD
or MSP, that enters into swaps with a CSE. See 17 CFR 23.151.
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Under this phase-in approach, a fund with MSE will come within the
scope of the IM requirements if it undertakes an uncleared swap with a
CSE. The CSE and the fund will not be required to post and collect IM
for their uncleared swaps until the IM threshold amount of $50 million
has been exceeded. The IM threshold amount will be calculated based on
the credit exposure from uncleared swaps between the CSE and its margin
affiliates on the one hand, and the fund and its margin affiliates on
the other.\18\
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\18\ Commission Regulation 23.151 defines the term ``IM
threshold amount'' to mean an aggregate credit exposure of $50
million resulting from all uncleared swaps between an SD and its
margin affiliates (or an MSP and its margin affiliates) on the one
hand, and the SD's (or MSP's) counterparty and its margin affiliates
on the other. See 17 CFR 23.151.
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The CFTC Margin Rule provides that the IM requirements may be
satisfied with only certain types of collateral. Commission Regulation
23.156(a)(1) sets forth the types of collateral that CSEs can post or
collect as IM with covered counterparties, including cash funds,
certain securities issued by the U.S. government or other sovereign
entities, certain publicly traded debt or equity securities, securities
issued by money market and similar funds, and gold.\19\
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\19\ See 17 CFR 23.156(a)(1).
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Under Commission Regulation 23.156(a)(1)(ix), the securities of
money market and similar funds \20\ may qualify as eligible collateral
if the investments of the fund are limited to securities that are
issued by, or unconditionally guaranteed as to the timely payment of
principal and interest by, the U.S. Department of Treasury, and
immediately-available cash denominated in U.S. dollars; \21\ or to
securities denominated in a common currency and issued by, or fully
guaranteed as to the payment of principal and interest by, the European
Central Bank, or a sovereign entity that is assigned no higher than a
20 percent risk weight under the capital rules applicable to swap
dealers subject to regulation by a prudential regulator, and
immediately-available cash denominated in the same currency.\22\ Also,
the asset managers of the money market and similar fund may not
transfer the assets of the fund through securities lending, securities
borrowing, repurchase agreements, or other means (``repurchase or
similar arrangements'') that involve the fund having rights to acquire
the same or similar assets from the transferee (``asset transfer
restriction'').\23\
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\20\ Although the scope of the eligible pooled investment funds
described in Commission Regulation 23.156(a)(1)(ix) does not fully
coincide with the regulatory definition of money market funds in
Rule 2a-7 under the Investment Company Act (17 CFR 270.2a-7), for
simplicity purposes, these funds will be referred to as ``money
market and similar funds.'' The securities of money market and
similar funds may also be used as collateral for variation margin
(``VM'') for uncleared swaps between a CSE and a financial end user,
provided that the securities qualify as eligible collateral under
Commission Regulation 23.156(a)(1)(ix). See 17 CFR 23.156(b)(1)(ii).
VM (or variation margin), as defined in Commission Regulation
23.151, is the collateral provided by a party to its counterparty to
meet the performance of its obligations under one or more uncleared
swaps between the parties as a result of a change in the value of
such obligations since the trade was executed or the last time such
collateral was provided. 17 CFR 23.151.
\21\ 17 CFR 23.156(a)(1)(ix)(A).
\22\ 17 CFR 23.156(a)(1)(ix)(B).
\23\ 17 CFR 23.156(a)(1)(ix)(C).
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II. Market Participant Feedback
In January 2020, the CFTC's Global Markets Advisory Committee
(``GMAC'') established a subcommittee of market participants to
consider issues raised by
[[Page 53411]]
the implementation of margin requirements for non-cleared swaps, to
identify challenges associated with forthcoming implementation phases,
and to prepare a report with recommendations.\24\ The subcommittee
issued a report with its recommendations in May 2020 (``Margin
Subcommittee Report'' or ``Report''), and the GMAC voted to adopt the
Margin Subcommittee Report and recommended to the Commission that it
consider adopting the Report's recommendations.\25\
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\24\ Membership of the GMAC Subcommittee on Margin Requirements
was comprised of a wide range of industry participants that had
expertise in, and experience with, margin requirements for non-
cleared swaps and the impact of the requirements on the marketplace
and market participants. The Subcommittee included representatives
of SDs, FEUs, asset managers, and third-party service providers,
among other market participants. The full list of members is
available at https://www.cftc.gov/About/AdvisoryCommittees/GMAC.
\25\ See Recommendations to Improve Scoping and Implementation
of Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps (May 2020), https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
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Among other things, the Margin Subcommittee Report asserted that
the current criteria for determining whether a counterparty comes
within the scope of the IM requirements unduly penalizes certain funds.
Because, under accounting consolidation principles, a fund will
generally be consolidated with its sponsor entity during the period in
which the start-up capital provided by the sponsor entity exceeds that
of third-party investors and represents up to 100 percent of the
ownership interest in the fund (``seeding period''), such fund,
referred to as a seeded fund, will be considered a margin affiliate of
the sponsor entity.\26\ As such, the seeded fund will be required to
calculate AANA on an aggregate basis with the sponsor entity and the
sponsor entity's margin affiliates. Although the fund may individually
have small amounts of AANA, due to its affiliation with the sponsor
entity and its margin affiliates, the fund may have MSE, on a
collective basis with the sponsor entity and its margin affiliates, and
may come within the scope of the IM requirements. As such, a CSE that
undertakes uncleared swaps with the fund would be required to exchange
IM with the fund.
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\26\ Supra note 16. See also CFTC Margin Rule, 81 FR at 646-47.
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The Report noted that regulators in other major financial markets,
including Australia, Canada, the European Union (``EU''), and Japan,
have adopted the Basel Committee on Banking Supervision and Board of
the International Organization of Securities Commissions' (``BCBS/
IOSCO'') Framework for margin requirements for non-centrally cleared
derivatives (``BCBS/IOSCO Framework'') \27\ without requiring seeded
funds to be consolidated with the sponsor and to be treated as a margin
affiliate of the sponsor.\28\
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\27\ See BCBS/IOSCO, Margin requirements for non-centrally
cleared derivatives (April 2020), https://www.bis.org/bcbs/publ/d499.pdf. The BCBS/IOSCO Framework, which was established in 2013
and most recently amended in 2020, sets out minimum standards for
margin requirements for non-centrally cleared derivatives. In
connection with the requirement for all covered entities to exchange
IM with a threshold not to exceed [euro]50 million applied at the
level of the consolidated group, the Framework specifies that
``investment funds that are managed by an investment advisor are
considered distinct entities that are treated separately when
applying the threshold as long as the funds are distinct legal
entities that are not collateralized by or are otherwise guaranteed
or supported by other investment funds or the investment advisor in
the event of fund insolvency or bankruptcy.''
\28\ Margin Subcommittee Report at 7 and 29.
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The Margin Subcommittee Report also recommended that the Commission
eliminate the asset transfer restriction in paragraph (C) of Commission
Regulation 23.156(a)(1)(ix). The Report stated that ``the ability to
use redeemable securities in a pooled investment fund, more typically
referred to as a money market fund (``MMF''), as eligible collateral in
the U.S. has been severely restricted by [such] condition.'' \29\
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\29\ Id. at 6.
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The Report noted that MMFs use repurchase and similar arrangements
to earn returns on cash and other high quality assets, to avoid any
cash drag on performance, to diversify their investments, and to
mitigate their potential exposure to their custodian's insolvency and
any consolidation issues with respect to any cash held at the
custodian.\30\ MMF asset managers, as fiduciaries, determine the types
of investments and transactions that are in the best interest of the
MMF and its investors.\31\ The Report further stated that nearly all
U.S. MMFs engage in some form of repurchase or similar arrangements,
and cited research that found that, given the asset transfer
restriction, the securities of only four MMFs, would qualify as
eligible collateral.\32\
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\30\ Id. at 27.
\31\ Id.
\32\ Margin Subcommittee Report at 24.
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Having considered the GMAC Subcommittee's arguments and based on
its experience administering the CFTC Margin Rule for several years,
the Commission preliminarily believes that, for the purpose of
determining whether a CSE should exchange IM with a seeded fund for
their uncleared swaps, the seeded fund should be treated as a separate
legal entity, not affiliated with the sponsor entity, for a period of
three years and subject to certain limitations. Similarly, the
Commission preliminarily believes that the current restriction on the
use of securities of money market and similar funds that transfer their
assets through repurchase and similar arrangements should be removed.
III. Proposals
A. Seeded Funds Proposal
The Commission is proposing to revise the definition of ``margin
affiliate'' to provide that a seeded fund that meets certain
requirements (described in further detail below) (``eligible seeded
fund''), would be deemed not to have any margin affiliates for the
purpose of calculating the fund's MSE and the IM threshold amount, for
a period of three years from the fund's trading inception date
(``eligible seeded fund exception''). The Commission is also proposing
to define the term ``eligible seeded fund'' to set forth the conditions
that investment funds must meet to qualify for the eligible seeded fund
exception.
1. Commission Regulation 23.151--Amendments to the Definition of
``Margin Affiliate''
Under the CFTC Margin Rule, a company is a ``margin affiliate'' of
another company if, based on accounting principles, either company
consolidates the other, or both companies are consolidated with a third
company, on a financial statement.\33\ The Commission is proposing to
adopt the eligible seeded fund exception through an amendment of the
definition of ``margin affiliate,'' which would provide that an
eligible seeded fund would be deemed not to have margin affiliates
solely for the purposes of calculating the fund's MSE and the IM
threshold amount for a period of three years after the fund's trading
inception date, notwithstanding the consolidation of the fund with
another entity under U.S. GAAP, IFRS, or other similar accounting
standards.
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\33\ Supra note 16.
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This proposed eligible seeded fund exception would effectively
relieve CSEs that enter into uncleared swaps with an eligible seeded
fund from the requirement to exchange IM with such fund for three years
after the fund's trading inception date. In addition, uncleared swaps
entered into between a CSE and an eligible seeded fund during the
three-year period would continue to
[[Page 53412]]
be relieved from the IM requirement after expiration of such
period.\34\ At the end of the three-year period, a fund that meets the
accounting standards for consolidation due to a sponsor entity holding
a significant equity stake in the fund would be deemed to have margin
affiliates. As a result, a CSE would be required to exchange IM with
the fund, if the fund, on a consolidated group basis, has MSE and the
IM threshold amount has been exceeded, for swaps entered into following
the expiration of the three-year period.
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\34\ For purposes of clarity, the Commission notes, however,
that if at any point during the three-year period from the fund's
trading inception date, the fund's AANA, calculated on an individual
entity basis, exceeds the MSE threshold and the fund, individually,
with its counterparty and the counterparty's margin affiliates
crosses the IM threshold amount, the exchange of IM would be
required.
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The proposed eligible seeded fund exception is intended to address
challenges confronted by seeded funds that have limited individual
swaps exposure, but, due to their affiliation with an entity or group
of entities, have on a collective basis sufficient AANA to meet the MSE
threshold, therefore requiring CSEs undertaking uncleared swaps with
the funds to post and collect IM with such funds. To limit the relief
to only such funds, the proposed treatment would be applicable only to
funds that have one or more margin affiliates that are already subject
to the IM requirements and post and collect IM pursuant to Commission
Regulation 23.152. Also, the Commission notes that notwithstanding the
proposed eligible seeded fund exception, CSEs would still be required
to count the uncleared swaps that they undertake with eligible seeded
funds for purposes of calculating their own AANA.
Market participants, including the members of the GMAC Margin
Subcommittee, have argued that absent relief, seeded funds would
experience a performance drag given that a portion of their investment
would be committed to, and segregated as, IM and would also incur
operational costs that are not commensurate with the size of their
uncleared swaps activity and the risks of their swaps. In addition, the
overall ability of start-up funds to attract new investors may be
compromised as a result.\35\
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\35\ Margin Subcommittee Report at 32.
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In its Report, the GMAC Margin Subcommittee discussed the costs
that seeded funds would incur if the funds were consolidated with their
sponsor entities and were treated as margin affiliates of their sponsor
entities, including the cost of setting up and maintaining margin
accounts and establishing custodial arrangements to segregate IM
collateral under Commission Regulation 23.157.\36\ The seeded funds
would also be required to engage in negotiation of complex margin
documentation and develop compliance infrastructures to handle the
exchange of IM.\37\ The Report further observed that, given their
typically small size, seeded funds are likely to encounter difficulties
in establishing the necessary margin documentation and processes, as
CSEs and custodians, which face competing demands for resources and
services to operationalize the exchange of IM, may prioritize larger
counterparties.\38\
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\36\ For purposes of clarity, these arguments, as well as the
proposed rule amendments, pertain only to the margin requirements
for uncleared swap transactions. The proposed amendments would not
impact any potential margin requirements that a seeded fund would
have to meet in connection with futures contracts or cleared swap
transactions.
\37\ Margin Subcommittee Report at 32.
\38\ Id.
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The Margin Subcommittee Report stated that although seeded funds
may be consolidated with other entities on a financial statement, they
are legally and operationally distinct and, as a result, may not be
able to share information about their exposure for purposes of managing
the $50 million IM threshold amount above which IM for uncleared swaps
must be exchanged. In addition to operational challenges, the Report
indicated that potential confidentiality obligations may prevent the
different affiliates within the seeded fund's consolidated group from
sharing uncleared swaps exposure information. As an example, the Report
noted that because of regulatory restrictions, an insurance company
that sponsors a seeded fund would not be permitted to share information
about the fund's trading activity with an affiliate engaging in swap
transactions for purposes of hedging general insurance risk.
Finally, the Report stated that seeded funds that do not otherwise
hold assets qualifying as eligible IM collateral under Commission
Regulation 23.156 \39\ would need to hold larger cash reserves, which
would be unavailable to implement the fund's investment strategy, or
would need to incur the costs of converting fund assets into eligible
IM collateral. The operational costs and potential difficulties arising
in the execution of margin documentation could also either negatively
impact a seeded fund's performance or inhibit its ability to trade,
defeating the purpose of the original seed capital.\40\
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\39\ Id.
\40\ Margin Subcommittee Report at 31.
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The Commission notes that the proposed eligible seeded fund
exception is consistent with the approach in other countries.
Jurisdictions such as Australia, Canada and the EU have adopted
provisions that permit investment funds to be treated as distinct,
separate entities for purposes of calculating the relevant IM
thresholds, subject to conditions similar to those that the Commission
intends to adopt through the proposed definition of ``eligible seeded
fund'' discussed below.\41\
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\41\ Margin Subcommittee Report at 29. As noted in the Report,
Canada has excluded investment funds from consolidated margin
calculations via the Office of the Superintendent for Financial
Institutions of Canada Guideline E-22 Margin Requirements for Non-
centrally Cleared Derivatives effective as of June 2017, Section
1.1. Scope of Applicability, Footnote 2, available at https://www.osfi-bsif.gc.ca/Eng/fi-if/rg-ro/gdn-ort/gl-ld/Pages/e22.aspx;
the EU adopted a similar approach via Commission Delegated
Regulation No. 2016/2251 of October 4, 2016, Supplementing
Regulation (EU) No.648/2012 of the European Parliament and of the
Council of July 4, 2012 on OTC Derivatives, Central Counterparties
and Trade Repositories with Regard to Regulatory Technical Standards
for Risk-Mitigation Techniques for OTC Derivative Contracts Not
Cleared by a Central Counterparty, 2016 O.J. L340/11, Articles
28(3); 29(3) and 39(2), available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv%3AOJ.L_.2016.340.01.0009.01.ENG;
and the Australian Prudential Regulatory Authority noted, in
paragraph 25 of Prudential Standard CPS 226 (available here https://www.apra.gov.au/sites/default/files/prudential_standard_cps_226_margining_and_risk_mitigation_for_non-centrally_cleared_derivatives.pdf) that for purposes of calculating
the IM threshold, an investment fund may be treated separately from
the investment adviser and other investment vehicles, provided
certain conditions are met. The Margin Subcommittee Report also
noted that Japan has adopted a similar approach, however, the
Commission could not verify that assertion because the Report did
not provide a citation to the relevant Japanese rules.
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The proposed approach is also consistent with the BCBS-IOSCO
Framework, which provides that investment funds should be treated as
separate legal entities when applying the IM threshold amount provided
that they are distinct legal entities that are not collateralized or
otherwise guaranteed or supported by other investment funds or the
investment advisor in the event of fund insolvency or bankruptcy.\42\
As such, the proposed approach would contribute to global harmonization
with respect to the treatment of investment funds, preventing potential
reductions in liquidity or trading disruptions due to non-U.S. funds'
limiting their trading activities to non-U.S. counterparties to take
advantage of approaches to
[[Page 53413]]
consolidation that exist in other jurisdictions.
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\42\ BCBS-IOSCO Framework, Footnote 10, supra note 27.
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The Commission recognizes, however, that the proposed amendments
would be a departure from the prudential regulators' approach, whose
margin requirements for uncleared swaps include a definition of
``margin affiliate'' that is equivalent to the current definition in
the CFTC Margin Rule. Furthermore, the prudential regulators have
reserved the right to include any entity as an affiliate or a
subsidiary based on the conclusion that an entity may provide
significant support to, or may be materially subject to the risks of
losses of, another entity.\43\ As noted below, the Commission requests
comment on whether it should proceed with the Seeded Funds Proposal if
the prudential regulators do not amend their rules in a manner
consistent with the proposal.
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\43\ See Prudential Regulators Margin Rule at 74859-60.
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The Commission preliminarily believes that the proposed approach
supports the CFTC Margin Rule's objective of imposing margin
requirements that are commensurate with the risk of uncleared swaps
entered into by CSEs.\44\ The Commission preliminarily believes, as
discussed in the Margin Subcommittee Report, that seeded investment
funds do not pose significant risks to their swap counterparties or the
financial system given that typically their capitalization does not
exceed $50-100 million and the funds have limited notional exposure.
The Report cited the results of an informal sampling conducted in 2018
among members of the Securities Industry and Financial Markets
Association's Asset Management Group (``SIFMA AMG'') and the American
Council of Life Insurers. According to the Report, the respondents
identified a total of 33 funds that would be within the scope of the IM
requirements due to their derivatives notional exposures being
consolidated with entities with MSE. The average gross notional
exposure for each seeded fund was $32 million. As the Report concluded,
none of these funds would be within the scope of the IM requirements
absent consolidation with their sponsor entity. Given their size and
limited individual swap activity, the Commission preliminarily believes
that affording relief to seeded funds at the early stages of formation
from coming within the scope of the IM requirements is consistent with
the CFTC Margin Rule's risk-based approach.
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\44\ See Section 4s(e)(3)(A)(2) of the CEA (directing the
Commission to adopt margin requirements ``appropriate to the risks
associated with'' the uncleared swaps held by the SD or the MSP). 7
U.S.C. 6s(e)(3)(A).
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The Commission also preliminarily believes that safeguards already
present in the CEA and CFTC regulations would mitigate the increase in
uncollateralized credit risk resulting from swap transactions between
CSEs and seeded funds that would be relieved from the IM requirements
given the disaggregation of eligible seeded funds from their sponsor
entities and other affiliated entities for purposes of calculating the
funds' MSE and the IM threshold amount. The Commission notes that
notwithstanding the relief, uncleared swap transactions between CSEs
and eligible seeded funds would still be subject to the VM
requirements.\45\ Moreover, section 4s(j)(2) of the CEA mandates CSEs
to adopt a robust and professional risk management system adequate for
the management of their swap activities \46\ and Commission Regulation
23.600 requires that CSEs, in establishing a risk management program to
monitor and manage risks associated with their swap activities, must
account for credit risk and must set risk tolerance limits.\47\
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\45\ See 17 CFR 23.153.
\46\ See 7 U.S.C. 6s(j).
\47\ 17 CFR 23.600.
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As an additional safeguard, the proposed eligible seeded fund
exception would be applicable only for a period of three years from an
eligible seeded fund's trading inception date. The three-year term is
designed to cover the period during which the fund would work towards
establishing a performance track record and towards attracting
unaffiliated investors.\48\
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\48\ Market participants have noted that after three years,
investment funds have typically established a sufficient record to
draw in third-party investors and are no longer consolidated with
their sponsor entity for AANA calculation purposes. See Margin
Subcommittee Report at 30.
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In adopting the CFTC Margin Rule, the Commission stated that the
requirement to calculate MSE and the IM threshold amount on a
consolidated basis was intended to prevent CSEs and their
counterparties from creating legal entities and netting sets that have
no economic basis and are constructed solely for the purpose of
applying additional thresholds to evade margin requirements.\49\
Consistent with this goal, the Commission intends for the eligible
seeded fund exception to be applied only for purposes of calculating
MSE and the IM threshold amount of the eligible seeded fund. Under the
Seeded Funds Proposal, a fund's sponsor entity and other margin
affiliates would continue to include the eligible seeded fund's
exposure in the calculation of their MSE and the IM threshold amount,
unless they independently qualify for the proposed eligible seeded fund
exception. As such, the proposed treatment for eligible seeded funds
would not serve as an incentive for a sponsor entity to create seeded
funds merely to reduce its own exposure and circumvent the
applicability of the IM requirements.
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\49\ CFTC Margin Rule, 81 FR at 652.
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In addition, the Commission proposes to make the eligible seeded
fund exception available only with respect to funds that have a bona
fide business and economic purpose, meaning that the funds are not
created for the sole purpose of evading the IM compliance thresholds.
Rather, the exception is intended for funds that engage in genuine
efforts to test their investment strategy and distribute the funds'
shares to third-party investors.\50\ To that end, in addition to
relying on anti-evasion provisions already existing in the Commission
regulations \51\ to address
[[Page 53414]]
the potential circumvention of the IM compliance thresholds, the
Commission proposes to limit the availability of the proposed treatment
for seeded funds to entities that meet certain requirements. These
requirements would be incorporated in the proposed definition of
``eligible seeded fund'' discussed below.
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\50\ The Commission notes that this position is consistent with
the policy approach taken by the prudential regulators and the
Commission in the regulations implementing the requirements of
section 619 of the Dodd-Frank Act, commonly referred to as the
``Volcker Rule.'' The implementing regulations recognize the concept
of a seeding period and exempt banking entities that acquire and
retain an ownership interest in a covered fund (as the concept is
defined under the implementing regulations) from some of the
prohibitions of the Rule during the seeding period, under certain
conditions. See 12 CFR 248.12(a)(1) and (2). In particular, these
conditions include that the covered fund must actively seek
unaffiliated investors to reduce, through redemption, sale,
dilution, or other methods, the aggregate amount of all ownership
interests of the banking entity in the covered fund to the amount
permitted under the regulations. 12 CFR 248.12(a)(2)(i). Also, the
aggregate value of all ownership interests of the banking entity and
its affiliates in all covered funds acquired and retained under the
relevant exemptions must not exceed 3 percent of the tier 1 capital
of the banking entity. 12 CFR 248.12(a)(2)(iii). Although the
Commission is not proposing identical conditions, the Commission is
proposing to incorporate a number of requirements to achieve the
same purpose as appropriate in the context of the CFTC Margin Rule,
including the requirement in the proposed definition discussed below
that an ``eligible seeded fund'' be managed pursuant to a written
investment strategy that follows a written plan to reduce each
sponsor entity's ownership interest in the fund.
\51\ See Commission regulation 23.402(a)(1)(ii) (requiring CSEs
to have written policies and procedures to prevent the evasion, or
participation in or facilitation of an evasion, of any provision of
the CEA or Commission regulation). 17 CFR 23.402(a)(1)(ii). See also
the definition of MSE in Commission Regulation 23.151 (stating that
activities not carried out in the regular course of business and
willfully designed to circumvent the calculation of the AANA at
month-end to evade meeting the definition of MSE shall be
prohibited). 17 CFR 23.151. The Commission also reminds market
participants that section 4b of the CEA prohibits any person
entering into a swap with another person from cheating, defrauding,
or willfully deceiving, or attempting to cheat, defraud, or deceive,
the other person. 7 U.S.C. 6b.
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2. Commission Regulation 23.151--Definition of ``Eligible Seeded Fund''
The Commission proposes to amend Commission Regulation 23.151 by
adding a definition for the term ``eligible seeded fund.'' ``Eligible
seeded fund'' would be defined as a collective investment vehicle that
has received a part or all of its start-up capital from a parent and/or
affiliate (each, a sponsor entity) and that meets certain specified
conditions.
A seeded fund would meet the proposed definition of eligible seeded
fund if, among other conditions: (i) the fund is a distinct legal
entity from each sponsor entity; (ii) the fund is managed by an asset
manager pursuant to an agreement that requires the fund's assets to be
managed in accordance with a specified written investment strategy;
(iii) the fund's asset manager has independence in carrying out its
management responsibilities and exercising its investment discretion,
and to the extent applicable, has independent fiduciary duties to other
investors of the fund; and (iv) the fund's written investment strategy
includes a written plan for reducing each sponsor entity's ownership
interests in the fund that stipulates divestiture targets over the
three-year period after the seeded fund's trading inception date.
Additionally, to meet the ``eligible seeded fund'' definition, in
respect of any of the seeded fund's obligations, a fund must not be
collateralized, guaranteed, or otherwise supported, directly or
indirectly, by any sponsor entity, any margin affiliate of any sponsor
entity, other collective investment vehicles, or the fund's asset
manager. These conditions are designed to ensure that the sponsor
entity would not retain a level of influence or exposure that is
materially above that of other minority or passive investors and that
the fund would follow a genuine plan to emerge from the seeding phase
by attracting unaffiliated investors.
To ensure that the three-year period contemplated by the eligible
seeded fund exception is not reinstated, due to rollovers of fund
assets or similar activities, the proposed definition would require
that the seeded fund has not received any of its assets, directly or
indirectly, from an eligible seeded fund that has relied on the
proposed exception.
Furthermore, the Seeded Funds Proposal is intended to be limited to
those seeded funds that, absent amendments to the CFTC Margin Rule,
would have to exchange IM due to their consolidation with a group that
collectively exceeds the thresholds triggering compliance with the IM
requirements. That is, the Seeded Funds Proposal, consistent with the
Margin Subcommittee Report, is intended to address seeded funds that
are ``seeded'' by parent entities that have MSE and thus cause the
seeded funds to come within the scope of the IM requirements. For
purposes of targeting these seeded funds, the proposed definition of
``eligible seeded fund'' would require as a condition for qualification
that at least one of the seeded fund's margin affiliates must be
subject to the IM requirements and must be required to post and collect
IM pursuant to Commission Regulation 23.152.
Finally, the proposed definition of ``eligible seeded fund'' would
provide that the seeded fund must not be a securitization vehicle. This
condition is designed to further limit the proposed treatment of seeded
funds only to funds subject to the Margin Subcommittee Report's
recommendation. The Commission notes that in adopting the CFTC Margin
Rule, despite receiving multiple comments from industry representatives
to exclude securitization vehicles from the definition of FEU, and
recommendations subsequent to the adoption of the rule, the Commission
has maintained the position that there are sufficient reasons to keep
these entities within the scope of the IM requirements. The Commission
stated in the preamble to the final CFTC Margin Rule that the relevant
IM compliance thresholds would address concerns related to the
applicability of the IM requirements to these entities.\52\ At this
time, the Commission does not believe that it is prudent to extend the
proposed eligible seeded fund exception to such entities.
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\52\ See CFTC Margin Rule, 81 FR at 683.
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In adopting the CFTC Margin Rule, the Commission modified the
proposed definition of ``margin affiliate,'' which relied on the
concept of legal control as a criterion for affiliation, to the current
definition based on accounting consolidation, in consideration of a
concern that the proposed definition may have been over-inclusive. The
Commission noted that the accounting consolidation analysis typically
results in a positive outcome (consolidation) at a higher level of an
affiliation relationship than the 25 percent voting interest standard
of the legal control test.\53\
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\53\ Id. at 647.
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The Commission recognized, however, that consolidation between a
seeded fund and the sponsor may occur during the seeding period or
other periods in which the sponsor may hold an outsized portion of the
fund's interest. The Commission stated that during those periods, when
an entity may hold up to 100 percent of the ownership interests of an
investment fund, it was appropriate to treat the investment fund as an
affiliate.\54\ The Commission further stated that such treatment may be
likewise justified for a sponsor or asset manager and a special purpose
entity created for asset management when accounting standards, such as
GAAP and IFRS variable interest standards, require consolidation for
such entities even though the manager might not hold an interest
comparable to a majority equity or voting control share given the level
of influence and exposure typically retained by the manager.\55\
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\54\ Id.
\55\ Id.
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The Commission notes that subsequently, in letters to the CFTC,
SIFMA AMG (on behalf of its asset manager members) requested relief
from the treatment as margin affiliate for seeded funds, consistent
with the arguments made in the Margin Subcommittee Report described
above. While acknowledging that a sponsor of a seeded investment fund
has influence beyond that of a passive, unaffiliated investor, SIFMA
AMG urged that seeded funds not be consolidated with their sponsors in
applying the CFTC's margin requirements because there are structural
and contractual safeguards that limit the sponsor's influence and
exposure with respect to the seeded fund.\56\ In particular, SIFMA AMG
noted that each seeded fund is a distinct legal entity that is managed
by an investment manager pursuant to an investment advisory agreement
that, among other things, requires the assets of the fund to be managed
in accordance with specified investment guidelines, objectives, and
strategies, and not
[[Page 53415]]
capriciously at the desire of the fund sponsor.\57\
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\56\ Letter by SIFMA AMG to the Commission and the Prudential
Regulators Regarding Final Margin Rules for Uncleared Swap
Transactions (Jan., 19, 2016) (``SIFMA AMG 2016 Letter'') at 3; see
also Margin Subcommittee Report at 16.
\57\ SIFMA AMG 2016 Letter at 3.
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Further, the Margin Subcommittee Report noted that neither the
sponsor nor its commonly consolidated entities controls or has
transparency into the management or trading of the seeded fund.\58\
Moreover, the Report stated that, typically, the sponsor or affiliate
of a seeded fund does not guarantee the obligations of the seeded fund
or participate in or control the management of the fund.\59\ The Report
further noted that the sponsor's exposure to the seeded fund is
generally capped at its investment, similar to any other passive
investor in a third-party instrument or vehicle.\60\
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\58\ Margin Subcommittee Report at 16.
\59\ Margin Subcommittee Report at 6 and16.
\60\ Margin Subcommittee Report at 16.
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These arguments highlight the safeguards generally exhibited in
seeded funds. As previously noted, the Commission is proposing to
incorporate these safeguards, among other conditions, in the proposed
definition of ``eligible seeded fund'' as requirements to be met by a
fund in order to benefit from the proposed treatment for eligible
seeded funds, discussed in more detail above. In proposing these
conditions, the Commission seeks to ensure that eligible seeded funds
are sufficiently independent and risk-remote from other entities in
their group such that treating them separately for purposes of
determining whether the thresholds for compliance with the IM
requirements have been met would be justified.
In particular, the proposed requirements that the fund is managed
in accordance with a written investment strategy, by an asset manager
that maintains independence in carrying out its management
responsibilities and exercising its investment discretion, and that, to
the extent applicable, has independent fiduciary duties to other
investors in the fund, seek to ensure that no sponsor entity or an
affiliate of a sponsor entity has control or transparency into the
management or trading of the seeded fund. Furthermore, the proposed
condition that the fund's investment strategy follows a written plan
for reducing each sponsor entity's ownership interest in the fund aims
to reserve the benefit of the proposed approach to seeded funds that
have a genuine economic purpose and intentions to emerge from the
seeding phase.
In addition, the proposed definition of ``eligible seeded fund''
would prohibit a fund sponsor entity, entities affiliated with a
sponsor entity, other collective investment vehicles, or the fund's
asset manager from collateralizing, guaranteeing or otherwise directly
or indirectly providing support in respect of any of the fund's
obligations. The Commission proposes this condition in recognition that
the sponsor of a seeded fund or its asset manager may be motivated to
provide financial assistance to the seeded fund whose uncleared swaps
may be uncollateralized as a result of the Seeded Funds Proposal, which
might heighten the risk of the fund's swap positions and weaken the
fund's financial condition. The sponsor entity or the asset manager may
also be inclined to provide financial assistance to the fund because of
reputational or other concerns even in the absence of a guarantee or
formal commitment, and at the risk of exhausting its own resources,
raising the risk of contagion and systemic risk, in particular during
times of widespread financial stress. The Commission preliminarily
believes that the requirements in the proposed definition of ``eligible
seeded fund,'' which seek to ensure the fund's genuine independence,
would serve as effective safeguards against financial contagion.
The Commission also intends to rely on tools that already exist
under the CEA and the Commission regulations to address evasion
concerns. In particular, the Commission notes that Commission
Regulation 23.402(a)(ii) requires CSEs to have written policies and
procedures to prevent the evasion, or participation in or facilitation
of an evasion, of any provision of the CEA or the Commission
regulations.\61\ The Commission also reminds market participants that
section 4b of the CEA prohibits any person entering into a swap with
another person from cheating, defrauding, or willfully deceiving, or
attempting to cheat, defraud, or deceive, the other person.\62\
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\61\ 17 CFR 23.402(a)(ii). As discussed above, the Commission
also notes that the definition of MSE in Commission Regulation
23.151 prohibits activities not carried out in the regular course of
business and willfully designed to circumvent the calculation of the
AANA at month-end to evade meeting the definition of MSE shall be
prohibited. 17 CFR 23.151.
\62\ 7 U.S.C. 6b.
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Request for comments: The Commission requests comments regarding
the proposed amendments to Commission Regulation 23.151, generally. The
Commission specifically requests comment on the following questions:
1. Under the Seeded Funds Proposal, eligible seeded funds would be
deemed not to have margin affiliates for purposes of calculating the
fund's MSE and the IM threshold amount during a period of three years
from the fund's trading inception date. As such, CSEs that undertake
uncleared swaps with such funds and would otherwise be required to
exchange IM with the funds, may be relieved from such obligation, as
only each fund's individual exposure would be considered in determining
whether the IM requirements apply to uncleared swaps between CSEs and
the fund. As a result, less margin may be collected and posted for
uncleared swaps than would be otherwise required under the current
requirements. Is the Seeded Funds Proposal appropriate in light of the
resulting potential uncollateralized swap risk?
2. The Commission recognizes that the proposed eligible seeded fund
exception would not only benefit the eligible seeded funds but would
also relieve CSEs from their obligation to post IM with seeded funds
that would otherwise come within the scope of the CFTC IM requirements.
Should only the eligible seeded fund, and not its CSE counterparty, be
relieved of the IM obligation?
3. Should the Commission impose any additional limits or conditions
to the proposed eligible seeded fund exception such as: (i) imposing a
separate MSE and/or IM threshold amount, calculated on the basis of the
eligible seeded fund's individual exposure and proportionate to the
perceived risks associated with funds' swap activities, (ii) imposing a
limit on the total number of eligible seeded funds to which a sponsor
entity provides start-up capital that may rely on the eligible seeded
fund exception, or (iii) requiring that all eligible seeded funds,
consolidated within the same group on the basis of accounting
principles, aggregate their exposures for purposes of calculating the
MSE and IM threshold amounts that apply to such funds?
4. What are the costs associated with a seeded fund calculating IM
and establishing a relationship with a custodian to transfer IM?
5. The proposed amendments to Commission Regulation 23.151, in
particular the requirements in the proposed definition of ``eligible
seeded fund,'' aim to ensure that the relevant funds are genuinely and
practically independent and risk-remote from their sponsor entities and
other affiliates. Do the proposed amendments incorporate sufficient
safeguards to achieve this goal? Given that other entities such as
sponsor entities or the asset manager may be incentivized to provide
resources to a seeded fund in financial distress even in the absence of
an
[[Page 53416]]
explicit business arrangement or guarantee, potentially putting their
own financial position at risk and thereby increasing the risk of
contagion and systemic risk, what measures could the Commission take to
limit the potential risks to such other entities and ultimately to the
financial system?
6. The Commission proposes to include, among other conditions, a
requirement providing that a fund would qualify as an eligible seeded
fund only if one or more of the seeded fund's margin affiliates is
required to post and collect IM pursuant to Commission Regulation
23.152. This condition is intended to limit the availability of the
proposed eligible seeded fund exception only to funds that, for reasons
described in the Margin Subcommittee Report, are disadvantaged
domestically and globally due to their affiliation with a group that
has MSE. Is this condition appropriate? Should the condition be amended
to ensure that the Commission is appropriately circumscribing the
proposed treatment of eligible seeded funds?
7. The Commission also proposes to include, among other conditions,
a requirement providing that to qualify as an eligible seeded fund, the
seeded fund's investment strategy must follow a written plan for
reducing each sponsor entity's ownership interest in the seeded fund
that stipulates divestiture targets over the three-year period after
the seeded fund's trading inception date. Should the Commission include
more specific requirements in connection with the written plan?
8. The Prudential Regulators Margin Rule contains a definition of
``margin affiliate'' that is equivalent to the current definition under
the CFTC Margin Rule. Furthermore, the prudential regulators have
reserved the right to include any entity as an affiliate or a
subsidiary based on the conclusion that an entity may provide
significant support to, or may be materially subject to the risks or
losses of, another entity. If the Commission amends Commission
Regulation 23.151, counterparties that trade with both prudentially
regulated SDs and CFTC-regulated SDs may need to adjust their swap-
related documentation and collateral management systems to reflect the
different margin requirements that may apply under the CFTC's and the
prudential regulators' rules. In that regard, the Commission requests
information on the potential additional costs associated with
maintaining two separate and distinct documentation and collateral
management processes. How much weight should the Commission give with
respect to the possible challenge that counterparties may need to
maintain two separate and distinct documentation and collateral
management systems? Should the Commission proceed to adopt the proposed
amendments to Commission Regulation 23.151 if the prudential regulators
do not adopt similar regulatory changes?
9. The Commission intends that the final rule will become effective
30 days after its publication in the Federal Register. With respect to
the Seeded Funds Proposal, are there any comments on the effective
date?
B. Money Market Funds Proposal
The Commission proposes to amend Commission Regulation
23.156(a)(1)(ix) to eliminate the restriction on the use of securities
of money market and similar funds that transfer their assets through
repurchase or similar arrangement (the asset transfer restriction). The
Commission is also proposing an amendment to the haircut schedule set
forth in Commission Regulation 23.156(a)(3)(i)(B) to add a footnote
that was inadvertently omitted when the rule was originally
promulgated.
1. Commission Regulation 23.156(a)(1)(ix)--Elimination of the Asset
Transfer Restriction
In adopting the CFTC Margin Rule, the Commission added redeemable
securities in money market and similar funds to the list of eligible
collateral in response to comments arguing for the inclusion of MMF
securities as eligible collateral for IM.\63\ The Commission explained
that the addition of money market and similar fund securities to the
list of eligible collateral would provide flexibility while maintaining
a level of safety, noting that to qualify, such fund securities would
need to meet the conditions in Commission Regulation 23.156(a)(1)(ix),
including the asset transfer restriction in paragraph (C), which has
the effect of disqualifying the securities of funds that transfer their
assets through repurchase or similar arrangements.\64\
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\63\ See CFTC Margin Rule, 81 FR at 666.
\64\ Id.
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As discussed above, market participants, and the GMAC Margin
Subcommittee, have urged the Commission to eliminate the asset transfer
restriction in paragraph (C), noting that it disqualifies the
securities of most MMFs and significantly restricts the ability of swap
counterparties to use such form of collateral.\65\ Based on its
experience implementing the margin requirements for several years and
for the reasons described below, the Commission preliminarily
recommends the elimination of the restriction.
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\65\ Margin Subcommittee Report at 23.
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MMFs are regulated, short-term investment vehicles that are subject
to liquidity and diversification requirements under U.S. regulations,
such as SEC Rule 2a-7.\66\ The MMFs that could qualify as eligible IM
collateral under Commission Regulation 23.156 invest in high quality
underlying instruments, namely securities issued or unconditionally
guaranteed as to the timely payment of principle and interest by the
U.S. Department of the Treasury and cash. More generally, the Margin
Subcommittee Report stated that the Commission has recognized MMFs as
safe, high quality investments, noting that, for example, Commission
Regulation 1.25 permits the investment of customer margin by futures
commission merchants (``FCM'') in MMFs without an asset transfer
restriction.\67\
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\66\ 17 CFR 270.2a-7.
\67\ Margin Subcommittee Report at 26. In the Commission's view,
the fact that Commission Regulation 1.25 permits investments in
interests in money market funds without imposing restrictions on
repurchase agreements and similar arrangements is not dispositive in
considering the proposed amendment to Commission Regulation
23.156(a)(1)(ix). Commission Regulation 1.25 was adopted under a
different regime (concerning FCMs and derivative clearing
organizations) and addresses different concerns than those
Commission Regulation 23.156 aims to target.
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The elimination of the asset transfer restriction in paragraph (C)
of Commission Regulation 23.156(a)(1)(ix) would allow for a broader
range of money market and similar fund securities to qualify as
eligible IM collateral.\68\ This is consistent with the Commission's
intent in identifying certain fund securities as eligible collateral
when it adopted the CFTC Margin Rule. The Commission stated that it
intended to permit MMF securities to be pledged as IM collateral in
order to permit flexibility, while also ``maintaining a level of
safety.'' \69\ As noted above, according to the Margin Subcommittee
Report, most multi-billion dollar MMFs available to the institutional
marketplace use repurchase or similar arrangements as part of their
management strategy.\70\ Given the widespread use of repurchase and
similar arrangements by MMFs,
[[Page 53417]]
only a few of the MMFs currently available to institutional clients
satisfy the asset transfer restriction in paragraph (C).\71\ As a
result, unless the restriction is eliminated, this form of margin
collateral would be of very limited availability to swap
counterparties, contrary to the intent of the Commission.
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\68\ If adopted, the amendment would also result in an expanded
scope of money market and similar fund securities that can serve as
VM for uncleared swap transactions between a CSE and an FEU, given
that Commission Regulation 23.156(b)(1)(ii), defining the types of
assets qualifying as VM collateral for these transactions,
incorporates the assets identified as eligible collateral for IM in
Commission Regulation 23.156(a)(1).
\69\ See 81 FR at 666.
\70\ Margin Subcommittee Report at 27.
\71\ Id. at 24 (noting that a leading custodial bank has
researched all the U.S. MMFs currently available to its
institutional clients in the U.S. and found that only four would
meet the requirements of Commission Regulation 23.156(a)(1)(ix)).
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The Commission preliminarily believes that expanding the scope of
eligible money market and similar fund securities may lead to more
efficient collateral management practices. In particular with respect
to the use of MMF securities as IM collateral, the Margin Subcommittee
Report noted that many custodians offer money market sweep programs,
which facilitate buy-side market participants' timely meeting margin
calls in cash that is subsequently used to purchase MMF securities,
thereby avoiding the settlement delays or additional costs associated
with the purchase and posting of non-cash assets.\72\ This is
particularly important given that under the custodian arrangement rules
under Commission Regulation 23.157, IM collateral in cash must be
promptly converted into other types of eligible collateral, such as
securities of MMF or similar funds, to avoid the possibility that cash
collateral may become a deposit liability of the custodian and to
prevent rehypothecation by the custodian.\73\
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\72\ Under Commission Regulation 23.157, a custodian may accept
and hold cash collateral as IM only if the funds are subsequently
used to purchase an asset that qualifies as an eligible form of
collateral under Commission Regulation 23.156(a)(1)(ii) through (x).
\73\ See 81 FR at 671.
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Moreover, the Report stated that the use of MMF securities as
collateral may enable market participants to avoid potential negative
interest rate charges that may be applied by custodian banks on cash
collateral.\74\ Finally, according to the Report, the sweep of cash
into MMF securities helps market participants mitigate the risk of
custodian insolvency as non-cash assets would not be consolidated with
the custodian's balance sheet or estate from a supplemental leverage
ratio \75\ or bankruptcy perspective.\76\
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\74\ See Margin Subcommittee Report at 27.
\75\ The supplementary leverage ratio represents the amount of
common equity capital that banks or bank holding companies must hold
relative to their total leverage exposure. CSEs and SD or MSP
counterparties that are banks or bank holding companies and
supervised by a U.S. banking regulator may be subject to this
requirement. For further information, see Regulatory Capital Rules:
Regulatory Capital, Revisions to the Supplementary Leverage Ratio,
79 FR 57725 (Sept. 26, 2014).
\76\ Margin Subcommittee Report at 26-27.
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Allowing a broader selection of money market and similar fund
securities to serve as collateral may address the potential
concentration of margin collateral in the securities of a few MMFs.\77\
The removal of the asset transfer restriction could lead to an
increased use of MMF securities as margin collateral. The Commission
acknowledges the risk of concentration of collateral in particular
assets and reiterates, as stated in the preamble to the CFTC Margin
Rule, that CSEs should take concentration into account and prudently
manage their margin collateral.\78\ For the same reasons, the
Commission preliminarily believes that CSEs should consider the overall
investment strategy of a money market or similar fund, including the
terms of repurchase or similar arrangements the fund may undertake, in
determining whether to use the fund's securities to meet margin
obligations under the CFTC rules.
---------------------------------------------------------------------------
\77\ As noted above, according to the Margin Subcommittee Report
(citing research by a leading custodian bank), only four MMFs have
securities that qualify as eligible collateral under the current
rules. See Margin Subcommittee Report at 24.
\78\ See 81 FR at 666.
---------------------------------------------------------------------------
The Commission explained in the preamble to the CFTC Margin Rule
that the asset transfer restriction in paragraph (C) of Commission
Regulation 23.156(a)(1)(ix) was included to ensure consistency with the
prohibition against rehypothecation of IM collateral under Commission
Regulation 23.157(c)(1). After further consideration and based on its
experience implementing the margin requirements for several years, the
Commission now preliminarily believes that although these rules are
similar in that they aim to mitigate loss, the objectives of these
rules are distinguishable as further discussed below.
Commission Regulation 23.157 provides for the segregation of IM
collateral with a third-party custodian to ensure that: (i) the IM is
available to a counterparty when its counterparty defaults and a loss
is realized that exceeds the amount of VM that has been collected as of
the time of default; and (ii) the IM is returned to the posting party
after its swap obligations have been fully discharged.\79\ In this
context, the prohibition in Commission Regulation 23.157(c)(1) against
rehypothecation, repledging, reuse, or other transfer (through
securities lending, repurchase agreement, reverse repurchase agreement,
or other means) of funds or property held by the custodian advances the
Commission's goal of ensuring that the pledged assets are available to
the non-defaulting party in the event of a default by its
counterparty.\80\ In the preamble to the CFTC Margin Rule, the
Commission explained that rehypothecation could allow the collateral
posted by one counterparty to be used by the other counterparty as
collateral for additional swaps, resulting in rehypothecation chains
and embedded leverage throughout the financial system.\81\
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\79\ Id. at 670.
\80\ In this regard, the Margin Subcommittee Report stated that
``in [ ] MMF sweep arrangements, under no circumstances does the
pledgor's custodian have any right to rehypothecate, reuse the IM
collateral or take any other independent actions with respect to the
pledged MMF shares. Instead, the CSE and financial end user agree
upfront in the collateral documentation to the list of eligible MMFs
and any associated haircuts, as pledgor any cash sweep into a MMF is
instructed by the financial end user or its manager and absent any
default, any transfers into and out of the collateral account by the
custodian is instructed by the financial end user and agreed to by
the CSE (as secured party).'' Margin Subcommittee Report at 25.
\81\ Id. at 688, n. 392 (describing as an example, the situation
where a default or liquidity event that occurs at one link along the
rehypothecation chain may induce further defaults or liquidity
events for other links in the rehypothecation chain as access to the
collateral for other positions may be obstructed by a default
further up the chain, and also explaining that in the event of
default along a rehypothecation chain, there is an increased chance
that each party along the chain will ask for the rehypothecated
collateral to be returned to them at the same time, leaving just one
party with the collateral).
---------------------------------------------------------------------------
In contrast, Commission Regulation 23.156(a) aims to identify
assets as eligible collateral that are liquid, and, with haircuts, will
hold their value in times of financial stress.\82\ Current paragraph
(C) of Commission Regulation 23.156(a)(1)(ix) furthers the goal that
money market and similar fund securities posted as IM collateral remain
liquid and retain their value during times of financial stress. More
specifically, paragraph (C) disqualifies the securities of money market
and similar funds that transfer their assets through repurchase or
similar arrangements to mitigate the potential impact of such transfers
on the liquidity or value of fund securities.
---------------------------------------------------------------------------
\82\ Id. at 665.
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For example, if the counterparty to a money market and similar fund
in a repurchase or similar arrangement does not fulfill its obligation
under the
[[Page 53418]]
arrangement, the fund may be left holding assets that might not be
easily resold or that might not provide sufficient compensation for the
assets tendered in the repurchase arrangement, in particular during a
period of financial stress, reducing the overall net asset value of the
fund and the price of the fund's securities. Also, the inability to
liquidate assets that a money market and similar fund might be left
holding upon the failure of a repurchase or similar arrangement, or the
inability to extract assets originally tendered in the repurchase
arrangement, may impact a fund's ability to promptly respond to
redemption requests, which may hinder the liquidity of the money market
and similar funds' securities, making the securities less suitable as
margin collateral.\83\ Repurchase and similar arrangements may
therefore undermine efforts that collateral be ``subject to low credit,
market, and liquidity risk.'' \84\
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\83\ The Commission, however, notes that any potential risk of
such a repurchase or similar arrangement may be mitigated by the
standard industry practice of applying haircuts to non-cash
collateral in repurchase or similar arrangements to compensate for
the risk that the value of the collateral may decline over the term
of the arrangement. See Primer: Money Market Funds and the Repo
Market, Prepared by the staff of the Division of Investment
Management, U.S. Securities and Exchange Commission at pp. 5-6.
\84\ 81 FR at 667 (noting that the CFTC Margin Rule does not
allow CSEs to fulfill the margin requirements with any asset not
included in the list of eligible collateral set forth in Commission
Regulation 23.156, as the use of alternative types of collateral
could introduce liquidity, price volatility, or other risks of
collateral during a period of stress that could further exacerbate
such stress and could undermine efforts to ensure that collateral be
subject to low credit, market, and liquidity risk).
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As discussed above, the asset transfer restriction was included in
the CFTC Margin Rule to provide consistency with the prohibition
against rehypothecation of IM collateral, given the possibility that
assets exchanged by parties in a repurchase or similar arrangement
might be lost in a chain of transactions similar to the chain of
hypothecations that the Commission intended to avert by prohibiting the
rehypothecation of IM collateral by custodians under Commission
Regulation 23.157(c)(1). However, unlike in the rehypothecation
situation, where collateral might be lost at any link of the chain with
the posting counterparty in the uncleared swap transaction potentially
losing its collateral without any recourse, in the repurchase or
similar arrangement context, each party to the arrangement would be
partially secured because the parties would exchange assets with each
other under the arrangement. Hence, the risk of loss would be
mitigated. If a party to the repurchase arrangement defaults by failing
to return assets tendered by its counterparty, the counterparty would
not lose the entire value of its assets as it would hold the assets
committed by the other party under the arrangement.\85\
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\85\ Of course, it might experience some loss as the retained
assets might not fully compensate such party for the unreturned
assets.
---------------------------------------------------------------------------
While acknowledging the concerns associated with repurchase and
similar arrangements, the Commission preliminarily believes that the
flexibility and safety that it aimed to achieve by specifically
identifying assets as eligible collateral, including certain money
market and similar fund securities, may be advanced even if repurchase
and similar arrangements are not restricted for the purpose of
qualifying money market and similar fund securities as eligible
collateral. In that regard, based on its experience administering the
CFTC Margin Rule, the Commission preliminarily believes that risks
associated with repurchase and similar arrangements would be adequately
addressed even in the absence of the asset transfer restriction by
safeguards already present in the CFTC regulations, as further
discussed below, which, in the Commission's view, can achieve the
desired level of safety with respect to fund securities without
restricting a fund's ability to undertake repurchase or similar
transactions.
First, Commission Regulation 23.156(a)(1)(ix)(A) and (B) qualify as
eligible collateral the securities of money market and similar funds
that invest only in securities issued or unconditionally guaranteed by
the U.S. Department of the Treasury, the European Central Bank or
certain other sovereign entities, and cash. The Commission
preliminarily believes that these provisions ensure that money market
and similar fund securities present the fundamental characteristics of
liquidity and value stability contemplated by the CFTC Margin Rule.\86\
In addition, the Commission notes that subparagraphs (A) and (B) of
Commission Regulation 23.156(a)(1)(ix) effectively limit the types of
assets that a money market and similar fund can receive in repurchase
or similar arrangements. As such, the securities of money market and
similar funds will qualify as eligible collateral only if the types of
assets that the fund receives in a repurchase or similar arrangement
are those described in subparagraphs (A) and (B).
---------------------------------------------------------------------------
\86\ See 81 FR at 665.
---------------------------------------------------------------------------
Second, Commission Regulation 23.156(c) requires that CSEs monitor
the market value and eligibility of all collateral and, to the extent
that the market value has declined, promptly collect or post additional
eligible collateral to maintain compliance with Commission Regulations
23.150 through 23.161.\87\ Thus, even if the value or liquidity of
pledged money market and similar fund securities may be affected by a
repurchase or similar arrangement undertaken by the fund, CSEs have the
obligation to monitor the value and suitability of the fund's
securities as margin collateral and collect or post additional eligible
collateral to compensate for collateral deficiencies.
---------------------------------------------------------------------------
\87\ 17 CFR 23.156(c).
---------------------------------------------------------------------------
In addition, section 4s(j)(2) of the CEA requires CSEs to adopt a
robust and professional risk management system that is adequate for the
management of their swap activities,\88\ and Commission Regulation
23.600 mandates that CSEs establish a risk management program to
monitor and manage risks associated with their swap activities
including, among other things, credit and liquidity risks. In
particular, pursuant to Commission Regulation 23.600(c)(4), credit risk
policies and procedures should provide for the regular valuation of
collateral used to cover credit exposures and the safeguarding of
collateral to prevent loss, disposal, rehypothecation, or use unless
appropriately authorized, and liquidity risk policies and procedures
should provide for, among other things, the assessment of procedures
for liquidating all non-cash collateral in a timely manner and without
a significant effect on price, and the application of appropriate
collateral haircuts that accurately reflect market and credit risk.\89\
---------------------------------------------------------------------------
\88\ See 7 U.S.C. 6s(j).
\89\ 17 CFR 23.600.
---------------------------------------------------------------------------
Given these safeguards and the recognition that the asset transfer
restriction is severely limiting the use of money market and similar
fund securities as eligible collateral, the Commission preliminary
believes that it is appropriate to eliminate the asset transfer
restriction. The Commission also notes that the elimination of the
restriction would bring the CFTC's eligible collateral framework more
in line with the SEC approach, which does not impose asset transfer
restrictions on funds whose securities are used as collateral for
margining purposes and expressly permits the use of government money
market fund securities as collateral, thereby potentially leading to a
reduction in costs for those market participants that dually register
as SDs and security-based swap SDs with the CFTC and the SEC,
respectively.
[[Page 53419]]
2. Commission Regulation 23.156(a)(3)--Amendments to the Haircut
Schedule
Commission Regulation 23.156(a)(3) sets forth percentage discounts
to be applied to the value of eligible collateral collected or posted
to satisfy IM requirements, varying according to asset class (``haircut
requirements'').\90\ The haircut requirements are intended to address
the possibility that the value of non-cash eligible collateral may
decline between a counterparty's default and the close out of such
counterparty's swap positions by the CSE.\91\
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\90\ 17 CFR 23.156(a)(3). Also, Commission Regulation
23.156(b)(1)(ii) provides that assets that qualify as eligible
collateral for IM can be used as collateral for VM for swap
transactions between a CSE and a FEU, subject to the applicable
haircuts for each asset. See also supra note 20.
\91\ 81 FR at 668.
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Although the Commission intended to align its margin rule for
uncleared swaps with the Prudential Regulators Margin Rule, in adopting
its rule, the Commission inadvertently omitted a footnote to the
haircut schedule included in the Prudential Regulators Margin Rule.\92\
The Commission is therefore proposing an amendment to Commission
Regulation 23.156(a)(3) to incorporate the omitted footnote. The
footnote, consistent with the footnote in the Prudential Regulators
Margin Rule, would describe the haircut applicable to the securities of
money market and similar funds. The haircut for such money market and
similar fund securities would be the weighted average discount on all
assets within the funds (the discount for each asset is specified in
Commission Regulation 23.156(a)(3)) at the end of the prior month. The
footnote would further specify that the weights to be applied in the
weighted average should be calculated as a fraction of each fund's
total market value that is invested in each asset with a given discount
amount.
---------------------------------------------------------------------------
\92\ Prudential Regulators Margin Rule at 74910.
---------------------------------------------------------------------------
Request for comments: The Commission requests comment regarding the
proposed amendments to Commission Regulation 23.156, generally. The
Commission specifically requests comment on the following questions:
10. Does the existing asset transfer restriction significantly
limit the use of money market and similar fund securities as eligible
collateral under the CFTC Margin Rule?
11. Under the Money Market Funds Proposal, the securities of
certain money market and similar funds that engage in repurchase or
similar arrangements would qualify as eligible collateral. A money
market and similar fund that engages in asset transfer transactions
under a repurchase or similar arrangement may be exposed to increased
risks, which may affect the liquidity and value of the fund's
securities pledged as collateral under the CFTC Margin Rule. In light
of the potential increased risk, should the Commission consider an
alternative to the proposed rule amendment, such as allowing the
securities of money market and similar funds to qualify as eligible
collateral only if a fund's repurchase or similar arrangements are
cleared? Should the Commission impose any additional limits or
conditions, such as restrictions on the type and terms of the
repurchase or similar arrangements permitted for money market and
similar funds for their shares to qualify as eligible collateral?
12. If the Commission eliminates the asset transfer restriction,
should the Commission impose an additional haircut beyond that required
by the haircut schedule in Commission Regulation 23.156(a)(3), as
revised by the proposed amendment? If an additional haircut were to be
adopted, what should the haircut be and how should the haircut be
calculated? Should such an additional haircut be proportionate to the
net asset value of the assets of a money market and similar fund that
are subject to repurchase or similar arrangements? Or instead, should
the additional haircut be a fixed percentage similar to the percentages
applicable to other assets that qualify as eligible collateral under
the haircut schedule, as it may be less complex to administer? Should
such additional fixed haircut apply to all securities of money market
and similar funds that are used as eligible collateral, or be
applicable only to such securities of money market and similar funds
that engage in repurchase or similar arrangements?
13. Given the potential impact that repurchase or similar
agreements may have on the liquidity and value of securities of money
market and similar funds that may be used as eligible collateral,
should there be a percentage cap on the amount of assets that a fund
can use for repurchase or similar arrangements, such as 10 percent of
the total net asset value of the fund?
14. To gain a better understanding of the risks posed by repurchase
and similar arrangements, the Commission requests information
concerning the types of counterparties that typically face money market
and similar funds in repurchase or similar agreements; the extent to
which repurchase and similar arrangements are used by money market and
similar funds; and whether the market treats differently money market
and similar funds according to the types of repurchase and similar
arrangements the funds enter into and the extent of repurchase
agreements or arrangements the funds engage in. Further, the Commission
requests comment with respect to the manner in which, and the extent to
which, CSEs will meet their obligation to monitor the value and
suitability of securities of money market and similar funds pledged as
margin collateral where the funds engage in repurchase or similar
arrangements.
15. Are the regulatory safeguards referenced in the Money Market
Funds Proposal adequate to address the potential risks that may arise
from the proposal? Are there other regulatory safeguards that the
Commission should consider?
16. Are there any risks associated with the Money Market Funds
Proposal that the Commission has not considered? In addition to the
possible measures discussed above, including a possible additive
haircut, or a percentage cap on the amount of assets that funds could
use in repurchase and similar agreements, are there other measures that
the Commission could take to mitigate such risks?
17. The Prudential Regulators Margin Rule contains an equivalent
asset transfer restriction. If the Commission amends Commission
Regulation 23.156, counterparties that trade with both prudentially
regulated SDs and CFTC-regulated SDs may need to adjust their swap-
related documentation and collateral management systems to reflect the
different treatments for fund securities under the CFTC's and the
prudential regulators' rules. In that regard, the Commission requests
information on the potential additional costs associated with
maintaining two separate and distinct documentation and collateral
management processes. How much weight should the Commission give with
respect to the possible challenge that counterparties may need to
maintain two separate and distinct documentation and collateral
management systems? Should the Commission proceed to adopt the proposed
amendments to Commission Regulation 23.156 if the prudential regulators
do not adopt similar regulatory changes?
18. The Commission intends that the final rule will become
effective 30 days after its publication in the Federal Register. With
respect to the Money Market Funds Proposal, are there any comments on
the effective date?
[[Page 53420]]
IV. Administrative Compliance
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires Federal agencies
to consider whether the rules they propose pursuant to the notice-and-
comment provisions of the Administrative Procedure Act, or any other
law, will have a significant economic impact on a substantial number of
small entities and provide a regulatory flexibility analysis respecting
the impact or issue a certification that the rule does not have such
impact.\93\ The Commission previously has established certain
definitions of ``small entities'' to be used in evaluating the impact
of its regulations on small entities in accordance with the RFA.\94\
The proposed amendments would only affect certain SDs and MSPs and
their counterparties, which must be eligible contract participants
(``ECPs'').\95\ The Commission has previously established that SDs,
MSPs and ECPs are not small entities for purposes of the RFA.\96\
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\93\ See 5 U.S.C. 601(2), 603, 604, and 605.
\94\ See Registration of Swap Dealers and Major Swap
Participants, 77 FR 2613 (Jan. 19, 2012).
\95\ Pursuant to section 2(e) of the CEA, 7 U.S.C. 2(e), each
counterparty to an uncleared swap must be an ECP, as defined in
section 1a(18) of the CEA, 7 U.S.C. 1a(18). Section 1a(18) of the
CEA defines ECP by listing certain entities and individuals whose
business is financial in nature or that meet defined asset or net
worth thresholds, as well certain government entities.
\96\ See Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ```Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR
30596, 30701 (May 23, 2012).
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Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the proposed amendments will
not have a significant economic impact on a substantial number of small
entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \97\ imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any collection of
information, as defined by the PRA. The Commission may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid Office of Management
and Budget control number. The proposed amendments contain no
requirements subject to the PRA.
---------------------------------------------------------------------------
\97\ 44 U.S.C. 3501 et seq.
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C. Cost-Benefit Considerations
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA.\98\ Section 15(a) further specifies that the costs and
benefits shall be evaluated in light of the following five broad areas
of market and public concern: (1) protection of market participants and
the public; (2) efficiency, competitiveness and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations. The Commission
considers the costs and benefits resulting from its discretionary
determinations with respect to the section 15(a) considerations, and
seeks comments from interested persons regarding the nature and extent
of such costs and benefits.
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\98\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
As described in more detail above, under the Seeded Funds Proposal,
the Commission is proposing to amend the definition of ``margin
affiliate'' to provide for a limited eligible seeded fund exception,
pursuant to which, during a period of three years after the fund's
trading inception date, a seeded fund meeting certain specified
requirements would be deemed to not have margin affiliates for purposes
of calculating the fund's MSE and the IM threshold. This proposed
treatment for eligible seeded funds would effectively relieve CSEs that
enter into uncleared swaps with certain seeded funds from the
requirement to exchange IM with the seeded funds during the three-year
period after the funds' trading inception date. The Seeded Funds
Proposal would make the proposed treatment available only with respect
to eligible seeded funds that, among other requirements: (i) are
distinct legal entities from each sponsor entity; (ii) have one or more
margin affiliates that are required to post and collect IM; (iii) are
managed by an asset manager pursuant to an agreement that requires the
assets of the fund to be managed in accordance with a specified written
investment strategy; (iv) have an asset manager who maintains
independence in carrying out its management responsibilities and
exercising its investment discretion, and has independent fiduciary
duties to other investors in the fund (if any), such that no sponsor
entity or any margin affiliate of a sponsor entity controls or has
transparency into the management or trading of the seeded fund; (v)
follow a written plan for the reduction of the sponsor entity's
ownership interest in the fund that stipulates divestiture targets over
the three-year period after the seeded fund's trading inception date;
(vi) are not collateralized, guaranteed or otherwise supported,
directly or indirectly by any sponsor entity, any margin affiliate of a
sponsor entity, other collective investment vehicles, or the seeded
fund's asset manager, in respect of any of the fund's obligations;
(vii) have not received any of their assets, directly or indirectly,
from an eligible seeded fund that has relied on the proposed eligible
seeded fund exception; and (viii) are not securitization vehicles.
Under the Money Market Funds Proposal, the Commission is proposing
to eliminate the asset transfer restriction in paragraph (C) of
Commission Regulation 23.156(a)(1)(ix), which has the effect of
disqualifying as eligible collateral the securities of money market and
similar funds that transfer their assets through repurchase or similar
arrangements. The Margin Subcommittee Report indicated that the asset
transfer restriction significantly limits the money market fund
securities that are available for use as collateral under the CFTC
Margin Rule.\99\
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\99\ As previously noted, according to the Margin Subcommittee
Report (citing research by a leading custodian bank), the securities
of only four MMFs would qualify as eligible collateral under the
current rules. See Margin Subcommittee Report at 24.
---------------------------------------------------------------------------
The baseline against which the benefits and costs associated with
the proposed rule amendments are compared is the uncleared swaps
markets as they exist today, including the treatment of seeded funds
and the securities of money market and similar funds under the current
CFTC Margin Rule.
The Commission notes that the consideration of costs and benefits
below is based on the understanding that the markets function
internationally, with many transactions involving U.S. firms taking
place across international boundaries; with some Commission registrants
being organized outside of the United States; with leading industry
members typically conducting operations both within and outside the
United States; and with industry members commonly following
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
below discussion of costs and benefits refers to the effects of these
proposed amendments on all activity subject to the proposed amended
regulations, whether by virtue of the activity's physical location in
the United States or by virtue of the activity's connection with
activities in, or effect on, U.S.
[[Page 53421]]
commerce under section 2(i) of the CEA.\100\
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\100\ 7 U.S.C. 2(i).
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The Commission recognizes that the proposed rules may impose
additional costs on market participants, including CSEs. Although the
Commission has endeavored to assess the expected costs and benefits of
the proposed rulemaking in quantitative terms, due to the lack of data
and information to estimate those costs, the Commission has identified
and considered the costs and benefits of the proposal in qualitative
terms. The lack of data and information to estimate costs is
attributable to the nature of the proposal and uncertainty relating to
how particular market participants would implement the proposed rules.
The Commission specifically requests data and information from market
participants and other commenters to allow it to better estimate the
costs of the proposal.
1. General Cost-Benefits Considerations
Seeded Funds Proposal
(a) Benefits
The Seeded Funds Proposal would effectively relieve CSEs entering
into uncleared swaps with eligible seeded funds from the requirement to
collect IM from the funds, subject to specified conditions. Absent the
Seeded Funds Proposal, seeded funds would be disadvantaged domestically
and globally in comparison to similar investment funds that are not
margin affiliates of an entity required to exchange IM or are subject
to the rules of jurisdictions such as Australia, Canada and the EU that
treat certain investment funds as separate legal entities, consistent
with the international standards established by the BCBS-IOSCO
Framework.\101\ The Seeded Funds Proposal would therefore level the
playing field domestically and globally with respect to the treatment
of seeded funds. However, the Seeded Funds Proposal may incentivize
trading with CSEs over SDs or MSPs subject to the U.S. prudential
regulators' margin rules given that the prudential regulators might not
revise their rules in a manner consistent with the Seeded Funds
Proposal and the prudential regulators' rules may continue to require
that seeded funds calculate the MSE and IM threshold amount on a
consolidated basis with their margin affiliates.
---------------------------------------------------------------------------
\101\ Margin Subcommittee Report at 7, 30 and 33.
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The Commission preliminarily believes that the Seeded Funds
Proposal would tend to benefit seeded funds whose AANA falls below the
$8 billion MSE threshold and that, given their level of swap activity,
such seeded funds would pose relatively low risk to the uncleared swaps
market and the U.S financial system in general. In that regard, the
Margin Subcommittee Report stated that seeded funds have limited
notional exposure and their capitalization typically does not exceed
$50-100 million.\102\ The Report further cited an informal sampling of
members of SIFMA AMG and the American Council of Life Insurers
conducted in 2018, which indicated that a total of 33 funds would be in
scope of the CFTC margin requirements due to their derivatives notional
exposures being consolidated with entities with MSE. Individually, each
of the funds had an average gross notional exposure of $32
million.\103\
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\102\ Margin Subcommittee Report at 31.
\103\ Id.
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As a result, in the Commission's preliminary view, the Seeded Funds
Proposal, if adopted, would address seeded funds that tend to engage in
less uncleared swap trading activity and, in the aggregate, pose less
systemic risk than entities that meet the MSE threshold. The impacted
eligible seeded funds, which would be in an initial stage of
development, would presumably have fewer resources to devote to IM
compliance and hence would benefit from being discharged from posting
IM during their seeding period without contributing significantly to
systemic risk. The eligible seeded fund's sponsor entities and their
margin affiliates that do not independently qualify for the proposed
eligible seeded fund exception would continue to include the eligible
seeded funds' exposure in their calculation of the MSE and IM threshold
amount. The CSE counterparty to the eligible seeded fund would also
still be required to count the uncleared swaps that it undertakes with
the eligible seeded fund for purposes of calculating its own AANA. The
Commission preliminarily believes that the flexibility provided by the
eligible seeded fund exception would be instrumental for investment
funds during the seeding period when funds typically use all their
resources to establish a performance track record to attract
unaffiliated investors.
In addition, the Commission believes that the Seeded Funds Proposal
would be beneficial for CSEs that enter into swap transactions with
investment funds. As a result of the proposed amendments, CSEs would
apply a consistent approach in their swap dealing activities with U.S.
and non-U.S. investment funds, which may lead to cost efficiencies.
Also, as noted in the Margin Subcommittee Report, a consistent approach
to seeded funds would reduce the incentive for non-U.S. funds to avoid
business with CSEs given the perceived more onerous treatment of funds
in the U.S.\104\
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\104\ Margin Subcommittee Report at 30.
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The proposed eligible seeded fund exception may also incentivize
some market participants to expand their swap business or enter into
the swaps markets because, by counting their AANA and uncleared swaps
credit exposure individually, seeded funds may not meet the thresholds
that would bring them within the scope of the IM requirements. This
would relieve CSEs entering into uncleared swaps with the funds from
the requirement to exchange IM with the funds. In turn, the elimination
of IM-related costs may encourage uncleared swaps trading between CSEs
and investment funds and increase the pool of potential swap
counterparties, enhancing competition and liquidity and facilitating
price discovery in the uncleared swaps markets.
(b) Costs
Amending the definition of ``margin affiliate'' to provide for a
limited eligible seeded fund exception under which seeded funds would
be deemed to not have margin affiliates for purposes of calculating the
funds' MSE and the IM threshold amount, subject to specified
conditions, may lead to the exchange of less margin between a CSE and a
seeded fund. The Commission recognizes that the uncollateralized
exposure that may result from the proposed change to the ``margin
affiliate'' definition could increase credit risk associated with
uncleared swaps. The Commission believes, however, that a number of
safeguards exist to mitigate this risk. The Commission notes that
seeded funds that would qualify for the eligible seeded fund exception
would typically be smaller entities that have limited swaps
activity.\105\ To grow in size, the funds would have to attract
unaffiliated investors, which may result in such funds no longer being
subject to consolidation with their sponsor entity.
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\105\ See Margin Subcommittee Report at 31.
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As such, the eligible seeded fund exception under the Seeded Funds
Proposal would primarily impact the exchange of IM between a CSE and
investment funds that are in their seeding period. During that period,
such investment funds would pose less risk to a CSE counterparty and
the financial system as a whole given the small size of the funds and
the scope of their derivatives activity. To ensure that
[[Page 53422]]
eligible seeded funds are afforded the benefit of a separate treatment
from margin affiliates only during the seeding period, the Commission
proposes to limit the applicability of the eligible seeded fund
exception only to three years after the fund's trading inception date.
To ensure that the three-year period is not reinstated as a result of
rollovers of fund assets or similar activities, the proposed definition
of eligible seeded fund would include a condition that the seeded fund
has not received, directly or indirectly, any of its assets from an
eligible seeded fund that has relied on the eligible seeded fund
exception to the definition of ``margin affiliate.'' The Commission
further notes that, pursuant to section 4s(j)(2) of the CEA and
Commission Regulation 23.600, CSEs are required to monitor and manage
risks related to their swap activities, including credit risk, and set
risk tolerance limits.\106\ Thus, if the credit risk associated with
CSEs' transactions with eligible seeded funds exceeds the CSEs' risk
tolerance limits, CSEs would be expected to take mitigating measures.
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\106\ 7 U.S.C. 6s(j)(2) (mandating that CSEs adopt a robust and
professional risk management system adequate for the management of
day-to-day swap activities) and 17 CFR 23.600 (requiring CSEs, in
establishing a risk management program for the monitoring and
management of risk related to their swap activities, to account for
credit risk and to set risk tolerance limits).
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In certain circumstances, the increase in uncollateralized credit
risk resulting from the Seeded Funds Proposal could also negatively
impact the sponsor entity or the asset manager of a seeded fund. In
particular, if a seeded fund is facing financial distress, a sponsor
entity or the fund's asset manager may be incentivized to intervene,
because of reputational risks or other concerns, and contribute
additional resources even in the absence of an explicit business
arrangement to provide financial support or a guarantee. Similarly, if
the fund is suffering the consequences of a swap counterparty default,
the sponsor entity or the asset manager may contribute financial
resources to improve the fund's condition and increase its own
exposure, potentially putting at risk its own financial position. Thus,
the fund's uncollateralized exposure may lead the sponsor entity or the
asset manager to incur risks, increasing the potential for contagion
and systemic risk. To account for these risks, the Commission is
proposing to define the term ``eligible seeded fund'' to incorporate
requirements meant to ensure that seeded funds are genuinely
independent and that the risks associated with their activities are not
assumed by other entities such as their sponsor entities or asset
managers. Specifically, among other conditions, the seeded fund would
have to be a distinct legal entity from each sponsor entity that is not
collateralized, guaranteed, or otherwise supported, directly or
indirectly, by any sponsor entity, any margin affiliate of any sponsor
entity, other collective investment vehicles, or the seeded fund's
asset manager, in respect of any of the fund's obligations. This should
mitigate the incentive for the sponsor's assets to be used if the
seeded fund fails.
Treating seeded funds as separate unaffiliated legal entities for
purposes of calculating the thresholds for determining whether
compliance with the IM requirements is required could also incentivize
swap counterparties to create legal entities that have no economic
basis and are constructed solely for the purpose of applying additional
thresholds to evade margin requirements. To address these concerns, the
Commission proposes to limit the applicability of the eligible seeded
fund exception by providing that eligible seeded funds would be deemed
not to have margin affiliates solely for the purpose of calculating the
fund's MSE and IM threshold amount. As such, under the Seeded Funds
Proposal, the eligible seeded funds' sponsor entities and their margin
affiliates would continue to include the eligible seeded funds'
exposures in the calculation of the IM compliance thresholds applicable
to such sponsor entities and margin affiliates. In addition, the
Commission proposes to include, in the proposed definition of
``eligible seeded fund,'' conditions designed to ensure that funds that
qualify as eligible seeded funds have a bona fide business purpose. In
particular, the proposed definition provides that the eligible seeded
fund must be managed by an asset manager pursuant to an agreement that
requires that the assets of the fund be managed in accordance with a
specified written investment strategy and that the asset manager has
independence in carrying out its management responsibilities and
exercising its investment discretion, and to the extent applicable, has
independent fiduciary duties to other investors in the fund, such that
no sponsor entity or a margin affiliate of a sponsor entity controls or
has transparency into the management or trading of the seeded fund.
Furthermore, the proposed definition of eligible seeded fund would
require that the seeded fund's investment strategy must follow a
written plan for reducing the sponsor entity's ownership interest in
the fund.
The Commission, therefore, believes that the costs associated with
the potential evasion of the IM requirements would be mitigated by the
proposed rule amendment, which would be narrowly tailored to make
available the proposed approach only for purposes of calculating the IM
compliance thresholds applicable to seeded funds that meet specified
requirements and only during the three years that follow the fund's
trading inception date. In addition, the Commission intends to use its
anti-evasion authority to prevent circumvention of the margin
requirements.\107\
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\107\ See supra note 51.
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Furthermore, given that the U.S. prudential regulators may not
amend their margin requirements in line with the Seeded Funds Proposal,
if the Commission finalizes the proposal described herein, the
Commission acknowledges the possibility that its requirements with
respect to the treatment of eligible seeded funds may diverge from that
of the U.S. prudential regulators, requiring funds that engage in swaps
transactions with both CSEs and prudentially-regulated SDs to adjust
their swap-related documentation and IM processes to reflect such
different treatments. Thus, market participants may incur additional
costs by having to maintain two separate and distinct types of
documentation and IM management processes. Similar costs may also be
incurred by CSEs that already transact with seeded funds that are
currently consolidated. Also, as discussed previously, given that the
Seeded Funds Proposal would provide for an eligible seeded fund
exception from the definition of ``margin affiliate,'' effectively
providing for the funds' deconsolidation for purposes of calculating
the funds' MSE and IM threshold amount, seeded funds may favor CSEs as
counterparties over SDs or MSPs subject to the prudential regulators'
margin rules, which might not be revised to provide for a similar
eligible seeded fund exception.
As noted above, to better assess the impact of a potential
divergence between the CFTC Margin Rule and the Prudential Regulators
Margin Rule, the Commission is requesting information on the potential
costs associated with maintaining distinct documentation and IM
management processes.
Money Market Funds Proposal
(a) Benefits
The Money Market Funds Proposal would expand the scope of assets
that
[[Page 53423]]
qualify as eligible collateral. In this regard, the GMAC Margin
Subcommittee Report stated that absent elimination of the asset
transfer restriction, the securities of very few MMFs would qualify as
eligible collateral, noting that nearly all U.S. MMFs engage in some
form of repurchase or similar arrangements.\108\ The Money Market Funds
Proposal may therefore reduce the potential concentration of collateral
in the few MMFs whose securities currently qualify as eligible
collateral under Commission Regulation 23.156(a)(1)(ix), which could
lead to greater diversity of assets used for collateral, thereby
reducing the riskiness of IM assets.
---------------------------------------------------------------------------
\108\ Margin Subcommittee Report at 24.
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Also, the Money Market Funds Proposal, by increasing the number of
MMFs whose securities qualify as eligible collateral, may promote more
efficient collateral management practices. The Margin Subcommittee
Report stated that custodians offer money market sweep programs that
afford institutional clients of such custodians the ability to timely
and efficiently meet margin calls without settlement delay, avoiding
other transaction costs that would otherwise arise in the absence of
the sweep programs. Such direct sweeps from cash into MMF securities
mitigate the risk of insolvency by the custodian because non-cash
collateral deposited with the custodian will not be consolidated in the
custodian's balance sheet. The Margin Subcommittee Report also stated
that the use of MMFs may avoid the risk of potential negative interest
rate charges that may be applied by custodian banks on cash collateral.
By eliminating the asset transfer restriction, the Money Market
Funds Proposal could also promote asset management policies that
improve the performance of money market and similar funds. Without the
restriction, the funds may undertake repurchase or similar arrangements
that increase returns for investors, including the return for CSEs that
post money market and similar fund securities as margin collateral for
uncleared swaps, contributing to the fund securities' liquidity and
retention of value even during periods of financial stress.
In summary, these benefits will accrue to CSEs and their
counterparties that enter into uncleared swaps transactions. As
discussed above, the potential concentration in certain types of
collateral has been acknowledged previously by the Commission as a
potential risk that CSEs should consider in managing their margin
collateral. CSEs and their counterparties will also benefit from the
more efficient use of their capital as discussed above and enhanced
returns on securities posted as collateral. Furthermore, the proposal
may lead to reduced costs for those market participants that dually
register as SDs and security-based swap SDs with the CFTC and the SEC,
respectively, as the proposed amendment would bring the CFTC's eligible
collateral framework more in line with the SEC approach, which does not
impose asset transfer restrictions on funds whose securities are used
as collateral for margining purposes and expressly permits the use of
government money market fund securities as collateral.
(b) Costs
The elimination of the asset transfer restriction in paragraph (C)
of Commission Regulation 23.156(a)(1)(ix) would remove a safeguard
intended to ensure that money market and similar fund securities posted
as margin collateral remain liquid and maintain their value in times of
financial stress. More specifically, paragraph (C) prevents the
transfer of money market and similar fund assets through repurchase or
similar arrangements to mitigate the impact of such transfers on the
liquidity or value of fund securities. For example, if a counterparty
to a money market and similar fund in a repurchase or similar
arrangement defaults, the fund may be left holding assets that, in
times of financial stress, may not be easily resold and might not
compensate for the value of assets tendered in the repurchase
arrangement. Such a default would reduce the overall net asset value of
the fund and the price of the fund's securities. Also, the inability to
liquidate assets that a money market and similar fund might be left
holding upon the failure of a repurchase or similar arrangement or the
inability to extract assets originally tendered in the repurchase
arrangement may impact the fund's ability to promptly respond to
redemption requests, hindering the liquidity of the fund's securities,
making them less suitable as margin collateral. The Commission,
however, notes that subparagraphs (A) and (B) of Commission Regulation
23.156(a)(1)(ix), which are not being amended, limit the types of
assets that a money market and similar fund can receive in repurchase
or similar arrangements to those assets specifically identified in
those paragraphs, alleviating in part the risks associated with
repurchase or similar arrangements.
In light of the proposed elimination of the asset transfer
restriction, the Commission is also seeking input on whether it would
be appropriate to include an additional haircut beyond that required by
the haircut schedule in Commission Regulation 23.156(a)(3), as
corrected by the proposed amendment discussed herein.
The Commission further notes that Commission Regulation 23.156(c)
requires that CSEs monitor the market value and eligibility of all
collateral and, to the extent that the market value has declined,
promptly collect or post additional eligible collateral to maintain
compliance with Commission Regulations 23.150 through 23.161.\109\
Thus, even if the value or liquidity of pledged money market and
similar fund securities may be affected by repurchase or similar
arrangements undertaken by the fund, CSEs have the obligation to
monitor the value and suitability of the fund's securities as margin
collateral and collect or post additional eligible collateral to
compensate for collateral deficiencies.
---------------------------------------------------------------------------
\109\ 17 CFR 23.156(c).
---------------------------------------------------------------------------
The elimination of the asset transfer restriction could give rise
to other costs. Given that the U.S. prudential regulators may not amend
their margin requirements in line with the proposed rule amendments, if
the amendments proposed herein are adopted as final, the CFTC and U.S.
prudential regulators' margin rules would diverge with respect to the
treatment of securities of money market and similar funds as eligible
collateral, requiring parties that trade with both prudentially-
regulated SDs and CSEs to adjust their swap-related documentation and
collateral management systems to reflect such different treatments.
Thus, market participants may incur additional costs by having to
maintain two separate and distinct types of documentation and
collateral management systems. Also, the Money Market Funds Proposal
may incentivize trading with CSEs over SDs or MSPs subject to the U.S.
prudential regulators' margin rules given that the prudential
regulators might not revise their rules in a manner consistent with the
Money Market Funds Proposal and the prudential regulators' rules may
continue to restrict the use of securities of money market and similar
funds that transfer their assets through repurchase and similar
agreements.
At the same time, the Commission notes that the removal of the
asset transfer restriction would bring the CFTC's eligible collateral
framework closer to the approach adopted by the Securities and Exchange
Commission (``SEC''), which does not impose asset
[[Page 53424]]
transfer restrictions with respect to money market and similar fund
securities and expressly permits the use of government money market
fund securities as collateral.\110\ Therefore, although there is the
potential for greater costs as a result of divergence with the U.S.
prudential regulators, there may be lower costs overall, given that
many CSEs are also cross-registered with the SEC as security-based SDs.
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\110\ See Capital, Margin and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital and Segregation Requirements for Broker-
Dealers, Securities and Exchange Commission, 84 FR 43872, 43919
(Aug. 22, 2019). In the preamble to its final rule, the SEC noted
that the final rule does not specifically exclude any type of
security provided it has a ready market, is readily transferable,
and does not consist of securities or money market instruments
issued by the counterparty or a party related to the nonbank
security-based SD or major security-based swap participant, or the
counterparty. Generally, U.S. government money market funds should
be able to serve as collateral under these conditions.
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2. Section 15(a) Considerations
In light of the foregoing, the CFTC has evaluated the costs and
benefits of the proposals pursuant to the five considerations
identified in section 15(a) of the CEA as follows:
Seeded Funds Proposal
(a) Protection of Market Participants and the Public
As discussed, the Seeded Funds Proposal would provide that, during
a period of three years from the fund's trading inception date, a
seeded fund meeting specific requirements would be deemed not to have
margin affiliates solely for purposes of calculating the fund's MSE and
the IM threshold amount. As a result, only the seeded fund's individual
AANA would be used to determine whether the fund has MSE, and only the
individual credit exposure of the fund resulting from the fund's swaps
with a CSE would be used to determine whether the posting and
collection of IM is required, and not the exposures calculated on an
aggregate basis with the fund's sponsor entities and other margin
affiliates, as currently required under the CFTC Margin Rule.
The Seeded Funds Proposal is thus proposing an approach to eligible
seeded funds that is consistent with the BCBS-IOSCO Framework and
similar approaches adopted by jurisdictions such as Australia, Canada
and the EU.\111\ As such, the Seeded Funds Proposal would eliminate a
disadvantage that U.S. investment funds face compared to non-U.S. funds
that are not subject to a consolidation requirement. The Seeded Funds
Proposal would also address the potential liquidity drain and trading
disruptions that CSEs might encounter if non-U.S. investments funds
were to avoid doing uncleared swaps business with the CSEs because of
the current treatment of seeded funds in the U.S. under the CFTC Margin
Rule. In addition, the Seeded Funds Proposal would level the playing
field between U.S. seeded funds that are consolidated within a group of
entities that collectively have MSE and other domestic investment funds
that are not part of a group whose combined exposure exceeds the
threshold for compliance with the IM requirements, while, at the same
time, potentially spurring greater interest in seeded funds as
potential counterparties.
---------------------------------------------------------------------------
\111\ See supra notes 27 and 41.
---------------------------------------------------------------------------
As a result of the Seeded Funds Proposal, less collateral may be
collected by seeded funds given that individually they may not meet the
threshold for exchanging IM. A seeded fund's uncollateralized swaps
exposure may negatively impact the sponsor entities of the fund or its
asset manager, given that, for reputational reasons, a sponsor entity
or the asset manager may provide financial support to the seeded fund
in times of financial distress, potentially putting at risk their own
financial position.
The Seeded Funds Proposal may also have implications for CSEs
entering into uncleared swap transactions with the fund's sponsor
entity. Specifically, a CSE evaluating the creditworthiness of its
counterparty--the fund's sponsor entity--may not be aware of the
sponsor entity's potentially weakened financial position. As such, the
Seeded Funds Proposal, by allowing seeded funds' exposures to not be
consolidated with the exposures of their sponsor entities and other
margin affiliates for purposes of determining the applicability of the
IM requirements, may increase the risk of contagion.
The Commission, however, believes that such concerns are mitigated
by the requirements incorporated in the proposed definition of eligible
seeded fund, including the condition that the seeded fund is not
collateralized, guaranteed or otherwise supported, directly or
indirectly by any sponsor entity, any margin affiliate of any sponsor
entity, other collective investment vehicles, or the fund's asset
manager in respect of any of the fund's obligations. These conditions
are intended to ensure that seeded funds are genuinely independent and
risk remote from the sponsor entities.
(b) Efficiency, Competitiveness, and Financial Integrity of Markets
The Seeded Funds Proposal would amend the definition of ``margin
affiliate'' in Commission Regulation 23.151 to provide an exception for
eligible seeded funds, which would effectively relieve CSEs from the
requirement to exchange IM for uncleared swaps with such eligible
seeded funds, subject to specified conditions. This eliminates a
competitive disadvantage between seeded funds that are consolidated
with their sponsor entities and margin affiliates, which collectively
exceed the thresholds for compliance with the IM requirements on the
one hand, from those investment funds whose sponsor entities and margin
affiliates do not have collective exposures exceeding such thresholds
on the other. This would potentially spur greater interest in seeded
funds as potential counterparties. In addition, the proposed amendment
to the ``margin affiliate'' definition would level the playing field
between U.S. funds and non-U.S. investment funds from jurisdictions
that do not require fund swaps exposures to be considered on a
consolidated basis for purposes of determining whether compliance with
the IM requirements is required.
The Seeded Funds Proposal would relieve CSEs entering into
uncleared swaps with eligible seeded funds from the requirement to
exchange IM with the funds if the funds meet specified requirements.
This would reduce the operational costs associated with the exchange of
IM for CSEs and their eligible seeded funds counterparties and would
allow seeded funds to allocate their financial resources to testing
their investment strategy and attracting unaffiliated investors. The
cost reduction may also incentivize more market participants to enter
into uncleared swaps. The Seeded Funds Proposal would thus promote
efficiency in the uncleared swaps market by increasing the pool of swap
counterparties and fostering competition.
Given that the Seeded Funds Proposal would relieve CSEs from the
exchange of IM with certain eligible seeded funds for their uncleared
swaps, the uncollateralized credit exposure for the uncleared swaps
would increase and could undermine the integrity of the markets. The
Commission, however, believes that the increased exposure would be
limited given the relatively limited derivatives activity of seeded
funds that would benefit from the eligible seeded fund exception. In
[[Page 53425]]
addition, the proposed relief is narrowly tailored given the
requirements incorporated in the proposed definition of ``eligible
seeded fund'' and the fact that it would only apply for purposes of
calculating the MSE and IM threshold amount applicable to the eligible
seeded funds, and not for the calculation of the IM compliance
thresholds applicable to the funds' sponsor entities and margin
affiliates that do not independently qualify as eligible seeded funds
(nor for the funds' CSE counterparties).
(c) Price Discovery
By amending the definition of ``margin affiliate'' in Commission
Regulation 23.151, the Seeded Funds Proposal would relieve CSEs from
the requirement to exchange IM when entering into uncleared swaps with
an eligible seeded fund. As a counterparty to a CSE, an eligible seeded
fund therefore would not have to incur operational costs associated
with setting up and maintaining processes and documentation to exchange
IM. The relief would permit eligible seeded funds to direct more
resources to building a successful performance track record and
attracting new investors. As a result, the overall cost of entering
into an uncleared swap transaction may decrease, incentivizing
increased participation in the uncleared swaps markets. In turn, the
trading of uncleared swaps may increase, leading to increased liquidity
and enhanced price discovery.
(d) Sound Risk Management
Because the Seeded Funds Proposal would relieve CSEs from the
obligation to exchange IM with certain seeded funds, less margin may be
collected and posted to offset the risk of uncleared swaps, which could
increase the risk of default. Nevertheless, the Commission believes
that the uncollateralized risk would be mitigated because during the
seeding period, investment funds are typically small and the extent of
uncleared swap activity a seeded fund may undertake with CSEs may be
limited. In addition, CSEs are required to manage the risk associated
with their uncleared swaps, including those swaps that might be
uncollateralized, by maintaining a robust and professional risk
management program that provides, among other things, for the
implementation of internal parameters for the monitoring and management
of swap risk, including credit risk.
The Commission also notes that the Seeded Funds Proposal, by
relieving CSEs from the requirement to exchange IM with certain seeded
funds, would reduce the operational costs of both CSEs and their
eligible seeded fund counterparties, potentially encouraging more
market participants to enter the uncleared swaps market. As such, by
increasing the pool of swap counterparties, the Seeded Funds Proposal
would encourage the careful consideration and selection of
counterparties, promoting sound risk management.
(e) Other Public Interest Considerations
By proposing a treatment of certain investment funds that is
consistent with the BCBS/IOSCO Framework, the Seeded Funds Proposal
would alleviate the potential disadvantage that U.S. seeded funds have
compared to non-U.S. investment funds, which may be perceived to be
subject to more favorable regulatory regimes than in the United States
given the differing consolidation treatments applicable to funds.
However, given that the U.S. prudential regulators may not amend
their margin requirements in line with the proposed amendments, the
possibility exists that the CFTC and U.S. prudential regulators'
differing rules may motivate certain investment funds to undertake
swaps with particular SDs based on which U.S. regulatory agency is
responsible for setting margin requirements for such SDs. In that
sense, the change can lead to trades that do not reflect the relative
merits of competing SDs. The divergence could also lead to additional
costs for investment funds that trade with both CSEs and prudentially-
regulated SDs because such funds would need to adjust their swap
related documentation and collateral management systems to reflect the
different margin requirements that may apply under the CFTC's and the
prudential regulators' rules.
Money Market Funds Proposal
(a) Protection of Market Participants and the Public
The Commission believes that the Money Market Funds Proposal would
protect market participants and the public by eliminating the asset
transfer restriction and allowing a broader range of money market and
similar fund securities to serve as collateral, thus addressing the
potential that margin collateral may be concentrated in the securities
of a few money market and similar funds and leading to greater
diversification by increasing the range of assets that may be used as
collateral.
The elimination of the asset transfer restriction would also
promote effective asset management policies for the benefit of fund
investors and market participants in general. Without the restriction,
money market and similar funds that otherwise would have refrained from
undertaking repurchase or similar arrangements to avoid the
disqualification of their securities as eligible collateral may enter
into such arrangements. The arrangements might generate higher returns
for investors, including for CSEs that use money market and similar
fund securities as margin collateral for uncleared swaps, and enable
funds to meet their commitments to investors concerning fund
performance.
Nevertheless, market participants might be harmed by the rule
change if a counterparty to the money market or similar fund in a
repurchase or similar arrangement defaults, and the fund is unable to
recover assets tendered to the counterparty in the arrangement and is
left holding assets of lesser value. The fund's overall net asset value
may decline, reducing the value and liquidity of the fund's securities.
This potential outcome would make the securities less suitable as
collateral for margining uncleared swaps.
(b) Efficiency, Competitiveness, and Financial Integrity of Markets
By eliminating the asset transfer restriction, the Money Market
Funds Proposal would allow a broader range of money market and similar
fund securities to serve as collateral for margining uncleared swaps,
increasing diversification in the assets that can be used as
collateral, and fostering competition among the funds whose securities
qualify as eligible collateral under the Proposal.
The elimination of the asset transfer restriction would also
promote effective asset management policies for the benefit of fund
investors and market participants in general. Without the restriction,
money market or similar funds would be able to undertake repurchase and
similar agreements, which may enable them to generate higher returns
for investors, including for CSEs that use the funds' securities as
collateral, and to meet commitments to investors concerning fund
performance.
Notwithstanding these benefits, the proposed elimination of the
asset transfer restriction might negatively impact market participants.
If a money market and similar fund undertakes a repurchase or similar
arrangement and the fund's counterparty in the arrangement defaults,
the fund may be unable to recover assets it tendered in the arrangement
and may be left holding assets of lesser value. The fund's overall net
asset value may decrease, affecting the value and liquidity of the
fund's
[[Page 53426]]
securities. This potential outcome would make the fund's securities
less suitable as collateral for margining uncleared swaps.
(c) Price Discovery
As previously discussed, with the removal of the asset transfer
restriction, fund managers may have more flexibility in determining the
type of investment and transactions that are in the best interest of
their fund and investors, leading to higher returns for investors,
including CSEs using money market and similar fund securities as margin
collateral for uncleared swaps. With such increased returns, the
overall costs of entering into an uncleared swap transaction may
decrease, incentivizing increased participation in the uncleared swaps
markets. In turn, trading in uncleared swaps may increase, leading to
increased liquidity and enhanced price discovery.
(d) Sound Risk Management
The proposed amendment would eliminate the asset transfer
restriction, allowing the use of securities of money market funds that
undertake repurchase or similar arrangements as collateral for the
margining of uncleared swaps. As such, even if the asset manager for a
money market and similar fund, as a fiduciary, acts in the best
interest of the fund and its investors, there is the risk that the fund
may incur a loss if the fund's counterparty in a repurchase or similar
arrangement defaults. Such a default would leave the fund holding
assets that it may not be able to easily resell in times of financial
stress, which might impact the value and liquidity of pledged fund
securities and make them less suitable as margin collateral for
uncleared swaps. The Commission, however, notes that any potential risk
of such a repurchase or similar arrangement may be mitigated by the
standard industry practice of applying haircuts to non-cash collateral
in repurchase or similar arrangements to compensate for the risk that
the value of collateral may decline over the term of the
arrangement.\112\
---------------------------------------------------------------------------
\112\ See Primer: Money Market Funds and the Repo Market,
Prepared by the staff of the Division of Investment Management, U.S.
Securities and Exchange Commission at pp. 5-6.
---------------------------------------------------------------------------
In addition, the Commission notes that Commission Regulation
23.156(c) requires that CSEs monitor the market value and eligibility
of all collateral and, to the extent that the market value has
declined, promptly collect or post additional eligible collateral to
maintain compliance with Commission Regulations 23.150 through 23.161.
Thus, even if the value or liquidity of pledged money market and
similar fund securities may be affected by repurchase or similar
arrangements undertaken by the fund, CSEs have the obligation to
monitor the value and suitability of the fund securities as margin
collateral and collect or post additional eligible collateral to
compensate for collateral deficiencies, although the risk that a fund's
repurchase or similar arrangements may fail remains. The Commission
further notes, however, that subparagraphs (A) and (B) of Commission
Regulation 23.156(a)(1)(ix), which are not being amended, limit the
types of assets that a money market and similar fund can receive in
repurchase or similar arrangements to those assets specifically
identified in those paragraphs, alleviating in part the risks
associated with repurchase or similar arrangements.
While the Money Market Funds Proposal could lead to more
variability in the value of the assets used as IM, it can also promote
sound risk management in that it increases the range of money market
and similar fund securities available as collateral for the margining
of uncleared swaps, reducing the chance of concentration in a few money
market and similar funds and the risks associated with such
concentration. As such, the removal of the restriction may incentivize
the increased use of money market and similar fund securities as
collateral. Consistent with Commission Regulation 23.156(c), which
requires CSEs to monitor the market value and eligibility of collateral
posted or collected as margin for uncleared swaps, the Commission notes
that CSEs must take into account the potential concentration of
collateral in particular assets and prudently manage margin collateral.
(e) Other Public Interest Considerations
As is the case for the Seeded Funds Proposal, it is possible that
the U.S. prudential regulators may not amend their margin rule in line
with the Money Market Funds Proposal. As such, the prudential
regulators and the Commission would diverge with respect to the
treatment of money market and similar funds securities as eligible
collateral for margining uncleared swaps. This divergence might lead to
increased costs for market participants that trade both uncleared swaps
subject to the CFTC's and the prudential regulators' margin rules, as
they may need to adjust or even maintain separate documentation and
collateral management systems to address the differing treatments for
fund securities under the different rules.
On the other hand, the Money Market Funds Proposal may lead to
reduced costs for those market participants that dually register as SDs
and security-based swap SDs with the CFTC and the SEC, respectively, as
the proposed amendment would bring the CFTC's eligible collateral
framework more in line with the SEC approach, which does not impose
asset transfer restrictions on funds whose securities are used as
collateral for margining purposes and expressly permits the use of
government money market fund securities as collateral.
Request for Comments on Cost-Benefit Considerations
The Commission invites public comment on its cost-benefit
considerations, including the section 15(a) factors described above.
Commenters are also invited to submit any data or other information
they may have quantifying or qualifying the costs and benefits of the
proposed amendments. In particular, the Commission seeks specific
comment on the following:
1. Has the Commission accurately identified all the benefits of the
proposed amendments? Are there other benefits to the Commission, market
participants, and/or the public that may result from the adoption of
the proposed amendments that the Commission should consider? Please
provide specific examples and explanations of any such benefits.
2. Has the Commission accurately identified all the costs of the
proposed amendments? Are there additional costs to the Commission,
market participants and/or the public that may result from the adoption
of the proposed amendments that the Commission should consider? Please
provide specific examples and explanations of any such costs.
3. Do the proposed amendments impact the section 15(a) factors in
any way that is not described above? Please provide specific examples
and explanations of any such impact.
4. Does the existing asset transfer restriction significantly limit
the use of money market and similar fund securities as eligible
collateral under the CFTC Margin Rule?
D. Antitrust Laws
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of this Act, in issuing any order or adopting any Commission
rule or regulation
[[Page 53427]]
(including any exemption under section 4(c) or 4c(b)), or in requiring
or approving any bylaw, rule or regulation of a contract market or
registered futures association established pursuant to section 17 of
this Act.\113\
---------------------------------------------------------------------------
\113\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requests comment on whether the proposed amendments implicate any other
specific public interest to be protected by the antitrust laws.
The Commission has considered the proposed amendments to determine
whether they are anticompetitive, and has preliminarily identified no
anticompetitive effects. The Commission requests comment on whether the
proposed amendments are anticompetitive and, if so, what the
anticompetitive effects are.
Because the Commission has preliminarily determined that the
proposed amendments are not anticompetitive and have no anticompetitive
effects, the Commission has not identified any less competitive means
of achieving the purposes of the Act. The Commission requests comment
on whether there are less anticompetitive means of achieving the
relevant purposes of the Act that would otherwise be served by adopting
the proposed amendments.
List of Subjects in 17 CFR Part 23
Capital and margin requirements, Major Swap Participants, Swap
Dealers, Swaps.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 23 as set forth below:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
1. The authority citation for Part 23 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21. Section 23.160 also
issued under 7 U.S.C. 2(i); Sec. 721(b), Pub. L. 111-203, 124 Stat.
1641 (2010).
0
2. In Sec. 23.151, add the definition of ``Eligible seeded fund'' in
alphabetical order and revise the definition of ``Margin affiliate''.
The addition and revision read as follows:
Sec. 23.151 Definitions applicable to margin requirements.
* * * * *
Eligible seeded fund: An eligible seeded fund is a collective
investment vehicle that has received a part or all of its start-up
capital from a parent and/or affiliate (each, a sponsor entity) where:
(1) The seeded fund is a distinct legal entity from each sponsor
entity;
(2) One or more of the seeded fund's margin affiliates is required
to post and collect initial margin pursuant to Sec. 23.152;
(3) The seeded fund is managed by an asset manager pursuant to an
agreement that requires the seeded fund's assets to be managed in
accordance with a specified written investment strategy;
(4) The seeded fund's asset manager has independence in carrying
out its management responsibilities and exercising its investment
discretion, and, to the extent applicable, has independent fiduciary
duties to other investors in the fund, such that no sponsor entity or
any of the sponsor entity's margin affiliates controls or has
transparency into the management or trading of the seeded fund;
(5) The seeded fund's investment strategy follows a written plan
for reducing each sponsor entity's ownership interest in the seeded
fund that stipulates divestiture targets over the three-year period
after the date on which the seeded fund's asset manager first begins to
make investments on behalf of the fund;
(6) In respect of any of the seeded fund's obligations, the seeded
fund is not collateralized, guaranteed, or otherwise supported,
directly or indirectly, by any sponsor entity, any margin affiliate of
any sponsor entity, other collective investment vehicle, or the seeded
fund's asset manager;
(7) The seeded fund has not received any of its assets, directly or
indirectly, from an eligible seeded fund that has relied on the
exception provided in paragraph 2 of the definition of margin affiliate
in Sec. 23.151; and
(8) The seeded fund is not a securitization vehicle.
* * * * *
Margin affiliate has the following meaning:
(1) A company is a margin affiliate of another company if:
(i) Either company consolidates the other on a financial statement
prepared in accordance with U.S. Generally Accepted Accounting
Principles, the International Financial Reporting Standards, or other
similar standards,
(ii) Both companies are consolidated with a third company on a
financial statement prepared in accordance with such principles or
standards, or
(iii) For a company that is not subject to such principles or
standards, if consolidation as described in paragraph (i) or (ii) of
this definition would have occurred if such principles or standards had
applied.
(2) Eligible seeded fund exception. Notwithstanding paragraph (1)
of this definition, until the date that is three years after the date
on which an eligible seeded fund's asset manager first begins to make
investments on behalf of the fund, an eligible seeded fund will be
deemed not to have any margin affiliates solely for purposes of
calculating the fund's material swaps exposure and the initial margin
threshold amount.
* * * * *
0
3. In Sec. 23.156:
0
a. Republish the introductory text of paragraph (a)(1);
0
b. Republish the introductory text of paragraph (a)(1)(ix);
0
c. Republish paragraph (a)(1)(ix)(A);
0
d. Revise paragraph (a)(1)(ix)(B);
0
e. Remove paragraph (a)(1)(ix)(C);
0
f. Revise paragraph (a)(3)(i)(B).
The republications and revisions read as follows:
Sec. 23.156 Forms of Margin
(a) * * * (1) Eligible collateral. A covered swap entity shall
collect and post as initial margin for trades with a covered
counterparty only the following types of collateral:
* * * * *
(ix) Securities in the form of redeemable securities in a pooled
investment fund representing the security-holder's proportional
interest in the fund's net assets and that are issued and redeemed only
on the basis of the market value of the fund's net assets prepared each
business day after the security-holder makes its investment commitment
or redemption request to the fund, if the fund's investments are
limited to the following:
(A) Securities that are issued by, or unconditionally guaranteed as
to the timely payment of principal and interest by, the U.S. Department
of the Treasury, and immediately-available cash funds denominated in
U.S. dollars; or
(B) Securities denominated in a common currency and issued by, or
fully guaranteed as to the payment of principal and interest by, the
European Central Bank or a sovereign entity that is assigned no higher
than a 20 percent risk weight under the capital rules applicable to
swap dealers subject to regulation by a prudential regulator, and
immediately-available cash funds denominated in the same currency; or
* * * * *
(3) * * *
(i) * * *
(B) The discounts set forth in the following table:
[[Page 53428]]
Standardized Haircut Schedule \1\
------------------------------------------------------------------------
------------------------------------------------------------------------
Cash in same currency as swap obligation................ 0.0
Eligible government and related debt (e.g., central 0.5
bank, multilateral development bank, GSE securities
identified in paragraph (a)(1)(v) of this section):
Residual maturity less than one-year...................
Eligible government and related debt (e.g., central 2.0
bank, multilateral development bank, GSE securities
identified in paragraph (a)(1)(v) of this section):
Residual maturity between one and five years...........
Eligible government and related debt (e.g., central 4.0
bank, multilateral development bank, GSE securities
identified in paragraph (a)(1)(v) of this section):
Residual maturity greater than five years..............
Eligible corporate debt (including eligible GSE debt 1.0
securities not identified in paragraph (a)(1)(v) of
this section): Residual maturity less than one-year....
Eligible corporate debt (including eligible GSE debt 4.0
securities not identified in paragraph (a)(1)(v) of
this section): Residual maturity between one and five
years..................................................
Eligible corporate debt (including eligible GSE debt 8.0
securities not identified in paragraph (a)(1)(v) of
this section): Residual maturity greater than five
years..................................................
Equities included in S&P 500 or related index........... 15.0
Equities included in S&P 1500 Composite or related index 25.0
but not S&P 500 or related index.......................
Gold.................................................... 15.0
Additional (additive) haircut on asset in which the 8.0
currency of the swap obligation differs from that of
the collateral asset...................................
------------------------------------------------------------------------
\1\ The discount to be applied to an eligible investment fund is the
weighted average discount on all assets within the eligible investment
fund at the end of the prior month. The weights to be applied in the
weighted average should be calculated as a fraction of the fund's
total market value that is invested in each asset with a given
discount amount. As an example, an eligible investment fund that is
comprised solely of $100 of 91 day Treasury bills and $100 of 3 year
U.S. Treasury bonds would receive a discount of (100/200) * 0.5 + (100/
200) * 2.0 = (0.5) * 0.5 + (0.5) * 2.0 = 1.25 percent.
* * * * *
Issued in Washington, DC, on July 31, 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 Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Voting Summary and Chairman's and
Commissioners' Statements
Appendix 1--Voting Summary
On this matter, Chairman Behnam and Commissioners Mersinger and
Pham voted in the affirmative. Commissioner Goldsmith Romero voted
in the negative. Commissioner Johnson voted to concur.
Appendix 2--Statement of Chairman Rostin Behnam
Today the Commission considered an eligible seeded funds
proposal and a money market funds proposal within a notice of
proposed rulemaking on margin requirements for uncleared swaps for
swap dealers (SDs) and major swap participants (MSPs) for which
there is no prudential regulator. The proposal would amend the
CFTC's margin rule for SDs and MSPs, as promulgated in 2016, to
incorporate two recommendations in the 2020 report to the CFTC's
Global Markets Advisory Committee (GMAC) by the Subcommittee on
Margin Requirements for Non-Cleared Swaps (the ``GMAC Subcommittee
Report'').\1\
---------------------------------------------------------------------------
\1\ See Recommendations to Improve Scoping and Implementation of
Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps (May 2020), https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
---------------------------------------------------------------------------
The seeded funds proposal would revise the definition of
``margin affiliate'' in Commission Regulation 23.151 to provide that
certain investment funds that receive all of their start-up capital,
or a portion thereof, from a sponsor entity would be deemed not to
have any margin affiliates for the purposes of calculating certain
thresholds that trigger the requirement to exchange initial margin
for uncleared swaps. This proposed amendment would effectively
relieve SDs and MSPs from the requirement to post and collect
initial margin with a limited number of eligible seeded funds for
their uncleared swaps for a period of three years from the date on
which the eligible seeded fund's asset manager first begins making
investments on behalf of the fund. While today's proposal builds
upon the GMAC Subcommittee Report's 2020 recommendation, the
proposal today also sets forth eight carefully calibrated conditions
to ensure that only the investment funds that were intended to be
targeted by the GMAC Subcommittee Report's recommendations are
eligible to qualify for the seeded funds exception.
I support today's seeded funds proposal as it is consistent with
the CFTC's margin rule risk-based approach of imposing margin
requirements that are commensurate with the risk of uncleared swaps
entered into by SDs and MSPs; is appropriately calibrated to
acknowledge the operational challenges for start-up funds; and
supports international harmonization as the approach is consistent
with the BCBS-IOSCO Framework.
The money market funds proposal would eliminate the current
provision in Commission Regulation 23.156(a)(1)(ix)(C) that
disqualifies certain securities issued by certain money market funds
(MMFs) from being used as eligible initial margin collateral. This
would expand the scope of assets that qualify as eligible
collateral. I support today's MMF proposal as it would remove a
restriction that has unintentionally and severely restricted the use
of securities of MMF and similar assets that transfer their assets
through repurchase and similar arrangements. According to the GMAC
Subcommittee Report, the impact of the restriction was that only
securities of four U.S. MMFs would meet the requirements to be used
as eligible collateral.\2\
---------------------------------------------------------------------------
\2\ Id. at 24.
---------------------------------------------------------------------------
Lastly, the proposal would also add a footnote that was
inadvertently omitted for the haircut schedule in Regulation
23.156(a)(3)(i)(B), when the Commission originally promulgated the
margin rule in 2016.
I look forward to receiving public comments on this proposal.
Appendix 3--Dissenting Statement of Commissioner Christy Goldsmith
Romero
I cannot support the proposed rule.
Seeded Funds
I am concerned that the proposed exception to initial margin
requirements for seeded funds rolls back Dodd-Frank Act reforms
designed for financial stability. I cannot support the Commission
changing our existing requirements--requirements that match U.S.
banking regulator requirements. The proposed change would relieve
initial margin requirements for uncleared swaps that are not
prudentially regulated in certain affiliate transactions known as
``seeded funds'' for three years.\1\
---------------------------------------------------------------------------
\1\ Seeded funds are investment vehicles that receive start-up
capital from a sponsor entity. Under the Commission's current
regulatory requirements, a seeded fund is treated as a margin
affiliate of a sponsor entity for the purpose of triggering the
exchange of initial margin for uncleared swaps.
---------------------------------------------------------------------------
The buildup of uncleared swap positions during the crisis
exposed swap entities to losses, putting the financial system at
risk. Dodd-Frank Act reforms required all uncleared swaps be subject
to initial and variation margin requirements, whether prudentially
regulated or not.\2\ Post Dodd-
[[Page 53429]]
Frank, the Commission and federal banking agencies adopted margin
rules to protect the safety and soundness of swap entities and to
guard against risks to financial stability.
---------------------------------------------------------------------------
\2\ 7 U.S.C. 6s(e)(2)--Registration and regulation of swap
dealers and major swap participants. Dodd Frank Act reforms provide
that:
(A) Swap dealers and major swap participants that are banks. The
prudential regulators, in consultation with the Commission and the
Securities and Exchange Commission, shall jointly adopt rules for
swap dealers and major swap participants, with respect to their
activities as a swap dealer or major swap participant, for which
there is a prudential regulator imposing--(i) capital requirements;
and (ii) both initial and variation margin requirements on all swaps
that are not cleared by a registered derivatives clearing
organizations.
(B) Swap dealers and major swap participants that are not banks.
The Commission shall adopt rules for swap dealers and major swap
participants, with respect to their activities as a swap dealer or
major swap participant, for which there is not a prudential
regulator imposing--(i) capital requirements; and (ii) both initial
and variation margin requirements on all swaps that are not cleared
by a registered derivatives clearing organization (emphasis added).
See Section 4s(e) of the Commodity Exchange Act.
---------------------------------------------------------------------------
Dodd Frank Act reforms in the Commodity Exchange Act required
that to offset the greater risk to the swap dealer or major swap
participant and the financial system arising from the use of
uncleared swaps, the Commission's margin requirements for uncleared
swaps must (i) help ensure the safety and soundness of the swap
dealer or major swap participant and (ii) be appropriate for the
risk associated with the uncleared swaps held by the swap dealer or
major swap participant.\3\
---------------------------------------------------------------------------
\3\ 7 U.S C. 6s(e)(3)(A); CEA section 4s(e)(3)(A).
---------------------------------------------------------------------------
I do not find that standard to be met in the proposed rule. Post
Dodd-Frank, regulators recognized that derivatives transactions with
affiliated parties can pose important risks that necessitate margin
requirements. The Commission and banking regulators adopted the same
definition of ``margin affiliate'' to cover both swaps that are, and
are not, prudentially regulated. The proposed rule would depart from
that definition where there is not a prudential regulator.
The proposed rule raises concerns about the prudence of the
Commission having two different definitions of ``margin affiliate''
for swap dealers, particularly when the majority of swap dealers (55
of 106) are prudentially regulated, and they account for a
substantial majority of swap activity. In a regulatory system where
jurisdiction is shared with other U.S. market and banking
regulators, it is important that the Commission maintain regulatory
harmonization with U.S. regulators where we can. Otherwise, we risk
a race to the bottom.
The proposed rule discusses the importance of harmonization with
global regulation but not U.S. banking regulations. And this
proposed rule came from recommendations by the Global Markets
Advisory Committee in 2020 (during the last Administration). The
majority of the nonbank swap dealers are U.S.-domiciled (27 of 51).
Also, importantly, the GMAC public interest representative from
Better Markets at that time did not vote for these recommendations.
I have serious concerns with potentially increasing risks
related to uncleared swaps, including risks to financial stability
by adopting a definition that harmonizes with global regulation, but
not domestic banking regulation. U.S. banking regulators are aware
of the Basel Committee on Banking Supervision and the International
Organization for Securities Commission's ``International Margin
Framework,'' but have chosen not to change their definition of
``margin affiliate.''
Likewise, I do not support the Commission changing our existing
definition. I appreciate that Commission staff have tried to put
constraints on this initial margin exception.\4\ The constraints are
not enough in my view to break from U.S. banking regulators on the
definition of margin affiliate. I am concerned that the effect of
this proposal would be to roll back Dodd-Frank Act reforms. Given
that those reforms were designed to promote the safety and soundness
of U.S. financial institutions and our financial system, I am
concerned that this change could produce unacceptable levels of
risk, possibly even systemic risk and harm to financial stability.
We do not know the full consequences of this change. While it may
save costs for these start-up funds, we cannot increase any risk to
financial stability of institutions or our financial system.
---------------------------------------------------------------------------
\4\ For example, the exception requires that the seeded fund
``is not a securitization vehicle.'' Should the Commission move
forward with this proposed rule, I have other concerns that I invite
public comment. This includes whether the proposed 3-year exception
period is too long a runway. Also, whether the exemption is meant to
apply to private funds? Private funds are part of a ``shadow banking
system'', and unlike banks, are not fully subject to risk,
liquidity, or capital restrictions. Private funds and shadow banking
contributed to the 2008 financial crisis, which has grown larger
since the crisis, and continues to pose risks to American investors,
pensioners, and the U.S. financial system.
---------------------------------------------------------------------------
Therefore, I must dissent.
Money Market Funds
I have concerns about the Commission's proposal to expand money
market funds that could be used for eligible non-cash collateral for
swap dealers for initial margin. The proposal contemplates
eliminating the restriction on the money market fund's use of
repurchase agreements or similar agreements.
In Dodd-Frank Act reforms contained in the Commodity Exchange
Act section 4s(e)(3)(C), Congress provided that ``[i]n prescribing
margin requirements,'' the Commission ``shall permit the use of
noncash collateral'' as ``determine[d] to be consistent with--
preserving the financial integrity of markets trading'' non-cleared
derivatives and ``preserving the stability of the United States
financial system.'' I have not seen an analysis that such standard
is met. I am very interested in public comment about whether that
standard is met.
We must not forget the lessons of the 2008 financial crises,
including when the Reserve Primary Fund ``broke the buck'', and the
role it had in the 2008 crisis. Money market funds are designed to
give retail customers and institutional investors a market-based
instrument that is highly liquid with lower risk and limited
volatility. For many Americans, money market funds often appear on
their bank app, right next to checking and savings accounts, as they
are financial vehicles often thought of as similar to a bank
account. That's why it came as such a shock when the Reserve Primary
Fund broke the buck.
I was counsel to the SEC Chairman when the Reserve Primary Fund
broke the buck, which contributed to Lehman failing, and short-term
lending drying up. Repurchase agreements also contributed to
liquidity problems at financial institutions. In my role as the
Special Inspector General for TARP, I reported to Congress about the
interconnectedness of these events. These experiences show how
interconnected money market funds and repurchase agreements are to
the overall stability of our financial institutions and the broader
financial system.
As a result, the SEC and other regulators implemented reforms to
make money market funds more stable and repurchase agreements more
transparent. Despite these reforms, in March 2020, during the Covid-
19 pandemic, money market funds and the short-term funding markets
experienced stress when institutional investors withdrew cash from
money market funds to avoid liquidity fees and gates, safeguards
that were part of post-crisis reforms.
With 2008 and 2020 as the backdrop, the Commission must be
careful how it approaches changes to our regulations that impact
money market funds and the short-term funding markets. These are
highly interconnected markets. Changes in one can impact changes in
the other markets. Before we take any action, it will be critical
for the Commission to determine that the change is ``consistent with
preserving the financial integrity of markets trading'' non-cleared
derivatives and ``preserving the stability of the United States
financial system.'' I look forward to public comment on whether the
rule meets this standard.
I thank the staff for their work. I am also grateful to the
former GMAC members. It must be remembered that advisory committees'
role is to advise the Commission. While I may not agree with their
recommendations, I am grateful for their service.
Appendix 4--Statement of Commissioner Caroline D. Pham
I support the notice of proposed rulemaking on margin
requirements for uncleared swaps for swap dealers and major swap
participants (Seeded Funds and MMFs Proposal) because it provides a
solution for seeded funds, and it supports greater liquidity by
providing more flexibility for money market and similar funds that
use repos, among other things. I thank the team in the Market
Participants Division for their dedication to ensuring the
Commission's uncleared swaps rules do not unduly burden market
participants, and for proposing workable solutions to challenges
that arose during an implementation period. I specifically commend
Amanda Olear, Tom Smith, Warren Gorlick, Rafael Martinez, and Liliya
Bozhanova for their work on the proposal.
This Seeded Funds and MMFs Proposal, looking at the big picture,
actually benefits
[[Page 53430]]
the end investors who will be able to more efficiently deploy
capital, access liquidity, and provide investment returns at less
cost to funds, such as pension plans that manage Americans' hard-
earned savings. The key public interest here is providing more
liquidity to markets. We have seen over the past several years many
recent market stresses, which seem to occur with greater and greater
frequency and high volatility, low liquidity market conditions.
Where there is shallow depth of liquidity, costs for end users,
customers, and investors go up, and access to markets is restricted.
When there is not enough liquidity, risks to financial stability
increase. The most significant and systemic financial crises in
recent years, including the 2008 financial crisis, were caused by a
critical lack of liquidity in markets, and our post-crisis reforms
have traded less credit risk for more liquidity risk.
Simply put, less liquidity means higher costs and more risk. And
risk to not only financial stability, but also systemic risk. In
light of ongoing capital reforms, it is incumbent upon me to remind
everyone that of course markets are interconnected, and that's why
we need to take a holistic approach to market structure with a full
understanding of the impact of various regulatory regimes,
particularly the impact of prudential requirements on the ability of
markets to function well, and especially the ability for market
participants to access markets for the benefit of American savers.
As an advocate for good policy that enables growth, progress,
and access to markets, I strongly support workable solutions to any
problems with our rules. While regulations play a critical role in
safeguarding our markets, we must acknowledge that issues--ranging
from technical \1\ to policy--must be continuously evaluated for
regulations to remain both effective and relevant in an ever-
changing landscape.
---------------------------------------------------------------------------
\1\ Statement of Commissioner Caroline D. Pham on Staff Letter
Regarding ADM Investor Services, Inc., U.S. Commodity Futures
Trading Commission (June 16, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement061623.
---------------------------------------------------------------------------
The first step in evaluating our regulations is to conduct
thorough assessments and identify areas for improvement.
Collaboration and open dialogue are key to formulating well-rounded
solutions that consider the interests of all impacted. That is why I
am grateful for the efforts of former Commissioner Dawn Stump, who,
as sponsor of the Global Markets Advisory Committee (GMAC),
established the GMAC's Subcommittee on Margin Requirements for Non-
Cleared Swaps to evaluate the CFTC's uncleared margin rules.\2\ The
subcommittee's thorough assessment, engagement with stakeholders,
and practical, flexible recommendations have given staff a
comprehensive roadmap to follow in implementing fixes that minimize
adverse impacts on market participants. I appreciate that staff is
continuing \3\ to try to adopt the recommendations that came out of
the GMAC subcommittee.
---------------------------------------------------------------------------
\2\ CFTC Commissioner Stump Announces New GMAC Subcommittee on
Margin Requirements for Non-Cleared Swaps, U.S. Commodity Futures
Trading Commission (Oct. 28, 2019), https://www.cftc.gov/PressRoom/PressReleases/8064-19.
\3\ In 2020, the Commission adopted rules that addressed
different GMAC recommendations on the uncleared margin rules. See
Statement of Commissioner Dawn D. Stump in Support of Final
Uncleared Margin Rules Based on Recommendations of Global Markets
Advisory Committee, U.S. Commodity Futures Trading Commission (Dec.
8, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement120820. Commissioner Mersinger has advocated for
adopting additional recommendations. See Dissenting Statement of
Commissioner Summer K. Mersinger Regarding CFTC's Regulatory Agenda,
U.S. Commodity Futures Trading Commission (Jan. 9, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/mersingerstatement010923.
Commissioner Pham now sponsors the GMAC. See Commissioner Pham
Announces CFTC Global Markets Advisory Committee Meeting on July 17,
U.S. Commodity Futures Trading Commission (July 17, 2023), https://www.cftc.gov/PressRoom/Events/opaeventgmac071723.
---------------------------------------------------------------------------
The adoption of margin requirements for uncleared swaps was a
key pillar of the 2008 financial crisis reform.\4\ Today, we
continue to appreciate that the requirements help ensure the
exchange of margin between large, systemic, and interconnected
financial institutions for their uncleared swap transactions.
---------------------------------------------------------------------------
\4\ G20 Pittsburgh Summit (Sept. 24-25, 2009).
---------------------------------------------------------------------------
Consistent with the G20 commitments, the Commodity Exchange Act
(CEA or Act) \5\ requires that the Commission adopt rules
establishing margin requirements for all uncleared swaps that are
entered into by a swap dealer or major swap participant for which
there is no prudential regulator. These requirements help ensure the
safety and soundness of the swap dealer or major swap participant.
In 2016, the Commission adopted Regulations 23.150 through 23.161 to
implement section 4s(e).\6\
---------------------------------------------------------------------------
\5\ 7 U.S.C. 6s(e) (capital and margin requirements).
\6\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016) (effective
April 1, 2016 and codified in part 23 of the Commission's
regulations). 17 CFR 23.150--23.159, and 23.161. In May 2016, the
Commission added Regulation 23.160 (17 CFR 23.160), providing rules
on its cross-border application. See Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants--Cross-
Border Application of the Margin Requirements, 81 FR 34818 (May 31,
2016).
---------------------------------------------------------------------------
Currently, a fund with material swaps exposure will fall within
the scope of the initial margin requirements if it undertakes an
uncleared swap with a covered swap entity. The covered swap entity
and the fund will not be required to post and collect initial margin
for their uncleared swaps until the initial margin threshold amount
of $50 million has been exceeded. The initial margin threshold
amount will be calculated based on the credit exposure from
uncleared swaps between the covered swap entity and its margin
affiliates on the one hand, and the fund and its margin affiliates
on the other.\7\ As discussed above, this requirement has unduly
burdened certain funds.
---------------------------------------------------------------------------
\7\ Commission Regulation 23.151 defines the term ``IM threshold
amount'' to mean an aggregate credit exposure of $50 million
resulting from all uncleared swaps between an SD and its margin
affiliates (or an MSP and its margin affiliates) on the one hand,
and the SD's (or MSP's) counterparty and its margin affiliates on
the other. See 17 CFR 23.151.
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Initial margin requirements may be satisfied with only certain
types of collateral.\8\ Under Regulation 23.156(a)(1)(ix), the
securities of money market and similar funds \9\ may qualify as
eligible collateral if the investments of the fund are limited to
securities that are issued by, or unconditionally guaranteed as to
the timely payment of principal and interest by, the U.S. Department
of Treasury, and immediately-available cash denominated in U.S.
dollars; \10\ or to securities denominated in a common currency and
issued by, or fully guaranteed as to the payment of principal and
interest by, the European Central Bank, or a sovereign entity that
is assigned no higher than a 20 percent risk weight under the
capital rules applicable to swap dealers subject to regulation by a
prudential regulator, and immediately-available cash denominated in
the same currency.\11\ Also, the asset managers of the money market
and similar fund may not transfer the assets of the fund through
securities lending, securities borrowing, repurchase agreements, or
any other means that involve the fund having rights to acquire the
same or similar assets from the transferee.\12\ As discussed above,
this requirement has unintentionally restricted funds.
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\8\ Commission Regulation 23.156(a)(1) sets forth the types of
collateral that CSEs can post or collect as IM with covered
counterparties, including cash funds, certain securities issued by
the U.S. government or other sovereign entities, certain publicly
traded debt or equity securities, securities issued by money market
and similar funds, and gold. 17 CFR 23.156(a)(1).
\9\ Although the scope of the eligible pooled investment funds
described in Commission Regulation 23.156(a)(1)(ix) does not fully
coincide with the regulatory definition of money market funds in
Rule 2a-7 under the Investment Company Act (17 CFR 270.2a-7), for
simplicity purposes, these funds will be referred to as ``money
market and similar funds.''
\10\ 17 CFR 23.156(a)(1)(ix)(A).
\11\ 17 CFR 23.156(a)(1)(ix)(B).
\12\ 17 CFR 23.156(a)(1)(ix)(C).
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Of course, compliance with significant reforms necessarily
entails significant resource expenditure by regulated entities.
Because of the vast number of counterparties impacted by the
uncleared margin rules, swap dealers and major swap participants
have been forced to engage in significant operational and
technological development to avoid disruptions which would limit
their options for taking on and hedging risk.\13\ As I have stated
in the past, it is imperative that the Commission continuously--or
at least periodically--evaluate its rules to ensure they are
functioning as intended, and propose workable solutions to any
challenges discovered to ensure that firms are able to effectively
comply with our rules.\14\
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\13\ Joint ISDA-SIFMA Report, Initial Margin for Non-Centrally
Cleared Derivatives: Issues for 2019 and 2020, 3-4 (July 2018),
https://www.isda.org/a/D6fEE/ISDA-SIFMA-Initial-Margin-Phase-in-White-Paper-July-2018.pdf.
\14\ See, e.g., Statement of Commissioner Caroline D. Pham
Regarding Reporting and Information Requirements for Derivatives
Clearing Organizations, U.S. Commodity Futures Trading Commission
(Nov. 10, 2022), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement111022b.
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[[Page 53431]]
I encourage commenters to comment on whether the Commission's
proposal sufficiently addresses the practical and operational
issues, and whether it gives sufficient time for firms to implement
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and comply with a final rule.
[FR Doc. 2023-16572 Filed 8-7-23; 8:45 am]
BILLING CODE 6351-01-P